Legal Briefing

Revisiting the tax contours of offshore private wealth management for the Indian wealthy

The In-House Lawyer Logo

India | 01 March 2012

India’s success story is discernible as new millionaires are being added to 
the number every day, some within a few years of creating their initial fortunes. According to the World Wealth Report compiled by Capgemini and Merrill Lynch, India’s high-net-worth individuals (HNI)1population entered the top 12 in the world for the first time in 2010. In 2011, India had the most number of billionaires after the United States and China. Kotak Wealth Management and rating agency CRISIL project India as having 219,000 ultra-high-net-worth Individuals (UHNI)2 by 2016.

Unique to the country’s wealth report, is the role of its diaspora. Needless to say, the wealth industry can no longer afford to ignore Indian HNIs and their investment trends, more particularly the regional allocation of India’s private wealth. As expected, the 2011 Asia-Pacific Wealth Report compiled by Capgemini and Merrill Lynch put the home-region allocation of investment by Indian HNIs at 83%. But, the tone for the future is pitched towards a more geographically diversified portfolio as Indian businesses go outbound, calling for offshore wealth management.

Offshore wealth management is also underpinned by tax considerations. Double taxation avoidance agreements (DTAA), which aim at avoiding double taxation of income in the hands of individuals as well as companies, provide significant insight into such tax considerations. India has an impressive network of comprehensive tax treaties spanning nearly 79 sovereign nations, including almost all of the world’s offshore financial centres. A significant advantage of incorporating offshore companies is the legal protection of the assets against debtors or any kind of litigation. To elaborate, the key drivers for individuals and corporations to use offshore planning and offshore companies include the desire to:

  • reduce tax;
  • protect assets;
  • manage risk;
  • maintain privacy;
  • avoid bureaucracy;
  • reduce costs; and
  • enhance assets.

Although negotiated by the Indian government to facilitate inbound investments, wealthy individuals are among the beneficiaries of the tax treaties with certain jurisdictions that offer a better regulatory environment for asset protection and tax planning. Of these, the equatorial nations of Mauritius and Singapore often compete to route investments into India.

One of the key reasons for preferring Mauritius has been the beneficial 
India-Mauritius Tax Treaty, signed by the countries in 1983. The treaty exempts gains derived by Mauritius residents on disposals of assets in India, with some exceptions, from Indian taxation. A resident of a state was defined to mean ‘any person who under the laws that state is liable to taxation therein’. Mauritius enables a corporate entity to be resident by registration, and although they are thereby liable to taxation, it does not levy tax on offshore gains.

In a circular dated 30 March 1994, the Central Board of Direct Taxes (CBDT), the apex direct tax body of the Indian government, confirmed that capital gains of a resident of Mauritius on disposal of shares of an Indian company would be taxable only in Mauritius, and a flood of foreign institutional investors made investments through the person of a Mauritius company. Faced by the end of the decade with perceived cases of treaty shopping, Indian tax inspectors issued notices requiring Mauritius companies to show why they should not be regarded as Indian resident. A flight of capital began or was threatened, and in April 2000, the Indian government issued a further circular to the effect that wherever a Certificate of Residence is issued by the Mauritian authorities, it 
would constitute sufficient evidence for accepting residence.

Ever since, as much as Mauritius has been the preferred base for the Indian wealthy to route investments into India, Mauritius’s tax treaty with India has been an equally prominent subject of tax debate and litigation in the country. More recently, the heightened scrutiny for cases of round tripping and incessant talks of renegotiation of the tax treaty has cast doubts on the Mauritian advantage.

On the other hand, Singapore has become a beneficiary of the controversies surrounding Mauritius. It is estimated that there are over 4,000 Indian origin companies in Singapore. Indian commerce and trade observers see the number of Indian companies in Singapore increasing to 6,000 over the next two to three years.

