Introduction
India and Mauritius have signed a protocol to amend the Double Taxation Avoidance Agreement (DTAA) that includes the introduction of a principal purpose test (PPT) rule, the proposed protocol aims to close tax loopholes, prevent tax avoidance, and align domestic tax practices with international norms and best practices. In this article, we will explore the protocol’s pros and cons and future aspects of the FPI (Foreign Portfolio Investors) and FDI (Foreign Direct Investments) of Mauritius in India.
What is a Double taxation avoidance agreement?
History
The DTAA has its origin from the Austro-Hungarian Empire (present-day Germany) as the first treaty related to DTAA was signed in 1899, during that period tax treaties were based on the principle of ‘reciprocity’ where certain commercial advantages were granted to countries or citizens on an equal basis. After many considerations and amendments, in the year 1928 the League of Nations renewed its interest in concluding DTAAs due to the excessive burden of double taxation, through the introduction of the Organisation for Economic Cooperation and Development (OECD) which laid the groundwork to develop its own Model Tax Convention, which further became the basis of most modern tax treaties including DTAA.
About
The Double Taxation Avoidance Agreement (DTAA) is an agreement entered into by India with other nations. It secures the flow of revenue for individuals who work in one nation but are residents of another so that they do not have to pay taxes on the same income twice. DTAA works on two principles they are:
The Source Rule: It is that when the income is taxed in the country of origin whether you are a resident of the country or not.
The Resident Rule: It specifies that the income would be taxed in the country where you reside, irrespective of the income’s origin. In India, the resident rule is followed.
India-Mauritius Tax Treaty
In the year 1983, the Government of India and the Government of Mauritius signed the Double Taxation Avoidance Agreement (DTAA), the treaty aimed to promote bilateral trade and investment by ensuring tax certainty for investors, thereby preventing the double taxation of the same income by both countries. Moreover, the agreement offers a list of benefits that the residents of the contracting states will get like:
Exempting tax on income in the resident country which has been earned in another country.
Lower with-holding tax rates for the taxpayers, and lower TDS rates on incomes like interest, dividends, and royalties in India.
The tax treaty establishes specific rules that the contracting states must follow when applying taxes on the international income of residents from the respective countries.
This tax treaty includes an anti-abuse provision that restricts the benefits of the convention to only the bona-fide residents of both contracting countries.
Over the period of time, India has become an attractive investment destination to many foreign investors, and being such, it makes it very important for India to capture such tax revenues happening from economic activities. In 2016, the Government of India came up with an amendment that gave India a right to tax capital gains arising from the alienation of shares in Indian companies. Only such gains, which arise from the transfer of shares acquired on or after April 1, 2017, are taxable in India. Investments made prior to this date were grandfathered and hence not subject to Indian tax.
Concerns in India-Mauritius Tax Treaty
The India-Mauritius tax treaty has been the subject of ongoing controversy and debate since its inception. At first, Article 13 of the treaty excluded capital gains from selling shares in Indian companies. But with the 2016 amendment, those gains were also taxed; this had great implications on how the treaty was used. The primary issues highlighted by the income tax department revolve around two main points: misuse of the treaty and ’round-tripping.’ There have been instances where illicit funds left India only to return through investments— benefiting from tax exemptions allowed by the treaty. The absence of an anti-abuse clause in the India-Mauritius tax treaty has facilitated the investments to exploit the treaty’s tax benefits and avoid taxes.
India-Mauritius Trade Relations
The India-Mauritius Tax Treaty was a significant factor that drew a large number of foreign portfolio investors (FPIs) and other foreign entities to route their investments into India through Mauritius. Data from the National Securities Depository Limited (NSDL) indicates that, up until 2023, Mauritius was the second-largest source of investments; however, since then, Singapore has eclipsed it. After Singapore, Luxembourg, and Ireland, Mauritius is currently ranked fifth in terms of foreign portfolio investment (FPI), having notably reduced from India.
On the other hand, Foreign Direct Investment (FDI) inflows into India have fallen in recent years. Still, Mauritius continues to be a major contributor, making up 25% of the total FDI received by India from April 2000 to March 2024. Yet change is afoot: Singapore is blazing trails as India’s rapidly growing source of FDI, currently providing approximately 24% of the total amount received. Experts attribute this change to the fact that before 2016, Mauritius was the preferred jurisdiction for foreign investment in India due to the tax advantages offered under the bilateral tax treaty. However, the 2016 amendment to the India-Mauritius tax treaty eliminated many of these benefits, leading investors to route their investments into India through Singapore instead. Singapore has become a favorable destination because of its tax regime and efficient regulatory environment, in fact, many multinational companies have also established their regional headquarters or holding companies in Singapore for a smooth route to invest in India.
