Amendments to India-Mauritius Tax Treaty 2016

Introduction 

The government on 10^th May 2016, announced the amendments made in India-Mauritius treaty under Double Tax Avoidance Agreement (DTAA). This move was surprising for the Indian Financial Markets. Financial markets reacted negatively.

In the long term every one see this move by the government to have positive impact on the business environment.

The change in treaty will lead Mauritius based companies to pay taxes on the short term capital gains realised after selling their investment. The amendments have ended the three decade old rule. Earlier companies sending money from Mauritius were paying zero taxes.

Amendments 

The India-Mauritius DTAA was signed in 1983. According to the treaty India would not be charging any tax on capital gains. The investors would only pay taxes in Mauritius. This greatly helped foreign investors.
From the year 2000, India attracted around $278 billion in foreign investments. One third of it came from Mauritius.

The government first started negotiating with Mauritius government in 1996, but the negotiations stopped in 2002.

The amendments were made to challenge the issues relating to treaty abuse. This will also restrict the flow of black money.
Capital gains tax will be levied on Investment routed through Mauritius.

Capital gains on Investments made from 1^st April, 2017 will have to pay 50% of the domestic tax rate till 31^st March 2019 and 100% domestic tax rate from 1^st April 2019.

If any Mauritius based company sell its stake in India. They will be taxed at 50% of the applicable rate from 1^st April 2017 to 31^st March 2019.

For e.g. if tax in India was 10%, the shell company from Mauritius will be taxed at 5% for the first two years starting from April 2017 till 31^st March 2019.

If any investments were made before 2017, they would not have to obey the new rules. This would mean share sale of investments made before this date will be immune from capital gains tax.

Most of these entities are set up as Shell Corporation. Through these companies investments are made in Indian Companies.

From the year 2000 to 2015, Mauritius has been the largest source of FDI for India. An enormous amount of $94 billion has been flowing from Mauritius

It was also brought into notice that any Mauritius based company investing in India will not allowed 50% tax reduction during the transition period if they do not spend at $40k in one year. The 50% tax reduction will be subject to Limitation of Benefit Article.

Companies to avoid double taxation would register gains in India and put it in tax have countries with whom India has double tax avoidance agreement (DTAA).

In tax haven countries the capital gains are treated as capital. This can then be invested back in India as Foreign Direct Investment. In the whole process the entity investing in India paid zero taxes. They all citied DTAA and argued to pay taxes in tax haven countries. The tax rates in tax haven countries was zero.


Effect of Amendments 

Many foreign investors will now have to restructure their strategies. The stock market did not take the news positively and dropped.

While many industry official believe this will reduce the flow of investments. Government on the other hand believe this will help curb the black money.

Offshore Derivative instruments account for more than two-thirds of investments via Participatory notes. Most of them flow through Mauritius and Singapore.They will be taxed now for short term capital gains.
Many believe the amendments in treaty will make Participatory notes less attractive. Earlier companies would send their money to India for investment via round tripping.

Round tripping is done by individual who route investments through one country to another country back to their own country.

The government also believe that not all of funds coming to India from Mauritius is foreign investment as most of it from rich Indian investors practising round tripping.

P-notes are used by investors who wish to invest in India without registering with market regulator.The new tax rules could affect in the short run. This can also reduce the net gains of a fund.


Conclusion

In the end many investors believe the new tax system would reduce the flow of investments from foreign funds. The aim of this treaty is to bring transparency into the tax system and also bring tax evasion and round tripping under check. It is great measure which will create a path for well-defined tax rule.
Also, DTAA should not be mixed with GAAR. GAAR is meant to reduce avoidance of tax. The tax authorities under GAAR have the power to inspect any financial transaction. If they believe it is for tax avoidance purposes. If tax authorities believe any foreign transaction is done to exploit DTAA, GAAR can be used to check the transaction. However, long term capital gains will be exempt from tax and it would be great for the country.