By: Aditi Rani
The protocol for amendment of the India-Mauritius Double Taxation Avoidance Agreement (“Protocol”) was signed between India and Mauritius on May 10, 2016.
Dating way back to 1983, the India – Mauritius Double Taxation Avoidance Agreement (“India-Mauritius DTAA”) has been instrumental in Mauritius bringing in foreign direct investment (FDI) close to USD 94 billion in the last 5 years. This is almost 1/3rd of India’s total FDI flowing in from this tiny island country in the period in question, pipping past larger economies such as the USA, United Kingdom and Japan. Largely, this rode on the exemption on capital gains tax on sale of shares of an Indian company in India. Under Indian law, the proceeds from the sale of shares held for less than 12 months for listed entities and 24 months for unlisted shares respectively attract short term capital gains tax at 15%. Such sale of shares are taxed at the rates applicable based on the tax residency of the seller. As no tax is imposed on capital gains in Mauritius, the “Mauritius route” became an attractive option for investors investing in India. However, this has often been in the news for the wrong reasons ranging from treaty abuse, round tripping of funds, revenue loss to the Indian exchequer and tax litigation in India.
The Protocol plugs the loopholes by gradually moving from a residence-based regime to a to a source- based taxation regime of capital gains on shares. The key features of the Protocol that is expected to significantly impact all FDI from Mauritius are as follows:
No more exemption on capital gains tax: India gets taxation rights on capital gains arising from sale of shares acquired on or after 1st April, 2017 in a company resident in India with effect from the financial year 2017-18.
Investment instruments: The Protocol applies only to investments in shares. Mauritius tax residents investing in convertible and non-convertible debentures or any other securities except “shares” shall continue to remain exempted from the capital gains tax in India. However, such an exemption shall cease to exist on the conversion of the securities into shares, converted on or after April 1, 2017. The date of such conversion shall be marked as the date of acquisition of those shares.
No retrospective application: Investments in shares acquired before 1st April, 2017 will continue to enjoy the benefits of the earlier tax regime.
Concessional rates for specific entities in the transitional phase: A reduced tax rate (i.e., 50% of the domestic tax rate of India) has been proposed in respect of capital gains arising during the transition period from 1st April, 2017 to 31st March, 2019. This is subject to the fulfillment of the conditions in theLimitation of Benefits Article as outlined below. Taxation in India at the full domestic tax rate will take place from financial year 2019-20 onwards.
Limitation of Benefits: A Limitation of Benefits (LoB) article has been introduced for the first time in the India-Mauritius DTAA. Essentially, this limits the benefits of reduced tax rates during the transition phase to residents of Mauritius that clear the main purpose test or bonafide business test. In order to weed out shell/conduit companies, the Protocol refers to shell/conduit companies as those residents of Mauritius with a total expenditure on operations not exceeding Indian Rupees 2.7 Million in the preceding 12 months. After the expiry of the transition phase, the capital gains on sale of shares shall be subject to the then prevailing tax rates in India.
India-Singapore DTAA: The capital gains benefit under the India-Singapore DTAA is directly linked to the corresponding provision under the India-Mauritius DTAA. Therefore, it is widely expected that the Government of India will re-negotiate the terms of the India-Singapore DTAA so that it is amended on similar lines at the earliest to address grey areas and mitigate double non-taxation and round tripping.
Our Observations: The Protocol is a positive development with the Government of India resorting to a “grandfathering” approach through which it aims to protect the investments made prior to April 1, 2017 and usher in the amendments gradually. The clear shift from the residence-based taxation to source-based taxation is expected to reduce tax litigation related to the India-Mauritius DTAA significantly. The two-year transitional period from April 1, 2017 to March 31, 2019 is expected to ensure market stability. It is a welcome step towards gradually migrating to a transparent tax regime that curbs treaty abuse, round-tripping of funds, double non-taxation and the resultant revenue loss. While the flow of investment will be streamlined, the Protocol will also prevent double non-taxation and curb tax evasion and tax avoidance.