India And Mauritius Sign A Protocol For Amendment Of India - Mauritius Double Taxation Avoidance Agreement
Contributed by SK Attorneys
20 May, 2016
A press note was released on 10 May 2016 notifying the signing of the Protocol and highlighting the major amendments to 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 (India-Mauritius DTAA) . The Protocol is the outcome of an extensive and long drawn-out negotiation process that has been going for more than a year and a half.
Summary of the key features of the protocol is as under:
- Source-based taxation on capital gains arising from alienation of Indian company shares acquired on or after 1st April, 2017;
- Source-based taxation of interest income of Mauritian banks; and
- Other changes.
The above-mentioned changes are discussed in detail below:
Source-based taxation on capital gains arising from alienation of Indian company shares acquired on or after 1st April, 2017
The basis of taxation will move from a residence based taxation to a source based taxation, thereby India shall have the right to tax capital gains earned in India from the transfer/ alienation of shares of an Indian company as per its domestic tax laws. However, in order to smoothen the transition to the new regime, the right to tax capital gains will be implemented in a phased manner as mentioned below:
Investment in shares prior to 1 April 2017
In the case of shares in Indian companies acquired prior to 1 April, 2017, gains arising to a Mauritius resident on the transfer/alienation of such shares will continue to be exempt from tax in India, regardless of when the shares are transferred. In other words, capital gains tax exemption under the India-Mauritius DTAA will continue to apply to these investments, irrespective of their date of transfer i.e. even if the shares are transferred on or after 31 March, 2017 the capital gains tax exemption would be available.
Investment in shares from 1 April 2017 to 31 March 2019 and taxation on transfer of shares
Capital gains arising from the transfer/ alienation of shares acquired by a Mauritius resident after 1 April 2017 shall be taxed at a concessional rate of 50% of the domestic tax rate in India during the transition period from 1 April 2017 to 31 March 2019. The concessional rate of tax will be available to the Mauritius tax resident only if the conditions set out in the Limitation of Benefits ('LOB') clause is/are satisfied.
Under the LOB clause, a resident of Mauritius (including a shell / conduit company) will not be entitled to benefits of concessional rate, if it fails the "main purpose" and "bona fide" business test.
While the press release does not provide clarity as to what will comprise the "main purpose" and "bona fide business" test, our understanding is that the requirements under these tests maybe along similar lines as the India-Singapore DTAA, which provides that benefits in respect of capital gains taxation are not available to a company whose affairs were primarily arranged to take advantage of the benefits available under the India-Singapore DTAA.
The LOB clause further provides that a Mauritian resident will be deemed to be a shell/ conduit company, if its total expenditure on operations in Mauritius is less than INR 2.7 million (Mauritian Rupees 1.5 million) in the immediately preceding 12 months.
Taxation from 1 April 2019 onwards
Capital gains arising on transfer of shares acquired in an Indian company on or after 1 April 2017 will be taxed at the full domestic tax rate (i.e. without any concession) when transferred on or after 1 April 2019.
Source-based taxation of interest income of Mauritian banks
Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5% in respect of debt claims or loans made after 31 March 2017. However, interest income of Mauritian resident banks in respect of debt claims existing on or before 31 March 2017 will be exempt from tax in India.
The Protocol further seeks to update the Exchange of Information (Article 26) as per international standard, provision for assistance in collection of taxes and source-based taxation of other income amongst other changes.
The Protocol also seems to provide source based taxation of "other income" and the actual text of the Protocol will throw light on the full impact of such changes.
The changes in the India-Mauritius DTAA will result in a more stable and transparent tax regime and will have long-term positive impact on investors. As the exact text of protocol is yet to be released by the Indian Government and actual impact will have be analysed post the protocol is released, our initial thoughts on the changes are summarised below:
Grandfathering of investments made prior to 1 April 2017 reflects the Indian government's commitment to provide certainty to taxpayers. Moreover the phased withdrawal of capital gains tax exemption will give time to investors to re-look their investment structures in relation to India.
The source based taxation approach will clearly impact foreign investment (from Mauritius) into India. Investors will now have to factor the impact of Indian capital gains tax before making investments in India through Mauritius.
These changes will also have an impact on India-Singapore DTAA.The India-Singapore DTAA would be affected to the extent that it provides that capital gains may be taxed only in the country of residence, since the relevant provisions have been linked to the continuation of the corresponding provisions of the India-Mauritius DTAA. However, the Indian Government is of the view that India will have to renegotiate the DTAA with Singapore to extend the capital gains tax provisions of the recently concluded tax pact with Mauritius.
The amendment will impact private equity and venture capital investors who invest in unlisted securities as they will now be liable to pay capital gains tax in India. However, investments made in hybrid instruments such as compulsory convertible debentures may still be taxable only in the state of residence of investor since the Protocol refers to allocation of taxation rights only in respect of capital gains arising on sale of shares. Having said this, clarity on this issue shall only be available once the exact text of the Protocol is released.
Similar to the position in respect of compulsory convertible debentures, Mauritius based entities that enter futures and options contract in India, may still be able to claim the benefits of residence-based taxation since such contracts relate to capital assets other than shares. However, clarity on this issue shall only be available once the exact text of the Protocol is released.
Income from sale of shares results in capital gains and at present Foreign Portfolio Investors ('FPIs') enjoy the benefits of the capital gains provisions under the India-Mauritius DTAA. FPIs who invest in securities listed on the Indian Stock Exchange but exit before twelve months from the date of purchase of securities will be impacted as they will be required to pay short term capital gains tax in India at the rate of 15%. During the transition period, i.e. from 1 April 2017 to 31 March 2019, and subject to the satisfaction of the LOB clause, this rate may be reduced to 7.5%. However, gains arising to the investors who invest in listed securities for more than twelve months will continue to remain exempt since long term capital gains tax from sale of listed securities is not taxable in India, where the transaction is effected on an Indian Stock Exchange.
Thus, after years of re-negotiations, the 33 year old DTAA between India and Mauritius has finally been amended to remove the capital gains exemption, though in a phased manner.The re-negotiation of the India-Mauritius DTAA is likely to prove beneficial for both investors and the Indian Government. The investors will get certainty on the tax front and a mechanism for smooth transitioning into the new regime. The Indian Government will be able to put long standing debate and negotiations to an end and will be able to put the controversial tax issues to rest. However, the Protocol will have a significant impact on inbound investment activity into India as the benefits available under both, India-Mauritius DTAA and India-Singapore DTAA shall be adversely affected. Existing structures may have to be reexamined.
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