Strategically located, Singapore has the reputation as an attractive financial centre and is an outstanding locale for offshore funds, while still being compliant with the international exchange for information norms. The Singapore government also provides numerous incentives to help foreign companies with their start-ups. The political and economic stability of the country is an added attraction and offers security to investors.

On 29 June 2005, India and Singapore 
signed the Comprehensive Economic 
Co-operation Treaty effective 1 August 2005 as a strategic compact between the two countries to enhance bilateral trade. The key provisions of the treaty include capital gains, which are taxable only in the country of residence of the seller, subject to certain conditions relating to proof of commercial substance.

As regards exchange for information, in 2011 India and Singapore signed a protocol to amend the said tax treaty. According to the protocol, the scope of the ‘exchange of information’ clause under the treaty has been widened to include a request in all tax matters for the administration and enforcement of domestic tax law without regard to a domestic tax interest requirement or 
bank secrecy for tax purposes.

In addition to an understanding of tax treaties and the reputation of the offshore jurisdiction, it is policy shift in India’s domestic tax law that must concern wealth managers. The Indian Revenue Services’ current crusade against perceived cases 
of tax avoidance has made it difficult for Indian corporations to move money offshore to minimise Indian taxation.

More importantly, the Supreme Court’s recent seminal decision in the case of Vodafone International Holdings BV v Union of India [2012], while upholding the legitimacy of genuine foreign direct investment structures has cast shadows on circuitous tax planning structures. The Honourable Supreme Court has observed that circular structures and round tripping may prove an adequate case for lifting of the corporate veil and re-characterisation of transactions to ascertain the economic substance thereof, while determining Indian income tax liabilities. In addition thereto, Radhaksrishnan J’s concurring judgment in the said case proceeds to suggest that once it is established that investment is black money or capital is hidden, it is nothing but circular movement of capital known as round tripping; then the tax residency certificates issued by Mauritian authorities can be ignored by the Revenue. Indeed, the Supreme Court’s observations will attract attention to and facilitate the Revenue’s endeavours in challenging investment and trust structures, which entail Indian tax residents.

Further, the impending Direct Taxes Code Bill 2010 (DTC) comes equipped with the General Anti-Avoidance Rules, which specifically empower the Revenue to re-characterise a transaction where it, inter alia, lacks commercial substance. It is noteworthy that the definition of commercial substance includes transactions of round trip financing.

Similarly, the DTC entails a new residency test for corporations whereby a corporation will qualify as a tax resident of India to the extent that it has its place of effective management in India at any time during 
the year. Under the DTC, the ‘place of effective management’ is defined as the place where the board of directors of the company or its executive directors, as the case maybe, make their decisions; or in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place 
where such executive directors or officers of the company perform their functions.Currently, the Income Tax Act 1961 has 
a very high threshold, where a corporation qualifies as a tax resident in India only if its entire control and management is situated in India, thereby rarely bring an offshore company within India’s tax net. This new residency test under the DTC, is complemented by Controlled Foreign Corporation Rules, the operation of which will also have a significant bearing on offshore wealth management.

Finally, an allied topic to this discussion is the recent public outcry in India against corruption and more particularly black money. Several Indian HNI have come under the tax scanner. In a related development, the CBDT has set up two overseas income tax units in Singapore and Mauritius, from where investment round-tripping activities are known to take place. CBDT will soon set up eight more such units in US, UK, Netherlands, Japan, Cyprus, Germany, France and UAE.

As India’s wealthy go global, in the time 
of its transitioning fiscal policy and heightened exchange for information 
norms, there is little doubt that tax 
outlook to offshore private wealth management will occupy centre stage. India’s wealthy will probably find it more difficult; to manage their money in the way that they decide is best. The institutions that help them make these decisions, be they offshore financial centres or private banks, both domestic and foreign, will have to be alive and responsive to these challenges of the future.

By Aseem Chawla, partner and 
Surabhi Singhi, associate, 
Amarchand Mangaldas.