Finally, a done deal with Mauritius

The India-Mauritius tax treaty has been a matter of media speculation and policy consideration for a considerably long time.

Mauritius has been the most preferred jurisdiction for investments in India, in view of its liberal business and economic environment as well as potential capital gains tax exemption under the treaty.

However, this has aggravated concerns on double non-taxation, treaty shopping and, more particularly, round-tripping where the Government has alleged that money from India was being re-routed via Mauritius back into the country. Extensive and long drawn-out negotiations have led to a landmark amendment of the treaty.

The amendment The protocol signed on May 10, 2016, amends the existing treaty to provide India the right to tax the capital gains arising to a Mauritian resident from alienation of shares of a company resident in India, if such shares are acquired after April 1, 2017. Shares acquired up to March 31, 2017, are ‘grandfathered’ such that its sale anytime in the future would be tax-protected as under the original India-Mauritius tax treaty.

At the same time, a transitional window is provided for a 50 per cent reduced tax rate on capital gains arising before April 1, 2019, from investments made after March 31, 2017, subject to the Mauritian investor satisfying the Limitation of Benefits (LOB) provisions.

The approach of the protocol resonates a clear intent to provide certainty and stability in tax regime albeit with an increase in tax costs. The grandfathering provisions are in line with the spirit of refraining from retrospective legislation. It can be anticipated that this move would potentially surge investments in India until March 31, 2017 to take advantage of the grandfathering window and potentially the onset of the general anti avoidance rules (GAAR) expected thereafter. Further, the window given in the transition period will give sufficient time investors to plan and reassess their investment structures.

The Mauritius LOB provision is comparable to its counterpart in the India-Singapore treaty, though ambiguity could arise in the interpretation of “primary purpose” test and “real business” test. Presently, the LOB provisions are applicable only for availing of the relaxed taxation of 50 per cent in the transition period.

The same would not apply to sale of shares after March 2019 and also to other aspects of the treaty such as treaty residence, application of reduced rate to interest income, beneficial ownership, and so on.

Some limitations The proposed amendment in capital gain taxation is limited in its applicability to ‘shares’ of a company resident in India. This would cover all kinds of shares such as equity/preference, shares with or without differential rights, etc.

However, the provisions do not cover other financial instruments such as derivatives, convertible debentures, hybrid instruments, interest in LLP and so on. Considerations for structuring future investments using alternate models such as LLP or other financial instruments may continue to provide more tax efficient alternatives.

Significantly also, the indirect transfer of shares of a Mauritian company may not be captured in the amended provisions unless it has its place of effective management in India. However, any such attempts would have to be kosher from a GAAR standpoint. Concerns may arise with regard to the grandfathering benefit on issue of shares after April 1, 2017, pursuant to transactions such as right issue, bonus issue, corporate reorganisations, etc.

The impact of the protocol to the India-Mauritius treaty on the India-Singapore treaty is important since the tax treatment of capital gains under the two treaties are co-terminus. It is unclear if the benefits under the India-Singapore treaty would be affected completely or whether the relaxation of grandfathering could also be extended.

Based on media statements, it is expected that a dialogue on renegotiation of the India-Singapore treaty is on the cards almost immediately.

In addition to capital gains taxation and LOB insertion, the protocol modifies taxation of interest income in the State where it arises (the source State) at a reduced rate of 7.5 per cent and provides for taxation of other income in the source State.

New provisions in terms of service PE and fees for technical services are inserted along with modification of provisions on exchange of information and assistance in collection of taxes in line with international standards.

It would be interesting to understand whether the options for the future were deliberately considered to be retained or are the unintended consequences of the process so far.

The writer is a partner and national leader, International Tax Services, EY. Senior tax professional Aastha Jain of EY contributed to the article. The views are personal