The amendment of the double taxation avoidance treaty with Mauritius is expected to trigger some short-term volatility in the markets on Wednesday, but the long-term impact is expected to be minimal.
Foreign portfolio investors are the largest class of investors in the Indian stock market, and control around a fifth of the shares. And India has received the most portfolio funds from Mauritius.
To that extent, market sentiment may be impacted in the short term, but since many foreign investors have already started routing their investments through Singapore and the US, that effect is expected to wear off.
The amendment incorporates a Limitation of Benefit (LoB) clause, which ensures that shell companies can no longer misuse the Double Tax Avoidance Agreement between India and Mauritius.
Companies will now have to prove that they have spent at least ₹27 lakh ($40,500) in Mauritius to get DTAA benefits.
Else, they will have to pay capital gains tax on investments made from April 1, 2017. The CGT rate will be 50 per cent of the domestic rate up to March 31, 2019, and the full rate thereafter.
India already has such LoB clauses in DTAAs signed with Singapore and the US. The double taxation avoidance treaty with Singapore states that a company will not be treated as a shell company if its annual expenditure on operations in the contracting state is at least 200,000 Singapore dollars or if it is listed on the Singapore stock exchange.
In the recent past, more foreign portfolio money has been coming in from the US and Singapore than from Mauritius.
While investors from Mauritius accounted for 28 per cent of FPI assets in February 2012, their share was down to 20 per cent in February 2016. Foreign investors have evidently been anticipating this amendment for some time now.