Will Cyprus Remain FIIs Gateway to Indian Debt

The near-bankruptcy of a tiny,distant tax haven could force many foreign investors betting on Indian bonds to look for an alternative gateway. Private equity houses, foreign institutional investors (FIIs) and international realty funds coming through the Mediterranean island have to pay only a small tax on the interest earned on bonds floated by Indian companies, thanks to a 20-year-old tax treaty between India and Cyprus. Withholding tax tax deducted by Indian authorities before remitting the interest amount for investors using Cyprus as a base is as low as 10%, compared with 40% for others.There is another advantage: offshore bond investors from Cyprus dont pay tax on capital gains booked after selling debt securities.Its this combination of a low withholding tax and zero capital gains tax that has made Cyprus irresistible, compared with jurisdictions like the Netherlands and Luxembourg, to overseas investors and foreign funds buying Indian fixed-income assets.

Investors in a Dilemma

On Monday, some of the funds asked their advisors whether it still made sense to route investments through Cyprus,and whether one should set up a vehicle in Singapore where the withholding tax would be 15%.The current troubles in Cyprus will not hurt existing assets, but there are fears that it could be difficult to move money freely in and out of a small,politically insignificant country whose banks have to be bailed out.What if cash sitting on Cypriot banks is taxed,just like the savings of small depositors Its natural that the woes of Cyprus, possibly the first tax haven to face such a massive run on banks,will make large investors question its future as a tax haven.Since 2004, Indian property firms have raised billions of dollars by issuing structured securities that are quasidebt in nature. Many PE players and other foreign funds investing in these papers came via Cyprus.In the years when the rupee was strong, the tax advantage paved the way for interest rate arbitrage: many proprietary investments involved borrowing cheap money to lend to Indian companies to earn the rate differential.Debt investment by FIIs, which captures just one part of the total debt money inflow, rose from.4,168 crore in 2006 to.46,292 crore in 2012. FIIs have put in more than.11,000 crore into Indian debt securities since Jan 2013.

Economic Times, New Delhi, 19-03-2013