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Why Tesla India is Routing Its Investment Through the Netherlands

Editor, TRANSFIN.
Jan 20, 2021 1:12 PM 5 min read
Editorial

Tesla is finally rolling into India.

On January 8th, Tesla India Motors and Energy Private Limited was officially incorporated in Bengaluru. The California-based auto giant will begin “first with sales for its vehicles” and, based on demand, might also scale up to set up manufacturing facilities.

Now, if you look at Tesla’s incorporation documents, one point stands out: The American electric carmaker has reportedly named Tesla Motors Amsterdam - its Netherlands subsidiary - as the parent for its India entity.

This mainly has to do with the ample taxation benefits and strong intellectual property framework that Netherland-based companies enjoy.

By routing its India investments via the Netherlands, Tesla has bucked a long-documented trend of foreign multinationals opting for Mauritius, Singapore and Cyprus to route FDI inflows into India. And it signals a significant shift in MNCs’ preferred route of investment, which has been a long time coming.

Foreign Direct Avoidance

Between 2000 and 2017, the lion’s share (34%) of all FDI that India received came from Mauritius.

Off the bat, this seems ludicrous. How can a tiny island nation with a nominal GDP of $14bn be the top source of foreign investment for a $3trn economy?

The answer lies in the intrigues of international taxation. Big companies are eager to invest in promising, up-and-coming economies like India. And they’re equally eager to lower their tax bill - be it on capital gains or dividend payments. So they “route” their investments through so-called tax havens, which have much more favourable corporate tax rates by engineering efficient corporate structures that allow them to seamlessly do so.

Let’s illustrate this with an example. Say a company in country A wants to invest in India. But it wants to minimise its tax obligations. It sees a chance to do this in country B, which happens to have a tax treaty with India - a Double Taxation Avoidance Agreement (DTAA).

FYI: A DTAA is signed between two countries to avoid instances where companies end up paying tax in both the country of residence and the country where investment is being made (ergo, “double taxation”). India has signed DTAAs with c. 85 countries. Some of these agreements are quite generous in that they created a system for effectively zero tax rate on capital gains. For example, the India-Mauritius DTAA, signed in 1983, gives the Indian Ocean island the capital gains tax rights. But Mauritius has no capital gains tax - and therein lies the loophole.

Therefore, the hypothetical firm in country A simply opens a shell division or holding company in country B and invests from B to India, managing to greatly thin its expense sheet. This is called treaty-hopping.

 

 

By the way, foreign companies are not the only ones who try to treaty-hop. Domestic companies can try to exploit the DTAA loophole too, by routing their investments in their own country via a third country! Fittingly, this is called round-tripping.

India’s DTAAs with Mauritius, Singapore and Cyprus are (in)famous examples of this tax loophole - and this is why they have been the top sources of FDI inflows into India. Even higher than would-be usual suspects like the US, UK and Japan.

 

Fixing Loopholes

Obviously, treaty-hopping and round-tripping hurt Government revenues. While some consider it as prime examples of corporate decadence, some see it as efficient tax strategy. Globally, such “base erosion and profit shifting” (BEPS) practices cost countries $100-240bn annually in lost revenue, equivalent to 4-10% of the global corporate income tax revenue.

Which is why the Government embarked on a mission to renegotiate faulty DTAAs with tax havens. Not an easy task, considering that remaking cross-border tax deals takes years of back-and-forth and compromises, and considering the delicate nature of the ordeal in that market sentiment may sour swiftly if a hardline approach is embraced by the Government.

But in 2016, after years of negotiation, the DTAAs with Mauritius and Singapore were finally amended, removing the effectively zero tax rate on capital gains. Beginning April 2017, investments routed from these countries were levied a 7.5% short-term capital gains tax.

Unfortunately, this did not signal the end of treaty-shopping and round-tripping.

 

The Dutch Cometh

Even as India was renegotiating its DTAAs with the aforementioned tax havens, foreign multinationals were jumping ship to other countries with favourable tax rates. These include Spain, France...and the Netherlands. Naturally, this caused a dip in FDI inflows from these countries, particularly from Mauritius. 

 

 

More than 50 FPIs, including the likes of JPMorgan, Morgan Stanley and Sweden’s SKB, began relocating to new tax haven favourites.

The Netherlands in particular is emerging as an attractive alternative - the next Mauritius, so to speak. Besides strong IP protection (a crucial bonus for companies like Tesla, which invest heavily in R&D), there’s the Indo-Dutch DTAA, which includes an exemption from Indian capital gains tax in many cases and a most-favoured nation (MFN) clause. Moreover, Dutch law makes it relatively easy for foreign companies to migrate to the Netherlands, become tax residents of the country...and avail the benefits of the country’s international tax treaties.

With India having reworked its DTAAs with Mauritius and Singapore, the treaty with the Netherlands stands out because it exempts capital gains from tax where India shares are sold by the Dutch company to a non-Indian buyer. Investments routed through the Netherlands can also avail lower rates of dividend taxes and withholding taxes.

And there you have it. That’s why Tesla tapped its Dutch wing to invest in India.

 

The Tricky Road Ahead

International taxation is a touchy subject because it blurs the lines between trade and politics. Remember the Google Tax? Countries like Canada, France, Russia, Vietnam and India are discussing (or have already imposed) levies on Big Tech companies exploiting tax loopholes.

The US protested aggressively, even threatening retaliatory tariffs if countries imposed these digital levies on American companies. This was not a unique, one-off Trumpian reaction - you can expect global digital levies to be admonished by even the Joe Biden administration.

It’s another matter that the US government itself is no fan of Big Tech’s business practices at home. Countries naturally want their companies to scale up globally and bring in maximum profits and this can mean exploiting every tax loophole possible. Invariably, if an FDI recipient attempts to level the playing field, doing so would be akin to walking a tightrope.

However, a “legal” loophole is a loophole nonetheless, and thus needs to be addressed and fixed. Renegotiating the DTAAs with Mauritius and Singapore took years for India; renegotiating the same with the Netherlands, France or Spain will likely be a lengthy and complicated process too. (India is already renegotiating its bilateral tax treaty with the Netherlands.)

But the potential rewards - of getting big companies to pay higher taxes, of eliminating the fortune dissipated in lost revenue, and of ensuring a level playing field for all players - are perhaps worth the ordeal?!

Interestingly, India's ratification of the international treaty on BEPS came into effect only in FY21. As a measure by the OECD and G20 to tackle multinationals exploiting cross-border tax loopholes, this could further help India fix its DTAAs.

In the end, it must be ensured that the “Mauritius route” is not replaced with a “Dutch route” or “French route”.

FIN.

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