US, Europe dominate FPI flows, Singapore & Mauritius lose out

The shifting landscape of Foreign Portfolio Investment (FPI) into India, characterized by a move away from traditional tax havens like Mauritius and Singapore towards direct routes from the US and Europe, represents a significant structural change in India's capital markets. This evolution is not a sudden occurrence but rather the culmination of years of policy reforms aimed at enhancing tax transparency and curbing illicit financial flows.

Historically, Mauritius emerged as a dominant source of FPI into India primarily due to the advantageous Double Taxation Avoidance Agreement (DTAA) signed between India and Mauritius in 1982. This DTAA, particularly its Article 13, exempted capital gains tax on the sale of shares in an Indian company by a Mauritian resident. This provision inadvertently encouraged 'treaty shopping,' where investors from other countries routed their investments into India via Mauritius to avoid paying capital gains tax in India. For decades, Mauritius accounted for a substantial portion of FPI, sometimes exceeding 40% of total inflows, leading to concerns about revenue loss and the potential for money laundering.

What happened is a direct consequence of India's commitment to international norms on tax transparency and anti-money laundering. A pivotal moment was the amendment to the India-Mauritius DTAA in 2016. This amendment introduced a clause that allowed India to tax capital gains on shares acquired on or after April 1, 2017, at the prevailing domestic rate. Furthermore, it incorporated the 'Principal Purpose Test' (PPT), a key recommendation from the OECD's Base Erosion and Profit Shifting (BEPS) initiative. The PPT aims to deny treaty benefits if one of the principal purposes of an arrangement or transaction was to obtain that benefit. Similar amendments were made to the India-Singapore DTAA. Alongside these DTAA changes, stricter beneficial ownership rules under the Prevention of Money Laundering Act (PMLA), 2002, and enhanced regulatory disclosures mandated by the Securities and Exchange Board of India (SEBI) have made it significantly harder and less attractive to route investments through opaque structures in traditional tax havens.

Key stakeholders involved in this shift include the **Indian Government and its regulatory bodies** such as the Central Board of Direct Taxes (CBDT) and SEBI, which have spearheaded these reforms. Their objective is to ensure tax fairness and market integrity. **Foreign Portfolio Investors (FPIs)** are adapting their investment strategies, now preferring direct routes from their home countries (like the US and Europe) rather than indirect routes through Mauritius or Singapore. **Mauritius and Singapore**, once preferred conduits, are now experiencing a decline in their share of FPI flows to India and are projected to see further withdrawals as investors realign. Finally, **international bodies like the OECD and G20** play a crucial role by setting global standards on tax transparency and anti-money laundering, which India is actively implementing.

This structural shift matters immensely for India. Economically, it promises **enhanced tax collections** from capital gains, reducing revenue leakage. It also leads to **greater transparency** in FPI flows, providing a clearer picture of the ultimate beneficial owners and reducing the scope for round-tripping or money laundering. This strengthens India's financial market integrity and aligns it with global best practices in combating illicit financial flows. Politically, it showcases India's commitment to international cooperation on tax matters and its resolve against financial crimes. Socially, transparent capital flows can contribute to a more equitable economic environment by curbing avenues for tax evasion.

Relevant constitutional provisions and acts include the **Income Tax Act, 1961**, particularly provisions related to capital gains taxation (e.g., Section 90 for DTAAs) and subsequent amendments that brought FPIs under the tax net. The **Prevention of Money Laundering Act (PMLA), 2002**, is critical for enforcing beneficial ownership rules and combating financial crime. The **Foreign Exchange Management Act (FEMA), 1999**, governs foreign exchange transactions, including FPI. While not a constitutional article, the **General Anti-Avoidance Rule (GAAR)**, though implemented with a deferred date, reflects the underlying policy intent to counter aggressive tax planning, which influenced the DTAA amendments. The shift also aligns with the global **OECD BEPS Action Plan**, which India has actively supported.

Looking ahead, the future implications are multi-faceted. We can expect a continued decline in FPI from traditional tax havens and a corresponding increase from developed economies, potentially leading to more stable and predictable capital flows. This could enhance investor confidence in India's regulatory environment. It also signifies a maturing of India's financial markets, where the focus shifts from tax arbitrage to fundamental economic opportunities. India's efforts to curb treaty shopping and improve transparency may also encourage other developing nations to strengthen their own tax treaties and regulatory frameworks, fostering a global environment of greater financial integrity. While there might be some short-term adjustments in FPI volumes as investors re-route, the long-term benefits of a transparent and rule-based investment regime are expected to outweigh these challenges, solidifying India's position as a responsible global economic player.