India-Mauritius tax treaty: Will investors redraw investment routes?

13 May, 2016

After several years of negotiations, the double taxation treaty between India and Mauritius has now been amended through a protocol signed between the two countries. This has ushered in a significant shift in the tax treatment for investments from Mauritius into India.

India now gets taxation rights on capital gains arising out of transfer or sale of shares of Indian companies acquired by Mauritian residents. The capital gains tax treatment for existing investments by Mauritius residents will not be affected. Investments made up to (but excluding) April 1, 2017, will continue to enjoy the existing tax benefits. However, all capital gains made on or after April 1, 2017, would be subject to capital gains tax as per Indian tax rates.

The protocol provides for a transition period from April 1, 2017 to March 31, 2019 (both days inclusive). Any capital gains arising during the transition period will be subject to a reduced tax at 50% of the domestic tax rate of India, subject to satisfaction of certain conditions. Full domestic tax rates will be applicable from financial year 2019-20 onwards.

The Mauritius resident investor will be required to satisfy the ‘main purpose test’ and the ‘bona fide business test’ in order to avail the reduced tax rates during the transition period. A resident is considered a shell company if its total expenditure on operations in Mauritius is less than Rs 27 lakh in the immediately preceding 12 months.

The protocol has introduced changes in the tax on interest arising in India. Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5%. Again, as in the case with the capital gains tax introduction, there is a grandfathering provision here as well. Interest income of Mauritian resident banks in respect of debt-claims existing on or before March 31, 2017 is exempt from tax in India. The tax at 7.5% will be applicable only for those debt claims or loans made after March 31, 2017.

The present language in the government’s press release appears to only include Mauritius banks within its fold. However, we believe that the tax rate of 7.5% may be extended to all debt investors from Mauritius. Some clarity from the government may help here.

The changes stipulated are in line with the government’s stated position on ridding the system of money laundering and tax avoidance issues. The press release from the Ministry of Finance attributes the changes to instances of treaty abuse and round-tripping of funds owing to the tax benefits previously accorded to Mauritian investments into India. The government seeks to curb revenue loss, prevent double non-taxation, streamline the flow of investment, and stimulate the flow of exchange of information between India and Mauritius.

The provisions introduced by the protocol have generated considerable debate and discussion amongst the investor community within and outside India. While the responses have been mixed, it has been seen that foreign investors (especially the ones who have structured their Indian investments through Mauritius) have not welcomed the change, while domestic investors have generally been more positive in response.

What, however, needs to be seen is whether the expected upshot for India in terms of raising money through tax levy would offset the expected drop in investments through Mauritius (a country which has accounted for about one-third of the total foreign direct investment into India during the last decade). We may be in a better position to gauge the impact post April 1, 2017, once the grandfathering provisions under the protocol expires.

India is expected to follow the same approach in negotiations with its second-biggest contributor of foreign direct investment, Singapore. While the capital gains tax benefit in the India-Singapore tax treaty is linked to the benefits under the Mauritius Treaty, an amendment of the treaty with Singapore would be required in order to bring into force any such changes. The Indian government has indicated that it proposes to commence negotiations with Singapore.

The year 2016-17 promises to be an interesting one for investors interested in India. It would need to be seen whether investors will decide to fast-track their plans by investing into India prior to April 1, 2017, so that existing treaty benefits may be availed, or whether they will go back to the drawing board to restructure their investment routes.

Probir Roy Chowdhury is a partner and Vishnu Nair is a senior associate at law firm J. Sagar Associates.

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India-Mauritius tax treaty: Will investors redraw investment routes?

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