Introduction
The India-Mauritius Double Taxation Avoidance Agreement (DTAA) has played a pivotal role in shaping cross-border investments and tax strategies between India and Mauritius. This agreement, signed in 1983, was designed to avoid the double taxation of income earned by individuals or entities in both countries. For years, it became a favorable tax instrument for investors looking to channel investments into India, particularly through Mauritius.
However, in recent years, the India-Mauritius DTAA has been subject to scrutiny and changes, largely due to concerns regarding round-tripping of funds, tax avoidance, and the shift of profits to Mauritius to take advantage of lower tax rates. This case study will explore the evolution of the DTAA, its implications on tax policy, and how it has been challenged and modified over the years.
Background of the India-Mauritius DTAA
The India-Mauritius DTAA was initially negotiated to facilitate the movement of capital between the two countries by preventing the risk of double taxation. Mauritius, with its relatively low tax rates and favorable investment policies, became an attractive destination for foreign investments into India. The agreement provided exemption from capital gains tax on the sale of Indian securities (equities and bonds) by Mauritian residents, making it a tax-efficient route for foreign portfolio investors (FPIs) to invest in India.
This exemption was perceived as a tax haven for investors from across the world, particularly those from Europe, the United States, and other regions. Mauritius, being a popular offshore financial center, did not tax capital gains on the sale of Indian shares, creating a significant incentive for investors to route their investments through Mauritius to avoid Indian capital gains tax.
Key Features of the Agreement
1. Exemption of Capital Gains Tax:
Under the DTAA, Mauritius-resident investors were not subject to Indian capital gains tax on the sale of Indian securities. This provided significant tax benefits to foreign investors.
2. Limitation on Taxation of Income:
Income from employment, pensions, and certain other income sources was taxable only in the country of residence of the taxpayer.
3. Residence Certificate Requirement:
To avail of the tax benefits, a Mauritian entity or individual had to produce a valid residence certificate issued by the Mauritius tax authorities, confirming that they were a tax resident of Mauritius.
4. No Tax on Dividend Payments:
The agreement provided relief on dividend income paid by Indian companies to Mauritian residents. While dividends were subject to Indian tax, the tax rates were limited under the agreement.
The Round-Tripping Issue: A Tax Evasion Concern
While the India-Mauritius DTAA was initially intended to encourage legitimate investment flows, the agreement soon became a vehicle for round-tripping of capital. Round-tripping refers to the practice where Indian money is routed through Mauritius (or other offshore jurisdictions) to avoid Indian taxes.
Indian companies or individuals would channel their investments through Mauritius to avail the benefits of the tax exemption on capital gains. This often led to the situation where Indian-origin capital was taxed at a significantly lower rate by using a conduit route through Mauritius, effectively circumventing Indian tax laws.
The Mauritius route became particularly attractive for investments in the Indian stock market, where capital gains taxes were zero for investors routed through Mauritius.
This loophole raised concerns within the Indian government regarding the potential loss of tax revenues, especially as capital inflows to India via Mauritius grew significantly over the years.
The 2016 Amendment: The Protocol to the India-Mauritius DTAA
In response to increasing concerns about tax evasion and round-tripping, the Indian government and the government of Mauritius amended the DTAA through a Protocol signed in May 2016. The key changes made to the agreement are as follows:
1. Capital Gains Tax Modification:
The amendment introduced a tax on capital gains arising from the sale of Indian securities by residents of Mauritius. Under the revised agreement, capital gains arising after April 1, 2017, would be taxable in India at a reduced rate of 50% of the domestic tax rate .
2. Transition Period:
The agreement also provided a grandfathering provision, where investments made before April 1, 2017, would continue to enjoy the tax exemption under the original agreement. This allowed existing investors time to adjust to the changes and prevented immediate adverse financial impacts.
3. Limitation on Benefits (LOB) Clause:
A crucial feature added was the Limitation on Benefits (LOB) clause, which aimed to prevent misuse of the DTAA by shell companies or entities whose primary purpose was tax avoidance. The LOB clause would restrict the benefits of the DTAA to entities with substantial economic activity in Mauritius.
Impact of the Amendment on India-Mauritius Investments
1. Short-Term Impact on Capital Flows:
In the short term, the modification to the capital gains tax provisions resulted in a reduction in investments through Mauritius. Many foreign investors found alternative tax-efficient jurisdictions for routing investments into India, including Singapore and the Netherlands.
2. Economic Substance Requirement:
The introduction of the LOB clause led to a crackdown on “letterbox companies” with minimal actual operations in Mauritius. Investors could no longer rely solely on Mauritius’ tax benefits without showing genuine economic substance.
3. Shift in Investment Patterns:
The tax amendment shifted the pattern of foreign investments into India. While Mauritius continued to be an important hub for investment, the tax benefits were no longer as lucrative for new investments, and countries like Singapore became more attractive due to the relatively favorable tax treaties.
Conclusion
The India-Mauritius DTAA has undergone significant changes, particularly in the area of capital gains taxation. What initially began as a tax-efficient route for foreign investments in India soon became a target for tax avoidance strategies. The amendments to the agreement reflect India’s determination to curb tax evasion and protect its tax base while still maintaining the flow of legitimate investments into the country.
The revised DTAA with Mauritius, while curbing abusive tax practices, ensures that foreign investors still benefit from reduced tax rates in a way that aligns with global tax standards. However, the legal battles and the implementation challenges around the LOB clauses and retrospective tax demands will continue to shape the landscape of international taxation in the region.
As the tax world continues to evolve, it is likely that tax treaties like the India-Mauritius DTAA will undergo further modifications to align with global standards, such as the OECD’s BEPS (Base Erosion and Profit Shifting) initiatives, which emphasize greater transparency and fairness in international tax systems.
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Author: Samiksha Singh, Student, University Institute of Legal Studies, Panjab University, Chandigarh
