The amendment of Double Taxation Avoidance Agreement (DTAA) by India and Mauritius signals a paradigm shift from promoting bilateral investment flows to preventing tax evasion.
A Principal Purpose Test (PPT) has been incorporated in the agreement under which tax administration can deny the tax treaty benefit if the principal purpose of the action undertaken by the taxpayer was to obtain a benefit.
Protocol details
The protocol amending the treaty was signed on March 7 and now the details of the signed protocol are out in public. There is change in the preamble where the expression ‘encouragement of mutual trade and investment’ has been removed. It has been said that both countries intending to eliminate double taxation with respect to taxes covered by this convention without ‘creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this convention for the indirect benefit of third jurisdiction).’
Explaining this, 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. “This is a paradigm shift in the applicability of the treaty provisions to situations that otherwise were the basis of deciding in favour of the taxpayer in the judgment of Azadi Bachao Andolan by the Supreme Court,” he said.
To apply PPT, a new article has been added to the treaty which says ‘a benefit under this convention shall not be granted in respect of an item of income if it is reasonable to conclude that obtaining that benefit was one of the principal purposes.’ Explaining this provision, Rakesh Nangia, Chairman of Nangia Andersen India said that such a provision aims to curtail tax avoidance by ensuring that treaty benefits are only granted for transactions with a bona fide purpose.
However, the application of the PPT to grandfathered investments remains ambiguous, highlighting the need for explicit guidance from the CBDT. “The omission of the phrase ‘for the encouragement of mutual trade and investment’ from the treaty’s preamble suggests a shift in focus towards preventing tax evasion over promoting bilateral investment flows. This development underscores India‘s commitment to international tax co-operation standards while raising critical considerations for investors leveraging the India-Mauritius corridor,” he said.
The preferred channel
The treaty was first signed on August 24, 1982 and amended on May 10, 2016. Mauritius was initially the preferred channel for foreign portfolio and foreign direct investors due to the tax advantage that accrued due to the DTAA between two countries. The agreement laid down that capital gains tax had to be paid in the country where the foreign investor was based. Since the rate of capital gains tax in Mauritius was zero, investors from this country paid no capital gains tax.
However, the situation changed in 2016 when it was decided that in case of shares purchased after April 1, 2017, capital gains arising from an investment in an Indian company will be taxed in India. With the double tax avoidance treaty with Singapore being linked to the agreement with Mauritius, investments from Singapore have also been brought into the Indian tax net.