CA Rahul Singhi
Recently Government of India has notified the revised tax treaty with Mauritius which was signed by both countries on 10 May 2016 under which India will impose capital gains tax on investments routed through the island nation from 1 April 2017 to curb tax evasion.
The tax treaty between India and Mauritius was signed in 1982 for the avoidance of double taxation and the prevention of fiscal evasion and for the encouragement of mutual trade and investment. The treaty provides for a capital gains tax exemption to a Mauritius resident on transfer of Indian securities. But in 1991, as India opened its doors for foreign investment, Mauritius became a favourite jurisdiction for investments in to India. This have been misused by many Indians & multinational companies to avoid paying tax. This route became tax heaven for Indians. They started routing cash through the island to avoid domestic taxes, a practice known as “round tripping”.
Thus to curb revenue loss by round tripping of funds and to fulfil promise on black money stashed abroad, Present government made efforts to renegotiate the treaty and made certain amendments in the existing protocol. The step taken by the government shows their belief in the economy and ability to attract foreign investment without tax incentives.
Amendments in Protocol
- India will now have the right to tax capital gains on transfer of Indian shares acquired on or after 1 April 2017. Existing investments will be grandfathered. Further the protocol provides for a two year transition period up to 31 March 2019 during which the tax rates will be 50% of the prevailing domestic tax rates, subject to fulfillment of conditions mentioned in the LOB (Limitation of Benefits) clause.
The conditions that to be fulfilled for claiming 50% abatement are: 1) The affairs should not be arranged with the primary intention of availing the benefit provision granting reduced rate of tax. 2) The company should not be a ‘shell or Conduit company’.
- The definition of PE (Permanent Establishment) has also expended with inclusion of service PE clause wherein deployment of personnel for a period of more than 90 days in any 12 months period shall constitute a PE.
- A new article 12A is inserted in the protocol that provides a right to source country to tax FTS (Fees for technical services) at a rate of 10% ( on gross basis) if the beneficial owner is a resident or the other contracting state.
- An exemption from tax on interest income arising in source country has been given to a bank of a resident country carrying on bona fide banking business on outstanding/existing debt claims on or before 31 March 2017. In other cases such income shall be taxable @ 7.5 %( on gross basis) in source country provided the recipient is the beneficial owner without regard to LOB.
- A new obstante clause is inserted that gives a right to the source country to tax such other income not connected with PE & not dealt in any other articles. Earlier this was taxable in resident country.
- The protocol amends the existing article 26 on information sharing mechanism. Now India can also insist on information in respect of persons who are not residents of Mauritius. It would be possible now to exchange information held by banks & financial institutions.
- A new article 26A is introduced in the treaty that both the countries shall lend assistance to each other in collection of revenue claims/taxes.
Impact of Changes
- A significant collateral damage of the protocol is its impact on the India-Singapore DTAA since the relevant provisions of capital gain tax exemption under India-Singapore tax treaty is similar with India-Mauritius tax treaty. So, the Indian government intends to renegotiate the treaty with Singapore to bring it on par.
- Long term funds will not be impacted as the domestic law currently provides for 0% tax on listed shares held for more than a year.
- Mauritius will continue to remain relevant for fixed income business with tax on interest being the lowest at 7.5% under the new treaty and capital gains continuing to be exempt.
- Shares acquired on or before 31 March 2017 have been grandfathered which would mean a continuance of the Mauritius structures for few more years.
- The government will also have to address and make appropriate changes in the General Anti Avoidance Rules (GAAR) notified in 2013. A need arises to bring clarity to GAAR rules wherein grandfathering date for investments for GAAR purpose have been extended to 1 April 2017 to eliminate unwanted confusion & interpretation by the tax authorities which is not in the spirit of what the government wanted.
The island nation with just 1.3 million people is the biggest single source of foreign direct investment into India. The amendment in treaty and information share mechanism puts at rest the long controversy around the Mauritius treaty. The revised treaty will result in similar tax treatment of capital gains for both domestic and overseas investors and establish a more stable and transparent taxation regime for overseas investors.
Overall this has been a great move by the government to promote a stable tax and predictable tax regime and attract FDI inflows. The measures will widen the tax base and will help in aligning the taxation to the BEPS (Base erosion & profit shifting) initiatives.