Ever since it was signed three decades ago, the Indian markets have had an almost sacred association with the Indo-Mauritius Double Taxation Avoidance Agreement (DTAA). So much so that even the hint of an amendment to the agreement would send the markets into a tailspin. That’s not surprising given that over the years Mauritius has been the single most important source of foreign investment in the stock market and foreign direct investment in India. Mauritius-registered entities account for a fifth of the assets held by foreign portfolio investors in the country and about a third of all FDI received since 2000. There was no such upheaval in the markets on Wednesday though, the day after news of renegotiation of the treaty with Mauritius was announced by the Centre. Of course, there was initial nervousness at the start of trade but the market shrugged it off soon enough and the indices closed the day with loss of well under 1 per cent. And that in itself tells a story.
There is more than one reason why the move has been digested well. First, the amendments to the treaty are prospective and provide enough time for existing investors to plan their investments. The ‘grandfathering’ of investments made until April 1 next year — which essentially means that only investments made after that will be liable to capital gains tax in India — protects existing investments and holdings. There is no need for an immediate sell-off to escape tax. Other things remaining the same, the ‘grandfathering’ provision may also lead to higher investments from foreign portfolio investors in the next 11 months to take advantage of the tax exemption. The Centre has also been considerate in giving a further two-year period of concessional taxation beginning 2017-18 subject to conditions; investments by Mauritius-based entities will suffer full capital gains tax only from 2019-20. This is a mature and orderly way of phasing out a sensitive concession without rocking the boat.
The second reason for the market taking the development in its stride is that it probably saw this coming, especially given the repugnance worldwide to tax havens in the context of the Panama disclosures. The recent initiative by the OECD against Base Erosion and Profit Shifting (BEPS) that aims to stop double non-taxation by corporations leveraging no-tax jurisdictions was a clear signal of a global campaign against tax havens. Finally, though it appears counter-intuitive, the fact is that the amendment brings certainty to foreign investors who can now plan their investments better, since the Centre has set out a clear roadmap to end the exemption. With the treaty out of the way, the Centre now needs to focus on deepening its engagement with the strategically important island nation. Similar treaties that India has with countries such as Singapore and Cyprus also need to be amended in line with the Mauritius DTAA. This can pave the way for a re-look at the delayed rollout of GAAR (General Anti Avoidance Rules).