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FIIs' tryst with tax waiver getting done?
April, 30th 2007

Last week, an accounting firm forewarned its FII clients in Cyprus about the chances of losing capital gains tax exemption on the sale of Indian equities in future.

The ground: India is in the advanced stages of renegotiating the double taxation avoidance agreement (DTAA) with Cyprus and is set to propose taxing capital gains on sale of shares. This means that residents and FIIs routing their investments from Cyprus may have to pay a 10% short-term capital gains tax.

The advisory triggered a chain reaction from other firms. Should Cyprus-based FIIs start rerouting their investments from alternate destinations? Mauritius may not be a bad bet, at least in the near term. Revenue authorities apprehend that informal inputs to FIIs could jeopardise the negotiation process.

That India is renegotiating tax treaties with Mauritius and a host of other low-tax jurisdictions such as Cyprus is an open secret. The government has also said that it would adhere to the model DTAA drafted a couple of years ago while renegotiating treaties, or entering into new ones. The model DTAA has safeguards to check misuse.

The reality is that India no longer needs the crutches of tax breaks to draw foreign investment; its booming growth story is enough of a draw. This naturally strengthens Indias negotiating position in all these tax treaties. One of the most talked about treaties in the recent past has been the revised DTAA with the UAE.

The treaty has not been notified yet. But indications are that the revised treaty is set to incorporate amendments in the provisions relating to the tax treatment of capital gains from sale of shares. This will enable India to get a share of the revenues generated here.

The UAE does not impose any local taxes. Under the existing treaty, a UAE resident who sells Indian shares does not pay capital gains tax here. This is set to change with the introduction of the principle of source-based taxation of capital gains in the revised treaty.

By virtue of this provision, India will have the right to tax capital gains accruing to UAE residents, or companies investing directly in Indian shares. There have also been changes in the definition of a resident. In India, short-term capital gains from the sale of listed securities are taxed at 10% while long-term capital gains are tax free. The tax rate is higher on capital gains from the sale of unlisted securities.

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