India-focused ETFs warn about India-Mauritius DTAA impact

Foreign funds have expressed worry about the renegotiated Double Tax Avoidance Agreement between India and Mauritius (DTAA), saying it can impact returns.

The $1-billion iShares India 50 ETF, like many funds, used to depend on the DTAA between India and Mauritius. Most other ETFs which invest in Indian securities currently do so through a subsidiary established in the Republic of Mauritius so as to take advantage of a tax treaty between India and Mauritius. The iShares India 50 ETF fund operates, in part, through a subsidiary, which in turn invests in securities of Indian issuers. The renegotiated DTAA between India and Mauritius has made life a tad difficult now.

"The fund and the subsidiary rely on the Double Tax Avoidance Agreement between India and Mauritius for relief from certain Indian taxes. The DTAA has recently been renegotiated and as such, treaty relief may be reduced or not available on investments from April 1, 2017, which may result in higher taxes and/or lower returns for the fund," a filing by iShares India 50 ETF said, specifying the tax risk.

From April 1, 2017, the fund may continue to invest in the subsidiary until an alternative method for investing the securities of Indian issuers is selected, said the iShares India 50 ETF filing. Without a more tax-efficient alternative method, returns may be affected.

The Double Taxation Avoidance Agreement between India and Mauritius was recently re-negotiated by way of a protocol (2016 Protocol). "The 2016 Protocol in its applicability to the fund or the WisdomTree subsidiary, or in the requirements established by Mauritius to qualify as a Mauritius resident, could result in the imposition of various taxes on the WisdomTree subsidiary or the fund by India, which could reduce the return to the Fund on its investments," said a filing by WisdomTree India Earnings Fund, which has assets of over $1.6 billion.

The Guggenheim S&P BSE MidCap Select India ETF has a similar predicament.

From April 1, 2017 through March 31, 2019, capital gains on sales of Indian securities that have been held for 12 months or less that are made through Mauritius subsidiaries may be subject to a tax rate of only 50% of the rate that would otherwise be applicable (which is generally 15%), subject to certain eligibility criteria.

"The fund has not established a subsidiary in Mauritius and therefore would be subject to the full tax rate on such short-term capital gains, even while certain other ETFs which invest in Indian securities through Mauritius subsidiaries may be eligible for the lower effective tax rate. This may adversely affect the after-tax return of the fund as compared to those of other ETFs which invest in Indian securities," the Guggenheim fund filing pointed out.

Numerous investors have relied on the benefits of the DTAA to invest in India through Mauritius in the past. Under the earlier bilateral pact between India and Mauritius, capital gains from the sale of securities were taxable only in Mauritius, where the levy is close to zero.

However, in the last 10-15 years, a number of parties have challenged the DTAA or the interpretation of the DTAA. In addition, both the Indian tax administration and Indian courts have been taking aggressive efforts to challenge structures involving offshore funds investing directly or indirectly in India, in particular, those from Mauritius. Ultimately, the renegotiated pact starting with FY18 virtually shut the door on investors using Mauritius to avoid paying taxes in India.

...& ANALYSIS

• The DTAA was recently re-negotiated
   
• From April 1, 2017, iShares may continue to invest in the subsidiary
   
• Its subsidiary has assets of over $1.6 billion