On 30 December 2016 Singapore and India signed a third protocol to the Avoidance of Double Taxation Agreement (DTA). The updates will be effective on 1 April, 2017 and reflect the provisions set forth in the India and Mauritius DTA. The purpose of the update was to bring parity between Singapore and Mauritius investors with respect to the alienation of shares of Indian companies.

Capital gains tax benefits

Key changes under the new protocol include:

  • Gains arising from shares in an Indian company acquired before 1 April 2017 are not taxable in India. But there are some limitations to this rule found in the Limitations of Benefits Article (LoB), which generally is intended to prevent tax avoidance.
  • Gains arising from shares of an Indian company between 1 April 2017 and 31 March 2019 may be taxed in India but only at a rate of 50% of the domestic tax rate. This particular provision is also subject to the LoB limitation.
  • Gains arising from shares of an Indian company acquired on or after 1 April 2019 may be taxed in India at the domestic tax rate.

The new rules are still subject to the “anti-conduit substance thresholds” before the capital gains tax exemption can be enjoyed. Amongst others, the anti-conduit substance thresholds require persons seeking to rely on treaty benefits referred to above to spend minimum threshold sums in Singapore and India (as the case may be) before they will not be deemed to be a “conduit”.

For Singapore investors that already directly hold shares of Indian companies, the protocol should not create a tax impact on the capital gains exemption currently enjoyed. For Singapore investors that plan to acquire shares of Indian companies on or after 1 April 2017, the protocol only introduces source taxation arising out of the alienation of shares of a company. Hence, capital gains tax may not be applicable in relation to the divestment of other assets, e.g., Indian partnership interests and an indirect divestment of shares of an Indian company (subject to domestic general anti-avoidance rules).

Transfer pricing changes in line with BEPS

Another part of the new protocol is that when a contracting state makes a transfer pricing adjustment to the profits of an enterprise, and the adjustment results in arm’s length transfer pricing, then the other party shall make an appropriate adjustment to the amount of tax charged on those profits. The tax authorities for each state may consult one another for these adjustments. This change makes the tax treaty in line with the Organization for Economic Co-operation and Development (OECD) model tax treaty.

This new provision is a welcome move and is consistent with the provisions of OECD’s Base Erosion Profit Shifting (BEPS) Action Plan 14 on Dispute Resolution Mechanism. The change will facilitate the relief of economic double taxation in scenarios where a transfer pricing adjustment has been made by a contracting state by using mutual agreement procedures.

Domestic law override provision

Finally, Article 28 A provides for a limited domestic law override. It allows a party to apply its domestic general anti-avoidance rule to transactions independently of the DTA. The new tax provisions in the DTA will continue to allow for investment in India, while also meeting BEPS requirements for transfer pricing adjustments.