The Mauritius-India DTT was entered into in 1983. The 1990’s brought about the Mauritian Global Business Services by encouraging foreign investors to channel their investments in India through companies set up in Mauritius.
For the past few years it has been argued by Indian authorities that a large number of investors in question are in fact Indians who set up companies in Mauritius to re-invest in their own country from Mauritius, a process which is known as ‘round-tripping’ and which has the objective of tax avoidance in India. This issue has been taken into account by Mauritian authorities which reinforced the local rules in order to facilitate identification and prevention of investments funds originating from India. However, the perceived abusive use of the Treaty has led the Indian tax authorities to renegotiate the DTT.
This led to the protocol being signed between India and Mauritius on 10 May 2016. This is the outcome of extensive discussion and negotiation processes which have been ongoing for the past year and a half.
Main points featured in the Protocol
- Capital gains
- India has gained the taxation rights on capital gains arising from the alienation of shares acquired on or after 1 April 2017 in a company resident in India effective as from the financial year 2017-18.
- Protection to investment has been granted in relation to the shares acquired before 1 April 2017.
- During the transitory period between 1 April 2017 – 31 March 2019, the rate of taxation on the capital gains shall be 50% of the domestic tax rate, and such reduced rate shall be subject to fulfillment of the Limitation of benefit (“LOB”) Article.
- Under the LOB Article, a resident of Mauritius, excluding a shell/conduit company (a resident of Mauritius shall be deemed to be a shell/conduit entity, if its total expenditure on operations in Mauritius is less than INR 2,700,000 (equivalent to MUR 1,500,000) in the immediately preceding 12 months), shall not be entitled to the benefit of 50% reduced rate of tax, if such resident fails the main purpose test or bona fide business test.
- Taxation (capital gains) post the transitory period will be at the full rate from the financial year 2019-20 onwards.
- Interest income – banks
- Interest income arising in India to a Mauritian resident bank, will be subject to withholding tax in India, at the rate of 7.5% in respect of debt claims or loans made after 31 March 2017.
- Interest income arising in India to a Mauritian resident bank in respect of debt claims or loans made on or before March 31, 2017 shall be exempt from tax in India.
What practical impact will the newly signed protocol have on Mauritius & Indian investments
- The source based taxation approach will clearly impact on foreign investment from Mauritius into India.
- The amendment will impact ongoing/proposed investments routed through Mauritius. Investments which will be made between the period of the amended provision and April 2017 may be seen as having been entered into mainly for the purpose of seeking the benefit under the Tax Treaty. However, there is a window of investment that will enjoy the exemption from capital gains tax, which may well draw investments into India.
- Entities incorporated in Mauritius for the mere purpose of investments will not be able to meet the LOB conditions, and will therefore be liable to tax at the normal domestic tax rates in India.
- From April 2019 onwards all benefits fall away which is likely to have a significant impact on Mauritius Indian investment.
- Private equity funds and venture capital funds proposing to invest through Mauritius will also be impacted after that date.
Certain areas which remain unclear
The protocol does not seem to have an impact on the taxation of indirect transfers. However, it will be arguable whether a transaction of indirect transfers prior to 1 April 2017 will now be taxed under the new Protocol based on the benefits secured to the Mauritian resident company without looking through the antecedent transaction of the indirect transfer.
Compulsorily convertible debentures are the most frequent convertible instruments through which foreign investors invest into Indian companies. If such instruments are converted after 1 April 2017, it thus remains unclear whether the shares are acquired after 1 April 2017 and accordingly taxed in India.
Comparison between the Mauritius-India treaty and the Singapore-India treaty
Around 50% of foreign direct investment (FDI) into India comes through Mauritius and Singapore, with Singapore as the second-biggest source of FDI. About 34% of such investment is channeled through Mauritius and 16% through Singapore.
It has also been indicated by the Indian government that the India-Singapore DTAA is proposed to be re-negotiated in order to prevent abuse of the treaty, loss of revenue and round-tripping.
Interestingly, the capital gains tax benefit under the India-Singapore Treaty is linked to the capital gains tax provision in the India-Mauritius tax treaty. However, this equivalence is not automatic and the India-Singapore treaty will have to be amended to clearly spell out any changes.
Singapore would appear likely to lose the benefit it has been enjoying, due to changes arising out of the likely re-negotiation of their Treaty with India.
According to the LOB clause in the India–Mauritius treaty, a resident entity would be deemed a shell or conduit company if total expenditure in Mauritius is less than USD 34,000 (MUR 1.5 million) in the preceding 12 months.
The India-Singapore tax treaty already has an LOB clause in place that makes expenditure of USD 100,000 (MUR 3.6 million) mandatory to avoid the limitation.
For a while therefore Mauritius retains a small advantage compared to Singapore. In addition, Singapore is subject to some uncertainty as to the terms which will be enforced after the DTAT with India is re-negotiated.
According to Article 6 of the protocol to the India-Singapore Income Tax Treaty (1994) the impact on the India-Singapore income tax treaty with regards to the exemption of capital gains arising to Singapore residents from the disposal of shares of an Indian company, is that it will only remain in force as long as the India-Mauritius treaty continues to provide for exclusive residence taxation on shares.
As mentioned previously, the protocol to the India-Mauritius treaty includes a provision which guarantees exclusive residence taxation for shares acquired before 1 April 2017, however it may not be possible to extend such treatment to investments made under the India-Singapore treaty. Therefore, the disposal after 1 April 2017 of shares in an Indian company, acquired before 1 April 2017 by a Singapore resident person, may not be eligible for exclusive residence taxation.
For more information, please go click here.