India begins to end the treaty shopping opportunities

“The protocol for amendment of the convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains between India and Mauritius was signed by both countries on May 10 at Port Louis, Mauritius,” has been announced by the Finance Ministry of the Government of India on May 11, 2016.

Though there has been talks about this amendments for more than 10 years. The current developments like Panama Papers, BEPS initiative of OECD to which India has committed which requires countries to curb treaty shopping and desire to implement ‘nexus’ approach finally lead to the both the countries agreeing for the amendment. This has brought to an end the uncertainty for the investor community. Further, it is expected that India will close other such loopholes existing in the treaties with other countries like Cyprus and Netherlands.

The amendments proposed by this protocol changes the taxation of capital gains to source-based. Prior to the proposed amendment, India Mauritius treaty provided residence based tax for capital gains. That means prior to this protocol the capital gains tax on sale of securities in India can be taxed only in Mauritius. The laws of Mauritius, on the other hand, provided zero capital gain tax. Hence, the Mauritius route to Indian capital markets was the most preferred and profitable route for foreign investors. The existing provision has been much used and talked about benefit which helped almost a third of FDI in India being routed through Mauritius.

Under the new protocol, capital gains arising from sale of shares of Indian resident companies acquired after April 1, 2017 will be taxed in India. However, the investments which have already been made will continue to have legally the benefit of zero double taxation. There are some doubts whether the protocol will apply only to shares or other securities as well. These details will be available as and when the text of the protocol is made public.

A transition window has been provided to the companies before the rules kick in. The following is the broad framework:-

• Presently, under India Mauritius Treaty, India does not tax capital gains on sale or transfer of shares of Indian-resident companies by Mauritius-resident companies.
• From April 1, 2017 to 31st March, 2019, companies based in Mauritius will pay capital gains tax @50% of the domestic tax rate. For example, if the current rate is 15%, the companies shall pay only 7.5%.
• After April 1, 2019, the companies will have to pay full tax.
• The benefit of tax at half the domestic tax rate will be given under special conditions of passing the ‘main purpose’ test and ‘bonafide business’ test.
• In case the expenditure of a company resident in Mauritius is less than Rs. 2,700,000 in the immediately preceding 12 months, it will be considered as a shell company and will not be able to claim benefit of tax at half the domestic rate during the transition period from April 1, 2017 to March 31, 2019.

The protocol also provides for updation of Exchange of Information as per international standard, provision for assistance in collection of taxes, source-based taxation of other income and other changes. It will be interest to see, once the details are available, the understanding and procedure for assistance in collection of taxes.

This Protocol will also impact the exemption available for capital gain tax in the India – Singapore tax treaty. There is a specific provision in India – Singapore treaty that the capital gains tax exemption shall remain in force so along as India – Mauritius treaty provides for residence based taxation for capital gains. With this change in India – Mauritius treaty, the benefit of residence based taxation available under India – Singapore treaty will not be available. Though the date from which this benefit will cease under India – Singapore treaty is not clear.