The Protocol between India-Mauritius:
A significant event occurred on the 7th of March, 2024 when India and Mauritius came together to sign a protocol that would see an amendment made to their current Double Taxation Avoidance Agreement (DTAA). Nevertheless, it is worth noting that the protocol has not yet been notified by the relevant authorities. The modifications proposed by the protocol are as follows:
Introduction of a New Preamble
The old tax treaty will now be substituted with a new one. The replacement preamble unambiguously declares the purpose of removing dual taxation without presenting any avenues for non-taxation or lesser taxation by tax evasion or avoidance — which also covers treaty-shopping agreements — intending to be achieved through it.
Principal Purpose Test
There is the Principal Purpose Test (PPT) under the protocol as a provision for anti-abuse. According to the PPT, benefits of tax treaties will not be granted if — by the reasonable conclusion — it can be shown that one of the principal purposes of an arrangement or transaction was obtaining those benefits unless it can be demonstrated that granting the benefit would fall within the object and purpose of the treaty. The aim behind introducing this PPT is because concerns have been raised over misuse of the India-Mauritius tax treaty for purposes of tax evasion and avoidance, which includes round-tripping of funds— although signed, the protocol has not yet been officially notified and comes into force. Until then, existing provisions in the India-Mauritius tax treaty such as capital gains tax exemption for investments made before April 1, 2017, will continue to apply.
Article 27B
In the protocol, Article 27B has been introduced in the treaty with the name ‘entitlement to benefits’ where the PPT will deny the benefits like reduction of withholding tax on royalties, interest, and dividends where it is found that one of the purposes of investing is to claim the benefits under the tax treaty.
India’s Attempt to align with the Global efforts
The recent amendment to the India-Mauritius tax treaty reflects India’s commitment to align with global efforts to combat treaty abuse, as part of the Base Erosion and Profit Shifting (BEPS)[1] framework. This framework aims to prevent multinational enterprises from using aggressive tax planning strategies, such as shifting profits to lower-tax jurisdictions, to avoid paying taxes in higher-tax jurisdictions. To align itself with the worldwide minimum tax system under Pillar 2 of the OECD, which prohibits multinational companies from transferring profits to low or no-tax jurisdictions in order to avoid paying taxes in higher-taxed ones, there was an amendment to the India-Mauritius tax treaty. Through Global Anti-Base Erosion (GloBE) rules that were issued in December 2021, a global minimum corporate tax rate of 15% will be implemented for MNCs earning more than €750 million in revenue whereby top-up tax will be charged on earnings made in areas whose effective rate is less than such threshold; this could raise additional annual taxes of about $150 billion. The adoption of revised treaties and enforcement of GloBE regulations by more countries demonstrates a significant shift towards a more coordinated and equal international taxation regime through the implementation of the global minimum levy.
Tax Authorities can probe based on Intent.
Under the protocol, it has given more powers to tax authorities of India and Mauritius to investigate transactions and deals by looking at the intention behind them rather than just being technical complaints. The introduction of the Principal Purpose Test (PPT) gives authorities the power to deny a treaty benefit if it is determined that one of the reasons for a taxpayer’s action was to obtain such benefits. This change in emphasis shifts the onus on taxpayers to demonstrate that their structures are legitimate and were not primarily aimed at the exploitation of loopholes in treaties in order to avoid payment of taxes. These greater investigative capabilities therefore signify an important tightening up of rules against abuse, which reveals the government’s willingness to fight the misutilization of tax treaties and cultivate a fairer international taxation regime.
Conclusion
The bilateral tax treaty has indeed made Mauritius an attractive destination for investors wishing to route their investments into India, as it provides favorable tax treatment. The recent protocol to this treaty has raised concerns amongst investors especially due to the introduction of the Principal Purpose Test (PPT). This means that there could be a further decline in FPI from Mauritius. FPIs made a net outflow of about Rs. 8,671 crores from Indian equities in April 2024 after the protocol was signed between India and Mauritius.
As per the Indian tax authorities, notification is yet to be given of the protocol amending this treaty with suggestions that the PPT model could apply retrospectively or not, meaning investors will have to justify the commercial rationale behind their structures located in Mauritius which may lead to higher legal disputes since no exact effective date and grandfathering rules on existing investments are provided by the authorities leaving the investors in an uncertain state.
[1] Base erosion and profit shifting (BEPS) https://www.oecd.org/tax/beps/
References:
- CNBC TV https://www.cnbctv18.com/market/mauritius-share-in-total-fpi-assets-shrinks-to-6-in-march-2024-19396155.htm.
- Drishti IAS News Daily https://www.drishtiias.com/daily-updates/daily-news-editorials/observing-india-mauritius-tax-treaty.
- KPMG Update https://kpmg.com/us/en/home/insights/2024/04/tnf-india-mauritius-tax-treaty-update.html.
- NSDL Data https://www.fpi.nsdl.co.in/web/Reports/ReportDetail.aspx?RepID=99.
- Francoise Chan, ‘Mauritius: A Passage to India’ (IFC review 1st January 2013 https://www.ifcreview.com/articles/2013/january/mauritius-a-passage-to-india/.
- Mohammed S Chokhawala, ‘Double Tax Avoidance Agreement (DTAA) Between India and Mauritius https://cleartax.in/s/india-mauritius-dtaa.
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