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New Singapore treaty harsher than GAAR, may impact FPI flows into India

Investors based out of Singapore continue to avail several tax benefits for putting money in India.

, ET Bureau|
Last Updated: Jan 22, 2020, 08.02 AM IST
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The MLI comes with the so-called ‘Principal Purpose Test’ (PPT) which will be used by tax authorities to determine if an investor has set up shop in Singapore for tax avoidance purposes or not.
Singapore might lose some of its allure for various foreign portfolio investors as a preferred destination to route their investments into India. With the Multi-Lateral Agreement (MLI) between the two countries set to come into force from April 1, fund managers in Singapore, who invest in India, could face a stiffer task of convincing local tax authorities that they have not set up shop in the island nation to avail the tax benefits.

Investors based out of Singapore continue to avail several tax benefits for putting money in India. These include exemption from capital gains tax on derivatives and lower capital gains tax rate for equities. But, these exemptions will be applicable only if the Indian taxman are convinced that they are not in Singapore to avoid taxes. While the government has already implemented the General Anti-Avoidance Rules (GAAR) to curb tax avoidance, MLI comes with much stricter provisions and is believed to override GAAR, say experts. GAAR, implemented in 2017, requires foreign investors to prove that they are in a jurisdiction not just to take advantage of the tax treaty.

The Indian and Singapore governments ratified the Multi-Lateral Agreement in December 2019 and its provisions come into force from April 1, 2020. MLI, an international tax law under the umbrella of Organization for Economic Cooperation and Development (OECD), comes with strict tax antiavoidance rules. As per the MLI, an entity can be declined treaty tax benefits if one of the reasons for choosing a jurisdiction is tax benefit.

Tax snip 1

The move could impact most of the mid and small sized funds that have created investing entities out of Singapore but don’t have any business or commercial interest in Singapore. Singapore is the fourthlargest source of FPI inflows with assets under management worth Rs 3.15 lakh crore.

The MLI comes with the so-called ‘Principal Purpose Test’ (PPT) which will be used by tax authorities to determine if an investor has set up shop in Singapore for tax avoidance purposes or not. As per the PPT, even if tax is amongst one of the key reasons for an entity to choose Singapore, then such an entity can be declined tax treaty benefits. GAAR, on the other hand, provides for much liberal interpretation in terms of tax avoidance since it can be invoked only if tax avoidance is the prime purpose for an entity to choose a jurisdiction.

“While both the Indian GAAR and PPT (of MLI) seek to prevent tax abuse, the scope of PPT is much stricter,” said Rajesh Gandhi, partner, Deloitte. “As per the PPT, tax abuse can be triggered even if one of the main or principle purposes of a transaction is tax avoidance. However, GAAR can used only if the main purpose of an arrangement is tax avoidance and also the arrangement does not have commercial substance.”

For instance, an FPI ‘X’ chose to set up an intermediary entity in Singapore that invests in India. The main reasons behind X choosing Singapore include availability of efficient manpower, good infrastructure and favorable tax agreement with India. In this scenario, if GAAR was the guiding law then the arrangement adopted by X may not be considered for tax avoidance since tax is not the only reason for choosing Singapore. However, under MLI, this arrangement could be termed for tax avoidance since tax is one of the reasons. The tax authorities will have the power to interpret if an entity has fulfilled conditions of MLI or not.

“The provisions of MLI in relation to India-Singapore tax treaty seem to be more stringent in comparison to GAAR provisions,” said Amit Singhania, partner, Shardul Amarchand Mangaldas. “GAAR provisions get invoked if the main purpose is to obtain a tax benefit and one of the four prescribed conditions gets satisfied. However under MLI, PPT is the solitary requirement to negate the treaty benefit.”

OECD had proposed the introduction of MLIs in order to curb tax avoidance, especially amongst multi-national companies (MNCs) who explore the gaps in the tax laws among different countries. Currently, 87countries including Australia, France, Japan and the United Kingdom are signatories to the initiative.

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