Till 31 March 2017, both the India–Singapore DTAA and India–Mauritius DTAA followed a residence based taxation model for capital gains arising from the sale of shares. This made Singapore and Mauritius highly preferred investment routes for foreign investors investing into India.
Pre-Amendment to DTAA
Under the earlier regime, if a tax resident of Singapore or Mauritius sold shares of an Indian company, the capital gains were not taxable in India.
Although a Limitation of Benefits (LOB) clause existed, its scope was extremely limited. The clause applied only to Article 1 of the Protocol, covering assets other than those specified under Articles 13(1) to 13(3) of the main DTAA. Since shares were covered under Article 13, the LOB clause did not practically restrict share sale transactions.
Post-Amendment to DTAA
In 2017, the Governments of both countries further amended few provisions by way of Protocol. The amendments are:
(i) Taxation of Capital Gains on shares – Shift of residence based taxation to source based taxation. Consequently, capital gains arising on or after April 1, 2017 from alienation of shares of a company shall be subject to tax in the country of source for the company (i.e. COS). The aforementioned change is subject to the following qualifications:
(ii) Shares acquired prior to 1 April 2017 are grandfathered and gains on sale of these shares are taxable only in COR.
(iii) A sunset clause for investments acquired between 1 April 2017 to 31 March 2019. The tax on gains so arrived on alienation of these shares would be restricted at 50% of the existing tax rates as per the domestic tax laws.
(iv) However, the benefits above in (ii) and (iii) will be applicable subject to the revised Limitation of Benefit (LOB) clause as per Article 24A (India–Singapore DTAA) / Article 27A (India–Mauritius DTAA).
Revised LOB Clause – India–Singapore DTAA
As per the revised Article 24A of the India–Singapore DTAA, a Singapore tax resident would not be entitled to the Capital Gains tax benefit if:
- Its affairs are arranged with the primary purpose of taking advantage of the benefits provided under the Singapore Treaty.
“Affairs” has not been defined. Generally, it can be considered as transactions and arrangements of the person. Thus, if a UK resident forms a company in Singapore with the purpose of taking advantage of Capital Gain exemption, the benefit may be denied (Affairs Test).
(b) It is a shell / conduit company. This is an independent test, not related to the first test of Affairs.
A shell/conduit company is defined to mean any legal entity falling within the definition of resident with negligible or nil business operations or with no real and continuous business activities carried out in Singapore.
The LOB clause provides that in order for a Singapore entity not to be deemed as a shell/conduit company (thereby making such entity eligible to claim the Capital Gains tax benefit), such entity would have to either:
(a) be listed on a recognized stock exchange in Singapore, or
(b) incur total annual expenditure of SGD 200,000 on operations in Singapore in the 12 months (earlier, 24 months) immediately preceding the date on which the gains arise (Expenditure Test).
This is in line with the earlier LOB except that earlier LOB clause under the 2005 Protocol required expenditure of SGD 200,000 on operations in Singapore in the 24 months immediately preceding the alienation of shares instead of 12 months.
This test applies to any legal entity and not just a company.
Interpretation Issues and Practical Challenges:
What is the meaning of operations in Singapore has not been explained. One has to consider a normal meaning. If the company spends on office rent, salaries and other costs in Singapore, it will be clearly expenses for Singapore operations.
The expenditure has to be incurred over a period of 12 months immediately preceding the month in which the capital gain arises. Thus, the period is not a financial year, but a block of 12 months “immediately preceding” the date of Capital Gains.
For example, if the capital gain is earned on 15th October 2018, the block of 12 months has to be considered as 15th October 2017 till 14th October 2018.
It is debatable if new companies, which have not completed at least 12 months of operations, will be eligible for relief.
It is a general understanding that if the Singapore company incurs expenditure of SGD 2,00,000 on operations in Singapore, then the DTAA should apply. However, is that sufficient?
As discussed earlier, clause (1) provides for the test based on affairs of the person. The explanation at the end of Article 3 of the Protocol provides that the case of entities not having bona fide business shall be covered by Article 3.1. Thus, the company may not be a shell company if it satisfies the tests laid down in clauses (2) to (4) of Article 1. Still, it could be considered as a company whose affairs are arranged to take advantage of the Capital Gain tax relief.
One may argue that it is necessary to split the LOB tests minutely. The interpretation of the DTAA should be broader and not technical. That, however, is for the courts to decide.
Enabling Language for GAAR:
Explicit language allows treaty provisions to be overridden by domestic anti avoidance measures such as the General Anti Avoidance Rule (GAAR), which came into effect from April 1, 2017.
The 2017 Protocol has inserted Article 28A to the Singapore Treaty which reads:
“This Agreement shall not prevent a Contracting State from applying its domestic law and measures concerning the prevention of tax avoidance or tax evasion”
The language of the newly inserted Article 28A makes it clear that the Indian government seeks to apply GAAR even to situations where a specific anti avoidance provision (such as an LOB clause) may already exist in a tax treaty.
Under the GAAR, tax authorities may exercise wide powers (including denial of treaty benefits) if the main purpose of an arrangement is to obtain a tax benefit and if the arrangement satisfies one or more of the following:
(a) non-arm's length dealings;
(b) misuse or abuse of the provisions of the domestic income tax provisions;
(c) lack of commercial substance; and
(d) arrangement similar to that employed for non-bonafide purposes.