The amendment of the Double Taxation Avoidance Agreement (DTAA) by India and Mauritius plugs another loophole in the tax treaty signalling a paradigm shift from promoting bilateral investment flows to preventing tax evasion.
The most recent amendment includes a Principal Purpose Test (PPT) that helps in deciding whether a foreign investor is eligible for treaty benefits or if their primary motive for routing investments via Mauritius is to get tax benefits.
The protocol seeks to amend the very preamble of the tax treaty to showcase the intent to mitigate opportunities for non-taxation or reduced taxation in line with Article 6 of the Multilateral Instrument (MLI) Base Erosion Profit Shifting.
Saurrav Sood, Practice Leader at SW India said, "The amendment aims to exclude encouragement of mutual trade and investment and include the intention of not providing treaty benefit that creates a situation of reduced taxation or non-taxation."
Further, by Article 7 of the MLI– Prevention of Treaty Abuse, a new Article 27B is sought to be included in the India-Mauritius Tax treaty which embodies a new test for limiting the ability to claim tax treaty benefits, i.e. the PPT wherein benefits under the tax treaty would not be granted if obtaining that benefit was one of the principal purposes of any arrangement or transaction taking into cognisance the underlying facts and circumstances.
As per the proposed changes, the benefits of lower taxation as available under the India-Mauritius DTAA can be denied to investors if one of the primary purposes of investing through Mauritius was to obtain a tax benefit.
“Bare reading of the proposed protocol suggests that Governments may want to curb the historical artificial structures created for obtaining advantage of any of the beneficial provisions under India-Mauritius DTAA which inter alia includes the grandfathered capital gains tax benefit,” said Mitesh Jain, Partner at Economic Laws Practice.
Under the 2016 Protocol between India and Mauritius, investments in shares till 31 March 2017 were grandfathered and capital gains taxing rights from the sale of investment made from 1 April 2017, were granted to the source state.
Jain further added that the wordings “shall have effect without regard to the date on which taxes were levied or the taxable years to which the taxes relate” indicates that provisions under protocol shall apply to any tax deducted post date of entering into force of the protocol irrespective of the date of accrual of such payment.
“However, the language of the current protocol is ambiguous and has led to doubts concerning the continuity of this grandfathering once the Protocol is put into effect. The aspect of retroactive applicability of the PPT to deny even such grandfathering benefits is raising serious concerns amongst non-residents who have adopted the Mauritius route for Indian investments.
"The Income Tax Department did acknowledge the concerns whilst stating them to be premature since the protocol on the Tax treaty is not yet notified and stated that queries or concerns would be addressed post-notification,” said Amit Gupta, Partner at Saraf and Partners.
The treaty between India and Mauritius was initially signed on 24 August 1982 and later amended on 10 May 2016. The agreement created a favourable tax environment for foreign portfolios and foreign direct investors who used Mauritius as a channel.
According to the treaty, capital gains tax was payable in the country where the foreign investor was based. Since Mauritius had a zero per cent capital gains tax rate, investors from this country were exempt from paying any capital gains tax.
However, things changed in 2016 when it was decided that capital gains arising from an investment in an Indian company would be taxed in India. This rule would be applicable only in the case of shares purchased after 1 April 2017.
“Post amendment by 2016 protocol, investment by Foreign Portfolio Investors (FPIs) in India from Mauritius has been on a decreasing trend. As of March 2024, FPI investments from Mauritius stood at Rs 4.18 lakh crore, representing 6 per cent of the total FPI assets as against about 20 per cent in 2016.
Even at 6 per cent, Mauritius is in the fourth spot only behind the USA (39 per cent), Singapore (9.77 per cent) and Luxembourg (7.15 per cent), according to country-wise asset under custody (AUC) data published by National Securities Depository (NSDL),” added Jain of Economic Laws Practice.
Mauritius has been a preferred intermediary jurisdiction for investors to infuse money into India. In fact, with the news of this amendment to the India- Mauritius tax treaty, it is being stated that FPIs nearly pulled out nearly USD 1 billion from the Indian stock market which goes a long way to reflect the significance of the Mauritius route for FPI and the gravity of the fears amongst such investors.
“Whilst Mauritius has been a preferred route for India investments, interestingly in the past few years jurisdictions like Singapore, Luxemburg, et al have also been coming up in the list of overall FPI funds coming into India,” added Gupta, Partner at Saraf and Partners.
In case of dividends for the financial year 2023-24 (FY24) which are declared and paid after the date of entering into force, TDS shall be deducted after applying the anti-abuse provision provided in the protocol. Post-amendment grandfathered capital gains benefit under DTAA shall be available only to investors who shall fulfil the principal purpose test.
“The protocol may not only impact the fresh investment but also deny DTAA benefit to historical structures which are created with tax benefit as one of the principal purposes of investing through Mauritius.
Hence, where the protocol is made applicable to historical investments made by FPI from Mauritius, investors not fulfilling the test may withdraw their investments in India and there may also be a fall in fresh investment from Mauritius,” mentioned Jain from Economic Laws Practice.
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