Introduction
The evolving international landscape of taxation has brought with it both opportunities and challenges. As cross-border economic activities became increasingly complex, one of the key responses by nations has been the establishment of bilateral agreements aimed at eliminating or mitigating the negative effects of double taxation. These agreements, commonly known as Double Tax Avoidance Agreements (DTAAs), have enabled nations to allocate tax rights effectively, thus creating an environment conducive to trade and investment.
The India-Mauritius DTAA, signed in 1982, stands out as a landmark treaty due to its significant impact on the flow of investments between India and Mauritius. Over the years, this agreement has facilitated large amounts of Foreign Direct Investment (FDI) into India, making Mauritius one of the leading sources of FDI into the country. Its attractive tax provisions, particularly the exemption from capital gains tax, attracted investments not only from Mauritian entities but also from global investors who used Mauritius as a base to invest in India.
However, this treaty also faced its share of challenges. Concerns over treaty shopping, the abuse of tax provisions, and base erosion led to questions about the integrity of the DTAA. The use of Mauritius as a tax haven by investors with no substantial economic activities in the country became a contentious issue.
This project explores the India-Mauritius DTAA in detail, providing an overview of its background, benefits, and challenges. We will also examine international measures to curb treaty abuse, recent amendments made to the DTAA, and their impact on trade and investment. The project concludes with suggestions for strengthening tax treaties to maintain a balance between attracting investments and safeguarding the tax base of the country.
Background of Double Tax Avoidance Agreements (DTAAs)
The concept of Double Taxation Avoidance Agreements (DTAAs) can be traced back to the early 1920s, during the interwar period when cross-border economic activities started to increase. Before the establishment of such treaties, businesses and individuals often faced the issue of double taxation. This meant that the same income was taxed by both the country of residence and the country where the income was earned, which discouraged international trade and investments.
The League of Nations recognized the adverse impact of double taxation on global trade and, in 1928, formulated the first model tax treaty. This model was a precursor to contemporary tax treaties such as the United Nations (UN) Model and the Organisation for Economic Cooperation and Development (OECD) Model. The initial goal was to prevent double taxation while ensuring that tax jurisdictions did not overlap unnecessarily. Over time, this model evolved into an extensive network of bilateral treaties that covered almost every major economy.
DTAAs are designed to address two primary issues: (i) the potential double taxation of the same income and (ii) the prevention of tax avoidance. Double taxation discourages businesses from engaging in cross-border activities, as the tax burden becomes excessive. By allocating taxing rights between contracting states, DTAAs help to reduce or eliminate instances of double taxation, thereby providing businesses and individuals with the certainty they need to operate internationally.
One of the critical components of any DTAA is the allocation of taxing rights. Typically, the agreement stipulates that income generated in one country by a resident of another should either be exempt from taxation in one of the countries or be taxed at a reduced rate. Provisions are made to allocate tax on various types of income such as interest, royalties, dividends, and capital gains.
The historical evolution of DTAAs has been instrumental in fostering economic cooperation between countries. They serve as legal frameworks that establish rules for determining the jurisdiction of taxation, create guidelines for resolving conflicts, and ensure predictability and transparency in international tax matters.
The Benefits of India-Mauritius DTAA
The India-Mauritius DTAA1, concluded in 1982, has played a significant role in driving foreign investment into India. By exempting capital gains from being taxed in India, the treaty became an attractive proposition for foreign investors who wanted to route their investments through Mauritius. The favourable tax regime allowed Mauritius to become the largest source of FDI into India for several decades.
The primary benefit of the India-Mauritius DTAA was its exemption from capital gains tax on investments made in India. This exemption applied to Mauritian residents who invested in shares of Indian companies. Under Article 13(4) of the DTAA, the right to tax capital gains from the sale of shares was assigned exclusively to the country of residence of the investor, which in this case was Mauritius. Given that Mauritius did not impose capital gains tax, investors could effectively avoid any tax liability on gains made from their investments in India.2
This favourable tax treatment made Mauritius an ideal jurisdiction for channeling investments into India, especially in high-growth sectors such as real estate, capital markets, and infrastructure. Investors from around the world, including those from non-treaty countries, established entities in Mauritius to route their investments into India, thus benefiting from the tax exemption.
Another significant benefit of the India-Mauritius DTAA was the role it played in providing tax certainty and predictability for foreign investors. By clarifying the rules regarding the taxation of income and capital gains, the treaty helped mitigate the risk of double taxation, which is a major consideration for businesses and individuals engaged in cross-border economic activities. This certainty played a crucial role in fostering investor confidence and attracting FDI into India.
Furthermore, the DTAA also strengthened the economic and diplomatic ties between India and Mauritius. The historical and cultural ties between the two nations, underscored by the presence of a large Indian diaspora in Mauritius, were bolstered by the economic linkages that the treaty helped create. This close association facilitated the flow of investments, which contributed to the economic development of both nations.
