Friday, May 20, 2016

Protocol to India-Mauritius DTAA: A move towards avoidance of double non-taxation

Introduction:
A thirty three year old journey, peppered with much fund inflows, tax benefits, and simultaneously, ample criticism, is set to change its course, aligning with the emerging global tax order. The India-Mauritius tax treaty has finally been amended to remove capital gain exemption, albeit in a phased manner, particularly in the wake of India's commitment to BEPS2Action plan which advocates Stateless income, treaty abuse and round tripping of funds.
The Indian Government needs to be lauded and given credit for the manner in which the treaty has been sought to be amended (in a phased manner and not an abrupt shift), namely levying capital gains tax on transfer of Indian shares, which are acquired after 1st April, 2017. In other words, all investments made through Mauritius in shares of Indian companies till 31st March, 2017, have been grandfathered, thus the existing interests of investors have not been infringed at all. Further, it is proposed to introduce capital gains tax with respect to investments made in Indian shares on or after 1st April, 2017, in a phased manner, namely 50% of the tax for capital gains arising between 1st April, 2017 and 31st March, 2019, subject to fulfilling the limitation of benefit clause; and post 1st April, 2019, capital gains tax shall be levied at full rate. The aforesaid amendment to the tax treaty with Mauritius is likely to impact the India-Singapore tax treaty in a similar manner, as per the protocol signed between India & Singapore.

Analysis
1.

Circular No 682, dated 30-3-1994 providing clarification regarding agreement for avoidance of double taxation with Mauritius states as follows:

"Article 13, Paragraph 4 deals with taxation of capital gains arising from the alienation of any property other than those mentioned in the preceding paragraphs and gives the right of taxation of capital gains only to that State of which the person deriving the capital gains is a resident. In terms of paragraph 4, capital gains derived by a resident of Mauritius by alienation of shares of companies shall be taxable only in Mauritius according to Mauritius tax law. Therefore, any resident of Mauritius deriving income from alienation of shares of Indian companies will be liable to capital gains tax only in Mauritius as per Mauritius tax law and will not have any capital gains tax liability in India"

Hence, under the bilateral agreement existing between the two nations, capital gains from sale of shares can be taxed only in the place where the alienator (holder of the shares) is resident. Consequently, capital gains on sale of Indian shares by Mauritius entities are taxable only in Mauritius as per the DTAA3, and as Mauritius generally does not levy capital gains tax, there is no capital gains tax on such transactions - this lead to structuring of investments into India through Mauritius.
2.

Relevant points of Press release

a.

Taxation of Capital gains: Shift to Source-based taxation of capital gains on shares:

Under Article 13 (4) of the India-Mauritius DTAA, capital gains derived by a Mauritius resident from alienation of shares of a company resident in India ("Indian Company") were taxable in Mauritius alone. However, the Protocol marks a shift from residence-based taxation to source-based taxation. Consequently, capital gains arising on or after April 01, 2017 from alienation of shares of a company resident in India shall be subject to tax in India.

The aforementioned change is subject to the following:-

(a)

Grandfathering of investments made before April 01, 2017

The Protocol states that capital gains arising out of sale of shares of an Indian Company that have been acquired before April 01, 2017 shall not be affected by the Protocol. Such investments shall continue to enjoy the treatment available to them under the erstwhile Article 13(4) of the DTAA.
(b)

Transition period

The Protocol provides for a relaxation in respect of capital gains arising to Mauritius residents from alienation of shares between April 01, 2017 and March 31, 2019 ("Transition Period"). The tax rate on any such gains shall not exceed 50% of the domestic tax rate in India ("Reduced Tax Rate"). However, this benefit has been made subject to a "limitation of benefits" article that is proposed to be introduced to the treaty (discussed below).
(c)

Limitation of benefits

As per the Press Release, the benefit of the Reduced Tax Rate shall only be available to such Mauritius resident who is (a) not a shell/conduit company and (b) satisfies the main purpose and bonafide business test. Further, a Mauritius resident shall be deemed to be a shell/conduit company if its total expenditure on operations in Mauritius is less than INR 2,700,000 (approximately 40,000 US Dollars) in the 12 months immediately preceding the alienation of shares.


b.

Taxation of interest income of banks

The Protocol revises the tax rate on interest arising in India to Mauritius resident banks to state that such streams of income shall be subject to withholding tax in India at the rate of 7.5% in respect of debt claims and loans made after March 31, 2017. At present such streams of income are exempt from tax in India under the India-Mauritius DTAA.
c.

Exchange of information

While the text of the Protocol is yet to be released, the Press Note states that the exchange of information article (Article 26) has been amended to bring it at par with the international standards. Provisions such as assistance in collection of taxes and assistance in source-based taxation of other income have been introduced.
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