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No Free Ride for Quasi Equity in Mauritius Pact

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WATCH OUT Agreement doesn't explicitly cover convertible instruments, but if converted after April 1, 2017, these may stand to lose tax benefit
There will be no free ride for those wanting to invest in India through quasi equity investments such as convertible debentures via Mauritius under the recently amended treaty between the two countries, officials said. Those holding such instruments would do well to convert them into shares before April 1, 2017, to enjoy the exemption on capital gains tax, or grandfathering, that's available until then.
“The date of acquisition will be the date on which an entity or individual comes to own shares and not the date on which investment in the instrument was carried out,“ said a finance ministry official. Tax experts said this interpretation will have an adverse impact on PE firms. Stating that private equity firms commonly use convertible instruments for greater flexibility on returns and control, tax experts called for a formal circular to clarify the position. There has been some confusion over whether entities making an investment in such instruments before April 1, 2017, can enjoy grandfathering with the full capital gains tax exemption benefit even after the amended India-Mauritius Double Taxation Avoidance Convention comes into effect.
According to the changes in the tax treaty announced on May 10, India gets taxation rights on capital gains arising from alienation of shares acquired on or after April 1, 2017, in a company resident in India with effect from FY18.
In respect of capital gains arising during the transition period between April 1, 2017, and March 31, 2019, the tax rate will be limited to 50% of the domestic tax rate of India, subject to fulfillment of conditions in the Limitation of Benefits clause.
After April 1, 2019, tax will be levied at par with that for domestic investors. A substantial part of the investment from Mauritius, particularly in the unlisted space, is structured in the form of convertible instruments that offer assured returns to investors and are turned into equity at a later date. This is essentially driven by the overall corporate strategy to keep debt on the books of Indian entities for appropriate transfer of voting rights through conversion into shares later. Tax experts said moving the conversion date to beat the deadline may not be easy .
“Investors will have to consider advancing the date of conversion and ensure that conversion into shares happens before April 1, 2017, so that they can benefit from the grandfathering provision,“ said Rajesh Gandhi, partner, Deloitte, Haskins & Sells.This is not easy to achieve and could require renegotiation of the investment terms with the promoters where the investor is a third party , he said. The government should make the position clear on convertible securities converted into shares after March 31, 2017, through a circular or a press release, said Sanjay Sanghvi, partner, Khaitan & Co. “From a plain reading of the protocol, it seems that shares acquiredreceived on or after April 1, 2017, pursuant to conversion of a convertible instrument like CCD (compulsorily convertible debentures) will attract tax and grandfathering will not apply.“
The Economic Times New Delhi,16th May 2016

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