Mauritius-based PEs on taxman's radar, at least 7 get notices

The Indian tax office has asked several Mauritius-based private equity (PE) funds to share their minutes of board meetings, deal agreements, residency and addresses of directors, and names of ultimate beneficiaries amid suspicions that unnamed persons call the shots in these funds while the boards and managements of the tax haven entities merely serve as dummies.

If the income tax (I-T) department has good reasons to believe that a fund’s ‘place of effective management’ (or POEM in tax parlance) is somewhere else-where the key decision makers are located -and not Mauritius, many funds could find themselves exposed to large tax demands.

At least seven PE funds have received notices from the international division of the Mumbai I-T office over the past two months, two sources told ET. The tax department wants to know the tax residencies of the real faces behind the Mauritius asset managers and fund investors. “Men who are controlling the funds may be in the US or even in India, while the directors in the Mauritius vehicle could just be the fronts. In that case, can these investment vehicles in Mauritius claim tax benefit under the India-Mauritius treaty?,” one of them asked.

Change in Provision after April 1, 2017

Till 2017, investors from Mauritius paid no capital gains tax on securities sold in India since under the treaty capital gains could be taxed only in Mauritius and the latter imposed no tax. Under the revised India-Mauritius tax protocol which changed this, April 1, 2017 was fixed as the cut-off date to introduce a grandfathering provision. According to this, all shares bought prior to this date, would not attract capital gains tax irrespective of when these securities are sold in future.

Funds that have come under the taxman’s lens avoided capital gains tax on the grounds that shares were acquired before April 1, 2017. But that’s not enough, according to tax assessing officers who suspect that the POEM of these investors is not Mauritius. For instance, if persons actually in control of a PE are US residents, then the PE may be asked to pay capital gains tax as the tax is not exempted under the treaty between India and USA. Or, if the men pulling the strings are based out of India, the PE could be treated as a ‘resident’ entity and be asked to pay the tax a local investor forks out after booking profits on stocks.

A company is treated as a ‘resident’ in India if it’s an Indian company or its place of effective management (POEM) is in India. POEM, as per the tax law, means a “place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made (sic)” The rule, which was changed five years ago, gave more latitude to tax officers. Till then, to treat a company as a ‘resident’, tax officers had to prove that “the control and management of its affairs is situated wholly in India”-which was difficult to establish.

Senior tax professionals are closely tracking the developments. “The department has questioned the substance of the holding of private equity entities based in Mauritius that have invested in India. The line of questioning suggests that the tax department wants to ascertain the POEM of these funds that are investing in India and this could result in huge tax liability for many funds,” felt Girish Vanvari, founder of advisory firm Transaction Square.

The information sought includes details of the holding company above the special purpose vehicle in Mauritius, the parent of the holding firm, and the ultimate parent; details of bank accounts of the PE entity and authorised signatory of the bank accounts together with their personal details and designations since the company was founded; copies of minutes of meetings where a resolution to acquire (or sell) shares was initiated and eventually passed; copies of valuation reports and details of source of funds for the transaction. According to a person who did not want to be named, the department is trying to fish out the names of people who have the final say, enjoy veto powers, and also whether funds were borrowed from entities or persons linked to India.

“If a fund is deemed a resident of India under POEM guidelines then the tax rate on dividend income could go up to 40% plus surcharge from 5-15% currently under most treaties. Long term capital gains tax could increase to 20% from 10%. Not just that but even income from investments made in other countries through these Mauritius entities could be taxed in India though the final determination could depend on the tie breaker rules prevalent under certain treaties,” said Rajesh H Gandhi, partner, Deloitte India. A ‘tie breaker’ is a tax regulation used to resolve impasse between countries in deciding who has the first right to impose tax.