Worldwide: The Singapore-India Connection: A Robust Past and a Compelling Future

Last Updated: October 21 2014
Article by Saionton Basu

In determining the optimum gateway for investing into India, reliance on industry data may be the most prudent opening gambit. Data released by India's Department of Industrial Policy & Promotion peg Mauritius and Singapore as the top two destinations through which foreign direct investment and private equity capital is routed into India. The data further suggest that Singapore's share of capital inflows into India nearly doubled in the last two financial years (i.e., 2012–2013 and 2013–2014), while the share of capital into Mauritius in the same check period halved.

Possible reasons are not far to seek. Indian tax authorities have long had concerns that Mauritius was being used for round-tripping of funds.
Round-tripping is typically the practice of routing domestic investments through Mauritius to take advantage of the Double Taxation Avoidance Agreement (DTAA) between the two countries. Whilst it is no one's case that every dollar of investment routed through Mauritius is of the round-tripped variety, this perception has not been easy to avoid. An added concern for Mauritius has been the absence of clarity over India's proposed re-negotiation of the DTAA.

Prompted by India's enactment of the General Anti-Avoidance Rules (GAAR), scheduled to come into force from 1 April 2015, more investors appear to be banking on Singapore as an intermediate jurisdiction for investing into India. The key factors that have led to this development include a robust tax and investment protection treaty between Singapore and India. In principle, the attraction for international investors choosing to structure investments via Singapore is no different from the Mauritius route—the potential to avoid paying Indian capital gains tax on their investments. Under the Singapore-India tax treaty, the sale of shares in an Indian company by a Singapore entity should generally be immune from payment of Indian capital gains tax. However, the key variance from the Mauritius route lies in the fact that the capital gains exemption can be obtained only upon satisfying the stipulations specified in the tax treaty. The conditions outlined in the "limitation of benefits" (LOB) clause in the India-Singapore tax treaty require that the benefits of the tax treaty cannot be claimed by an entity if such entity was set up primarily for the purpose of obtaining the capital gains exemption. To qualify for the capital gains exemption, the Singapore entity must have incurred an annual expenditure of 200,000 Singapore dollars on operations in Singapore in the 24 months prior to the date the capital gains arise.

GAAR – The Road Ahead

The test has thus become demonstrating commercial substance in the Singapore operations due to the LOB clause and also the looming implementation of the GAAR provisions. It is pertinent to note that under the GAAR rules, Indian tax authorities have wide-ranging powers to tax "impermissible avoidance arrangements," including the power to disregard entities in a structure; reallocate income and expenditure between the parties to the arrangement; alter the tax residence of such entities and the legal situs of assets involved; and treat debt as equity and vice versa.

The net effect of such wide powers could mean that an investor could be denied the benefits of a tax treaty as a result of applying the GAAR provisions. The drafting intention behind the GAAR provisions is to move the center of tax laws in India from the "form" of an arrangement or transaction to the "substance" of a transaction. Foreign investors in the throes of upstream planning for investing into India have often found that it is easier to establish the necessary substance for a Singapore company for a variety of reasons. Singapore's reputation as an economic hub in Southeast Asia, as opposed to a low-tax jurisdiction, is perceived as acceptable in the eyes of the Indian tax authorities. In addition to the lower capital gains tax, Singapore residents are entitled to a lower rate of tax withholding in India of 15 percent on interest income that would otherwise vary from 20 percent to 40 percent under the regular domestic tax provisions. This cost-saving has been a magnet for several India-focused debt funds basing themselves in Singapore.

Bilateral Investment Protection

The Comprehensive Economic Cooperation Agreement (CECA) between India and Singapore provides for guarantees against expropriation. Further, the CECA aims to ensure that foreign investors are treated on the same basis as domestic investors and are not subject to discrimination. Similarly, the guarantee against expropriation limits the circumstances under which the state may expropriate foreign investments (with due compensation). Bilateral investment protection agreements (BIPA) provide foreign investors a valuable remedy to protect their investment broadly against any arbitrary state action that could jeopardize their investment. India has more than 70 BIPAs, but until recently, it has been fairly immune to arbitration proceedings. That is changing. Recently, Australian firm White Industries prevailed against India over a Coal India investment, under the India-Australia BIPA, while The Children's Investment Fund has raised the possibility of BIPA action over its investment in the same public-sector undertaking. Russian telecom Sistema and Norway's Telenor are also cautioning action under various BIPAs over the telecom license cancellations. The CECA allows for investors to directly initiate arbitral proceedings against a state without approaching its own government in case of a violation. Foreign investors have an option of initiating arbitration under the UNCITRAL rules directly.

In conclusion, the Singapore-India connect is likely to become compelling as further capital inflows pursuant to the encouraging reforms are initiated by the new government in saddle. Equally, the GAAR provisions may lead to Indian tax law becoming increasingly substance driven, thus further adding to the allure of Singapore.

For Further Information

If you have any questions about the topics discussed in this Alert, please contact Saionton Basu in Duane Morris' London office.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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