India, Mauritius amend tax treaty to plug loopholes

India and Mauritius on Tuesday amended an existing tax treaty to allow India to impose capital gains tax on investments routed through Mauritius from April next and thereby curb tax evasion and round-tripping of funds.

The protocol for amendment of the 1983 Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income and capital gains will have a significant bearing on capital flows from the island nation.

Till now the convention did not provide for taxing capital gains in either of the two nations.

The protocol signed by both countries at Port Louis, Mauritius on Tuesday, provides for source-based taxation of capital gains on shares, which would give India taxation rights on capital gains arising from alienation of shares acquired on or after 1 April 2017.

The taxability would apply for a company resident in India with effect from financial year 2017-18, while simultaneously ensuring protection to investments in shares acquired before 1 April 2017.

Further, in respect of such capital gains arising during the transition period from 1 April 2017 to 31 March 2019, the tax rate will be limited to 50 per cent of the domestic tax rate of India, subject to the fulfillment of the conditions in the Limitation of Benefits Article.

Taxation in India at full domestic tax rate will take place from financial year 2019-20 onwards.
 
The benefit of 50 per cent reduction in tax rate during the transition period from 1 April 2017 to 31 March 2019 will be subject to LOB Article, under which a resident of Mauritius (including a shell / conduit company) will not be entitled to benefits of 50 per cent reduction in tax rate, if it fails the main purpose test and bona fide business test.

A resident is deemed to be a shell / conduit company, if its total expenditure on operations in Mauritius is less than Rs2,700,000 (Mauritian Rs1,500,000) in the immediately preceding 12 months.

Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5 per cent in respect of debt claims or loans made after 31 March 2017. However, interest income of Mauritian resident banks in respect of debt-claims existing on or before 31 March 2017 will be exempt from tax in India.

The protocol also provides for updation of exchange of information article as per international standards, provision for assistance in collection of taxes, source-based taxation of other income, amongst other changes.

The protocol will tackle the long pending issues of treaty abuse and round tripping of funds attributed to the India-Mauritius treaty, curb revenue loss, prevent double non-taxation, streamline the flow of investment and stimulate the flow of exchange of information between India and Mauritius.

It will improve transparency in tax matters and will help curb tax evasion and tax avoidance. At the same time, existing investments, ie, investments made before 1 April 2017, have been grand-fathered and will not be subject to capital gains taxation in India.

The island nation with just 1.3 million people was the biggest single source of foreign direct investment into India in 2014-15, accounting for about 24 per cent of $24.7 billion foreign direct investment (FDI). Singapore accounted for 21 per cent.
 
The three-decade-old taxation treaty, which came into force on 1 April 1983, has been misused by many Indian and multinational companies to avoid paying tax or to route illicit funds.

India has been insisting on review of the treaty since 2006 as it felt a chunk of the funds were not real foreign investment but Indians routing cash through the island to avoid domestic taxes, a practice known as "round tripping".

It wanted to ensure firms in Mauritius that invest in India are not just 'shell' and have substantial operations in the island, such as paying staff there, to qualify for tax exemption under the tax treaty.

Mauritius agreed for a review only in June 2011.

Prime Minister Narendra Modi discussed the treaty on a visit to Mauritius in March last year.

The DTAC till now provided that capital gains on sale of assets in India by companies registered in Mauritius can only be taxed in Mauritius. While short-term capital gains are taxed at 15 per cent in India, they are exempt in Mauritius. So, such companies escape paying taxes in both countries.
 
A large proportion of foreign investment in the stock market comes through companies registered in the Indian Ocean island nation and are exempted from tax in India under the treaty.

From next financial year, he said, exchequer will be benefit from capital gains tax on share deals with Mauritius.