By ELLEN SHENG
HONG KONG—In a move that could have wide-ranging impact on foreign investment into India, Indian lawmakers are preparing to introduce a new tax code next year that could change Mauritius’s status as a tax haven for foreign funds investing in India.
The proposals are part of efforts by Indian regulators to raise more tax revenue from the financial-services sector. The proposals, which are currently in a comment period, cover a wide variety of measures including a draft bill to override the tax treaty with Mauritius.
That bill would have a significant impact on investments coming into India as currently 80% to 90% of foreign investment into the country flows through Mauritius, a small tropical island off the coast of Africa.
“In its current form [the tax proposals are] onerous and can impact foreign investment into India,” said Akil Hirani, managing partner at Majmudar & Co. in Mumbai. “However, because the Indian economy is on an upswing, investors may, nevertheless, [continue to] enter India,” he added.
Many private-equity, hedge funds and mutual funds that invest in India through Mauritius stand to be affected, such as Airisaig Partners and Kotak Mahindra Asset Management.
Brevan Howard Asset Management LLP, Europe’s largest hedge-fund manager, last year set up two funds in Mauritius to hold Indian investments for its flagship Brevan Howard Master Fund.
Regulators “see so much Indian investment coming through foreign institutional investors and private equity, all through Mauritius … and see it as a revenue loss. They want to try to capture that on some level,” said Roshan Thomas at Lexygen, an Indian law firm.
According to Eurekahedge, some 42% of India-investing funds are currently domiciled in Mauritius, while 27% of funds are domiciled in the Cayman Islands.
Industry insiders say funds already domiciled in Mauritius aren’t fleeing but have been examining alternatives, such as Cayman or Singapore, while some start-up funds are looking at other locales.
“Funds are still in a watch-and-wait game. For a few years now, the Indian government has been rattling sabers and raising questions about why this should be going on,” Mr. Thomas said. “But there’s been a fair amount of pushback from the Mauritius government.”
Industry watchers say various Mauritian ministers and the prime minister have been visiting India regularly, but that Indian officials are on a mission to raise revenue. Mauritian government officials declined to comment on the tax treaty with India.
Under the current double taxation treaty, capital gains on Indian shares that are held by a Mauritian company aren’t subject to Indian tax. Mauritian companies are simply taxed according to Mauritius tax laws, which are extremely favorable.
Hoping to raise some revenue, Indian lawmakers have introduced new provisions that have caused an uproar among the foreign investment community.
One is a draft bill that could override current tax treaties that exclude investment firms from paying a capital-gains tax. Another is a proposed flat tax rate of 30% on capital gains.
“We are trying to inform clients that there is this whole dialogue going on and that changes are likely,” Mr. Hirani said.
He sees a 50% chance that the tax treaty with Mauritius will be changed next year. Indian authorities want to bring some revenue in, he said, and it is likely the new direct tax code next year will have a treaty override, meaning tax treaties will need to be renegotiated.
If that happens, Indian authorities would likely introduce a 10% to 15% capital-gains tax on funds domiciled in Mauritius—putting it in line with other jurisdictions, Mr. Hirani said.
The introduced provisions are currently in a comment period.
The move to change Mauritius’ tax treaty with India come as governments around the world look for ways to raise money to pay for stimulus moves during the global economic slump.
Hedge funds, in particular, have been facing scrutiny as the sector was widely blamed for pushing stock markets lower as the global financial crisis deepened.
In India, the proposed tax changes are also a sign of the government’s desire to exert greater control on offshore money flowing into the country. Regulators have made moves limiting the use of promissory notes in order to increase market transparency.