Protocol amending the India-Mauritius tax treaty

India Mauritius Tax Treaty was entered into on 24 August 1982 and it legally came into effect in the year 1991. The treaty aimed to avoid double taxation in India as well as Mauritius and to prevent evasion of the tax with respect to taxes on income and capital gains. It also aimed to encourage mutual trade and investment. As per the treaty, any capital gains realized by a Mauritius resident for sale or transfer of share in an Indian company are not taxable in India. Further, Mauritius does not impose tax on capital gains. Therefore the gains arising out of sale of Indian company shares were taxable neither in Mauritius nor in India.

Thus, as long as the investor provided a tax residency certificate in Mauritius and did not have a permanent residence in India the investment vehicle set up in Mauritius did not have to pay tax on capital gains. However due to this-

• Many domestic foreign investors routed their business deals via Mauritius to avoid paying tax in India. In past, Mauritius did not apply strict rules in issuing Tax Residency Certificate which could have led to tax gains for India on account of loss of its peculiar business model and taxes.
• Mauritius route became a hub for money laundering by Indian tax evaders as well as criminals without being detected or taxed.
• India wanted vigilance and information sharing on Round Tripping and possible Money Laundering from Indian investors.

Recently, India and Mauritius have signed a protocol amending the India-Mauritius tax treaty in May 2016. The amendment confers India the right to tax capital gains earned in India from the transfer of shares of an Indian company as per its domestic tax laws. However, in order to facilitate the transition to the new regime, the right to tax capital gains will be implemented in a phased manner. Capital gains tax at discounted rate will begin to be levied by India from 1 April 2017.

Salient features of the amendment are:

Full taxation from April 1, 2019 onwards

Capital gains arising on sale or transfer of shares of an Indian company acquired by the investor on or after April 1, 2017 will be taxed at the full domestic tax rate from April 1, 2019 onwards.

Introduction of a permanent establishment (PE) clause for services

After the amendment, a Mauritian tax resident will have a PE in India if it furnishes services (including consultancy services) through its employees or personnel and if the activities of the project of such nature continue for a period aggregating more than 90 days within any 12 month period.

Introduction of an article on fee for technical services (FTS)

India may now tax FTS income arising in India to a Mauritian tax resident at 10% of the gross amount of the FTS. Further, FTS has been defined in accordance with India’s domestic law to mean consideration for any managerial or technical or consultancy services.

Source based taxation of ‘Other Income’

Previously, only the country of residence had the right to tax the income falling under the residuary category of ‘Other Income’. Now the source country has the right to tax ‘Other Income’ arising in the country.

Update of exchange of information provisions and insertion of article on assistance in collection of taxes

The exchange of information between the two countries will now be as per international standards with the insertion of a new article on assistance in collection of taxes.

Till now the taxation structure had an inbuilt incentive for fund managers to operate from offshore locations. With the capital gains exemption being phased out in the India-Mauritius tax treaty, there is no upside for these fund managers to be based outside India. So it is expected that the fund managers managing India-focused funds and who want to be close to the market they invest in will shift base to India.

At present, investors coming in from Mauritius do not have to pay capital gains tax in India. But from 1 April 2017, India gets the right to tax capital gains from share transactions in Indian companies, though it will levy the tax at a discounted rate till 2019. This means that portfolio investors will have to pay short-term capital gains tax of 15% from 1 April 2019.

Questions for Analysis

• What are the reasons that necessitated such an amendment to a long standing treaty like this?
• How does India stand to gain from it?

What are the reasons that necessitated such an amendment to a long standing treaty like this?

As per the India Mauritius Tax Treaty, any capital gains realized by a Mauritius resident for sale or transfer of share in an Indian company are not taxable in India. Further, Mauritius does not impose tax on capital gains. Thus as long as the investor provided a tax residency certificate in Mauritius and did not have a permanent residence in India the investment vehicle set up in Mauritius did not have to pay tax on capital gains. However these led to under-mentioned issues:

• Many domestic foreign investors routed their business deals via Mauritius to avoid paying tax in India. Also, Mauritius did not apply strict rules in issuing Tax Residency Certificate fearing loss of its peculiar business model and taxes.
• Mauritius route became a hub for money laundering by Indian tax evaders as well as criminals without being detected or taxed.
• India wanted vigilance and information sharing on Round Tripping and possible Money Laundering from Indian investors.

The recent amendment confers India the right to tax capital gains earned in India from the transfer of shares of an Indian company as per its domestic tax laws as well as up-gradation of the exchange of information provisions as per the extant international norms.

How does India stand to gain from it?

Recent amendment to the India Mauritius tax treaty confers India the right to tax capital gains earned in India from the transfer of shares of an Indian company as per its domestic tax laws.

We review some of the features to understand how India seeks to benefit from it:

• Capital gains arising on sale or transfer of shares of an Indian company will be taxed at the full domestic tax rate from April 1, 2019 onwards.
• Mauritian tax residents will have a PE in India if they provide services through their employees and if the activities of the project of such nature continue for a period aggregating more than 90 days in a year.
• India may now tax fee for technical services (FTS) income arising in India to a Mauritian tax resident and FTS has been defined in accordance with India’s domestic law to mean consideration for any managerial or technical or consultancy services.
• The exchange of information between the two countries will now be as per international standards with the insertion of a new article on assistance in collection of taxes.

With the capital gains exemption being phased out in the India-Mauritius tax treaty the incentive for fund managers to be based outside India will vanish and consequently they are expected to shift base to India.