Capital gains now a part of India-Mauritius tax treaty
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Capital gains now a part of India-Mauritius tax treaty

Varun Marwah

As a part of Government’s continuous effort to tackle the menace of base erosion and profit shifting (BEPS), India and Mauritius yesterday, in Port Louis, signed a Protocol amending the Double Taxation Avoidance Agreement (DTAA) between both the countries.

More specifically, the DTAA will prevent tax avoidance with respect to taxes on income and capital gains. The Government is now looking at re-negotiating the DTAA with Singapore to plug any similar loopholes.

BEPS refers to tax planning strategies which exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.

To resolve this, the treaty was re-negotiated in the recent past to incorporate certain changes in current tax treatments in order to prevent treaty abuse and round-tripping of funds.

The amendment comes in the wake of the Panama Papers Leak and also following the announcement made during the 2016-17 budget by the Finance Minister promising to implement General Anti-Avoidance Rules (GAAR) from April 1, 2017.

Revenue Secretary Hasmukh Adhia said,

The treaty amendment of DTAA with Mauritius brings about a certainty in taxation matters for foreign investors. It reinforces India’s commitment to OECD-BEPS initiative of stopping ‘double non taxation’ enjoyed by companies

Current Status

As per existing DTAA, 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.

While gains on shares held for less than 12 months are treated as short-term capital gains tax, the gains on sale of shares after holding for 12 months are treated as long-term capital gains tax and, currently, attract zero tax.

As a result, entities operating out of Mauritius avoid paying even short-term capital gains tax on share transfers.

The amendment

As per the amendment:

  • Beginning April 1, 2017 till March 31, 2019 – India will kick in the GAAR. Entities based in Mauritius and Singapore will have to pay capital gains tax at 50 per cent of domestic rate in India.
  • After April 1, 2019 – Full domestic tax rate applicable on entities’ capital gains on sale/transfer of India shares by Mauritius and Singapore based entities.

What this means is, investments made before April 1, 2017, will be “grand-fathered”, meaning they will not be subjected to capital gains taxation in India even after the GAAR kicks in.

Daksha Baxi, Executive Director at Khaitan & Co told Bar & Bench that,

One excellent thing that has happened  is bringing in certainty- all investment made prior to 2017 are grandfathered. Government has kept its promise of not making retrospective changes in law. The smart thing that has been done is- a time period of 10.5 months is provided to foreign investors to make their investments, and get tax exemptions. This should see a flurry of  inflow of foreign investments in India in this period”

While the the transition period is a welcome move, there is slight ambiguity in the language.

Adds Baxi,

But the press release is a little ambiguous on the point of transition period- will investments made during the transition period be qualified for 50% exemption whenever they are sold OR is it only the investments which are sold during that period which will qualify for 50% exemption?

If it is the latter, then the first provision which is a grandfathering provision seems to clash with it. So, the first interpretation seems to be right one, but the language of the press release does not support this interpretation”

  • However, in order to claim the benefit of 50% reduction in tax rate during the transition period of April 1, 2017 to March 31, 2019, the entity based in Mauritius (including shell/ conduit company) must pass the ‘main purpose and bonafide test’ according to which its total expenditure in operations in Mauritius should be more than 27 Lakh in the immediately preceding 12 months.To this, Baxi says,

“Firstly, as is provided for the GAAR also, there should be a commercial substance. It is not plausible to provide objective definition of commercial substance. This is bound to be subjective. 

Each business has its own business concerns and business purposes. What can be provided is- some sort of guidelines. Basically, there has to be a commercial reason for making such an investment and not just a tax reason. 

Secondly- the amount of expenditure. Investments made by companies which have already been set up are already protected. So now, companies which cannot sustain that kind of expenditure should not be set up.”

  • Further, any interest income arising in India to Mauritian resident bank will be subject to 7.5 per cent withholding tax after March 31, 2017.

So will the changes introduced affect foreign investments in India?

Baxi explains:

“Investors from the US are most likely to be affected. This is because in the US there is a source rule, which says that capital gains realised by a US resident from sale of shares is US source income, it cannot have a foreign tax credit. India-US treaty should have provided for re-sourcing the income which arises out of capital gains in India, which has not been provided.

There are other treaties which US has entered into which provide such resourcing rule. In such jurisdictions when a US resident pays capital gains tax, they get a tax credit in the US.

India should consider amending the US- India treaty  as well such that the capital gains taxes paid in India can be credited against US capital gains tax.”

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