However, the benefits of the DTAA came at a cost, as it also provided opportunities for tax avoidance. Investors from other countries exploited the provisions of the treaty through a practice known as treaty shopping, which ultimately undermined the treaty’s effectiveness.
Treaty Shopping and its Challenges
Treaty shopping refers to the practice where investors take advantage of the favourable provisions of a tax treaty by routing their investments through an intermediary jurisdiction.3 In the context of the India-Mauritius DTAA, this often meant that investors from third countries, which did not have similarly favourable tax treaties with India, would establish shell companies in Mauritius for the sole purpose of gaining access to the benefits of the DTAA.
Mauritius became a popular route for investment into India because of the tax exemptions provided under the DTAA, particularly concerning capital gains. By establishing entities in Mauritius, investors could ensure that their investments in Indian companies were exempt from capital gains tax. These entities had no substantial economic presence in Mauritius and were established solely to exploit the favourable provisions of the tax treaty.
The issue of treaty shopping brought to light several challenges. First, it led to an erosion of the tax base, as the Indian government was unable to collect taxes on capital gains arising from investments that had no real economic connection with Mauritius. This situation raised concerns about fairness and equity, as legitimate Indian businesses and individual taxpayers bore the tax burden while foreign investors were able to avoid taxation through treaty shopping. Second, treaty shopping also challenged the integrity of the DTAA itself. The very purpose of the treaty—promoting cross-border investment between India and Mauritius—was undermined by investors who used Mauritius merely as a conduit for routing investments. This highlighted the need for anti-abuse measures to ensure that the treaty served its intended purpose of promoting genuine economic activity.
Third, treaty shopping practices often lacked economic substance, which meant that the benefits accrued to entities that contributed little or no economic value to either Mauritius or India. Such practices distorted the international tax system, allowing multinational corporations to shift profits to low-tax jurisdictions while avoiding tax liabilities in the countries where their economic activities actually took place.
The challenges posed by treaty shopping led to growing calls for reform. The Indian government, in response to concerns about base erosion and profit shifting, began to explore ways to address treaty abuse, ultimately leading to amendments to the DTAA.
International Efforts to Curb Treaty Abuse
The phenomenon of base erosion and profit shifting (BEPS) has become a major concern for countries around the world. BEPS refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax jurisdictions.4 The Organisation for Economic Co-operation and Development (OECD) launched the BEPS project in 2013 to combat these practices and ensure that profits are taxed where the economic activities that generate them take place.5
One of the key actions under the BEPS project is Action Plan 6, which addresses the issue of treaty abuse. Action Plan 6 aims to prevent the granting of treaty benefits in inappropriate circumstances, specifically targeting treaty shopping practices. The plan provides recommendations for countries to incorporate anti-abuse provisions in their tax treaties to ensure that treaty benefits are granted only when there is a genuine economic connection between the taxpayer and the jurisdiction providing the benefits.
Action Plan 6 introduced the Principal Purpose Test (PPT) and the Limitation on Benefits (LOB) clause as the primary tools for preventing treaty abuse. The PPT allows countries to deny treaty benefits if obtaining those benefits was one of the principal purposes of an arrangement or transaction. The LOB clause, on the other hand, sets specific conditions that entities must meet to qualify for treaty benefits, ensuring that only those with a substantial economic presence in the contracting state can access the benefits.
India has taken proactive steps to align its tax treaties with the recommendations of the BEPS project. The amendments to the India-Mauritius DTAA, which became effective in 2017, incorporated elements of the PPT and LOB clauses to prevent treaty abuse.6 These measures were aimed at ensuring that the benefits of the DTAA were available only to those entities that had genuine economic activities in Mauritius.
The introduction of the PPT and LOB provisions in tax treaties is part of a broader international effort to curb treaty abuse and promote a fairer global tax system. By denying treaty benefits to entities that lack economic substance, these measures aim to protect the tax base of both source and residence countries and ensure that tax treaties serve their intended purpose of promoting legitimate cross-border economic activities.
Recent Amendments and Their Impact on Trade and Investment
In response to concerns over treaty abuse and base erosion, India and Mauritius agreed to amend the DTAA in 2016, with the changes becoming effective from April 2017. These amendments marked a significant shift in the taxation of capital gains and introduced new provisions to prevent treaty abuse.
One of the key changes introduced by the amendment was the shift from residence-based taxation to source-based taxation for capital gains arising from the sale of shares in Indian companies. Under the amended treaty, capital gains on shares acquired on or after April 1, 2017, would be taxed in India. This change effectively eliminated the tax exemption that investors had previously enjoyed under the DTAA.
