India to tax capital gains under revised Mauritius treaty

India will get the right to tax capital gains on investments after April 2017 under an amended tax treaty with Mauritius, the government said on Tuesday, in a move that it expects will help fight tax evasion and curb misuse of the pact.

However, investments made before April 2017 will not be subject to taxation, the finance ministry said in a statement.

India and Mauritius had signed a Double Taxation Avoidance Agreement in 1983. The pact allowed only Mauritius to tax capital gains. However, the island nation generally doesn’t impose a capital gains tax. This meant that companies gaining from investments made in Indian companies via Mauritius-based entities managed to avoid paying taxes in both countries.

The tax treaty made Mauritius the biggest source of foreign direct investment into India. According to data from the Department of Industrial Policy and Promotion, India received about $93.6 billion of FDI from Mauritius between April 2000 and December 2015. This is 34% of the total FDI inflows into India. Many private equity and venture capital firms also invest in India through funds registered in Mauritius.

India has been pressing for a change in the treaty for several years and has often alleged that the tax treaty enabled some Indians to route cash via the island nation to avoid paying local domestic taxes, a practice known as round-tripping.

The revised pact “will tackle the long-pending issues of treaty abuse and round-tripping of funds” attributed to the India-Mauritius treaty, the finance ministry said. It will also help curb revenue loss, prevent double non-taxation and streamline the flow of investment, it said. “It will improve transparency in tax matters and will help curb tax evasion and tax avoidance,” the ministry added.

According to the revised pact, sale of shares of an Indian resident company will be taxed at 50% of the applicable rate between April 1, 2017 and March 31, 2019. Full capital gains tax will apply from April 1, 2019, the ministry said.

However, the benefit of 50% reduction in tax rate during the transition period from 2017 to 2019 shall be subject to Limitation of Benefits. This means a resident of Mauritius will have to pay the full rate if it fails the main purpose test and bonafide business test. A resident is deemed to be a shell or conduit company, if its total expenditure on operations in Mauritius is less than Rs 27 lakh (about $40,000) in the immediately preceding 12 months.

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