The amendment also incorporated anti-abuse provisions in line with the recommendations of the BEPS project. The Principal Purpose Test (PPT) became an integral part of the DTAA, allowing India to deny treaty benefits if it determined that one of the principal purposes of an arrangement was to obtain those benefits. The Limitation on Benefits (LOB) clause was also introduced to ensure that treaty benefits were available only to entities that had a substantial connection with Mauritius.
The impact of these amendments on trade and investment has been mixed. On the one hand, the changes have helped India protect its tax base by ensuring that capital gains arising from investments in Indian companies are taxed in India. This has resulted in increased tax revenue for the government and has contributed to fiscal sustainability. The amendments have also helped create a more transparent and predictable regulatory environment, which is essential for building investor confidence.
On the other hand, the amendments have introduced challenges for investors who had previously relied on the favourable provisions of the DTAA. The shift to source-based taxation has led to an increase in the tax liability of investors, which has prompted some of them to reassess their investment strategies. Additionally, the introduction of anti-abuse provisions has increased the compliance burden for investors, who now need to demonstrate that their investments meet the criteria for accessing treaty benefits.
Despite these challenges, the long-term impact of the amendments is expected to be positive. By aligning the India-Mauritius DTAA with international standards for preventing treaty abuse, the amendments contribute to a fairer global tax system and help foster a level playing field for businesses operating in India. The changes also reflect India’s commitment to promoting responsible tax practices and attracting genuine foreign investments that contribute to the country’s economic growth.
Suggestions and Conclusion
The India-Mauritius DTAA has played a significant role in shaping the flow of investments between the two countries. However, the challenges of treaty abuse and tax avoidance necessitated amendments to ensure that the treaty serves its intended purpose of promoting legitimate cross-border economic activities. While the recent amendments have addressed some of these challenges, there is still room for improvement to further strengthen the treaty. One of the key suggestions for strengthening the India-Mauritius DTAA is to enhance the enforcement of anti-abuse provisions. While the introduction of the Principal Purpose Test (PPT) and the Limitation on Benefits (LOB) clause are positive steps, their effective implementation is crucial. Authorities must be vigilant in assessing the economic substance of entities claiming treaty benefits and ensure that the PPT and LOB clauses are applied consistently. Training tax authorities and improving administrative capacity can help in the effective enforcement of these provisions.
Another suggestion is to improve the exchange of information between India and Mauritius. The existing provisions for information exchange are not comprehensive enough and leave room for interpretation. Strengthening these provisions by aligning them with international best practices, such as the OECD’s standard for the exchange of information, will enhance transparency and cooperation in combating tax evasion. A more robust information-sharing framework will also deter investors from using Mauritius as a base for tax avoidance.
It is also important for India to continue engaging with international organizations like the OECD and other countries to ensure that its tax treaties are in line with global standards. By actively participating in international initiatives aimed at preventing tax avoidance, India can help shape the future of international tax policy and ensure that its interests are represented. The recent amendments to the India-Mauritius DTAA have helped address some of the concerns related to treaty shopping and tax avoidance. However, it is important to consider the broader implications of these changes on investment flows into India. While the amendments may initially deter some investors, the long-term benefits of a fair and transparent tax regime are likely to outweigh the short-term disruptions. A predictable and transparent tax environment is crucial for attracting high-quality investments that contribute to economic growth and development.
In conclusion, the India-Mauritius DTAA has undergone significant changes to address the challenges posed by treaty abuse and align with international standards. These changes have helped safeguard India’s tax base while promoting a more transparent and equitable tax environment. Moving forward, it is essential for India to continue strengthening its tax treaties and international cooperation to create a conducive environment for sustainable economic growth. By striking a balance between promoting investments and protecting the tax base, India can ensure that its tax treaties contribute to its long-term economic development.
Notes:-
1Mauritius dtaa.pdf. Available at:
https://www.taxsutra.com/sites/taxsutra.com/files/dtaa/MAURITIUS%20DTAA.pdf (Accessed: 06 October
2 Sunainaa Chadha, Should FPIs be worried about latest change to India-Mauritius tax treaty, Business Standard, (Apr. 16, 2024).
3 Taxmann, https://www.taxmann.com/research/international-tax/top-story/105010000000023214/treat-shopping-blessing-or-abuse-experts-opinion
4 (Sept. 29, 2017), https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/tax-2016/in-tax-deloitte-beps-analysis-and-india-outbound-final-noexp.pdf.
5 Base erosion and profit shifting (BEPS), OECD (May 30, 2024), https://www.oecd.org/en/topics/policy-issues/base-erosion-and-profit-shifting-beps.html.
6 ALMT Legal, (May 10, 2024), https://almtlegal.com/articles-pdf/ALMT%20Tax%20update%20-%20India-Mauritius%20Tax%20Treaty%20-%20The%20amending%20protocol.pdf.
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