The India-Mauritius DTA Saga
By TreatyPro Editorial
27 February, 2013
Theyè´e tried a number of times over the past decade or more, but the Indian government has failed every time to force the changes it wants to the India/Mauritius tax treaty to stop foreign investors from avoiding Indian taxes. With the two governments once again discussing this issue, this article examines the history of the dispute, and the possibilities for change.
It has been a long established fact in international investment circles that if you want to invest into India, one of the best ways of doing so is to route your investment through Mauritius because of the tax advantages such a path offers. This situation throws up one of those lop-sided statistics that to the casual observer barely seems credible ï¿½ that one of the worldç´ smallest countries is responsible for providing almost half of the FDI into one of the worldç´ largest countries. But it is true, as figures for 2011 show: of the USD54.2bn invested into India from March 2010 through April 2011, 40% originated from Mauritius.
Traditionally, foreign investors are liable to tax in India on capital gains made from the disposal of shares in an India-registered company. Depending on the nature of the share-holding and the length of time it has been held, investors face capital gains tax of up to 20% in India. However, under the Indo-Mauritius tax treaty, capital gains accruing to a company resident in Mauritius are only taxable in Mauritius. As capital gains tax in Mauritius is 0%, and other taxes and fees are low, it becomes obvious why a large percentage of foreign investors into India choose to do so via a corporate structure involving a holding company registered in Mauritius.
As Article 13 of the treaty, which deals with capital gains, confirms: æµains from the alienation of immovable propertyï¿½ may be taxed in the Contracting State in which such property is situated.ï¿½
It adds: æµains from the alienation of immovable property forming part of a business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in the other State.ï¿½
The Indo-Mauritius tax treaty has been effective in India since April 1, 1983, and has been used since then for investment purposes, but since the year 2000 it has also become popular to use this structure to escape capital gains tax on stock exchange investments in India, something known as åªound-trippingï¿½, and this has particularly irked the Indian authorities. In recent years, India has been successful in persuading a certain number of parties to its other tax treaties to insert limitation of benefits clauses into treaty texts to prevent such treaty abuse. However, direct talks with the representatives of the Mauritius government have so far proved fruitless.
Looking back as far as 2002, the Indian government was setting out its clear intention to change aspects of the Indo/Mauritius tax treaty, particularly with regard to the tax residence certificates of companies claiming to be resident in Mauritius. Following a ruling by the High Court in Delhi, which struck out a Ministry of Finance circular (circular number 789 dated 13 April 2000) permitting æ¢oreign Investment Investorsï¿½ to benefit from capital gains tax exemption under the treaty (see below for key case law), the ministry set up a working group to examine the functioning of the Mauritius-India double tax avoidance agreement (DTAA). The mandate of the group was to suggest ways to improve the administration of the treaty and it has been looking at ways and means of exchange of information and documents to establish the tax residency status of entities operating from Mauritius. The working group comprised representatives from the MoF and the Securities and Exchange Board of India (SEBI) who visited Mauritius for discussions with the tax authorities in Mauritius and following the talks it was reported that a clause would be introduced in the treaty which would prevent Indian entities calling themselves residents of Mauritius. It was also said that a provision would be included in the DTAA for enforcement of the information sharing arrangement between the two countries even at the investigation stage, and that a requirement will be introduced for Overseas Corporate Bodies (the name given to companies eligible for exemption under the DTAA) to have at least 60% ownership by Non-Resident Investors. But the proposed changes didnç¨ materialize.
In the meantime, India has attempted various inducements in an attempt to persuade the Mauritian government to agree to the treaty changes it wants. Reports surfaced in December 2004 that the government was offering the carrot of a USD100m line of credit to Indian companies willing to set up in Mauritius; and in March 2008 it was being reported in Indiaç´ media that another approach had been made to the Mauritians, this time with the offer of direct compensation for potential loss of business fee income the jurisdiction might suffer as a result of the proposed treaty change.
It was thought that progress had finally been made by India after the governments completed a further round of DTAA renegotiation talks in August 2012. It was anticipated following these talks that exchange of information and administrative assistance clauses would be added to the treaty, in addition to clauses clarifying requirements as to the commercial substance of Mauritius-based entities entitled to treaty benefits. Still no changes were made to the treaty, however.
In January 2013 the Indian government revealed that the joint working group set up in 2006 would once again discuss the Indo-Mauritius DTAA in February. Announcing the meeting, Shri Anand Sharma, India's Commerce, Industry and Textiles Minister said that he hoped the group "would be able to take the deliberations forward."
On the strength of past talks however, it is hard to see where a breakthrough will come from. Mauritius has made it clear that, while it is open to a dialogue to combat abusive treaty shopping, it is not renouncing the existing exemption from source taxation on capital gains.
å±e have listened attentively to the concerns expressed by the Indian side and we are willing, as part of an all-inclusive package, to consider changes to the treaty that would address the Indian concerns, while ensuring that the changes do not affect the mutually beneficial effect of the treaty,ï¿½ the Mauritius government declared in a statement issued in December 2011. æººauritius is the main provider of FDI to India and also the preferred jurisdiction for Indian outward investments into Africa now. We believe that this should remain so. Why? It is a model that works, which has served and continues to serve the interests of both India and Mauritius and it does not make business sense to change a winning formula.ï¿½
While direct talks between the two governments have gone nowhere over the past decade or more, the Indian tax authorities have had limited success in challenging Mauritius-based structures established by foreign investors into India. Rulings issued over the past 12 years or so have tended to favor taxpayers by backing the terms of the treaty. Still, the situation is far from clear cut.
As alluded to above, there was consternation among some Indian companies in 2002 after the High Court in Delhi struck out the Ministry of Finance circular permitting foreign investors to benefit from capital gains tax exemption under the DTAA simply based on a Mauritian residence certificate. The Circular provided that "wherever a Certificate of Residence is issued by the Mauritian Authorities, such Certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC (Double Tax Treaty) accordingly." However, the Court believed that Indian companies were abusing the treaty by setting up Mauritian èost-boxï¿½ companies which could benefit from tax relief under the treaty. Quashing the circular, the Court ruled that the Central Board of Direct Taxation (CBDT) had exceeded its powers. It stated that: évoidance of double taxation would mean that a person has to pay tax at least in one country. Avoidance of double taxation would not mean that a person does not have to pay tax in any country whatsoever. In Mauritius, in terms of the statute a foreign company is not entitled to own any property, open any bank account, do any business. Several restrictions have been imposed in that country; as a result thereof no income may be generated in Mauritius and no income tax may be payable therein. Double taxation treaty clearly is not envisaged in such situation.ï¿½
However, in October 2003, the Supreme Court of India overturned the Delhi High Courtç´ ruling in a case known as Azadi Bachao Andolan, which following the æ³¥uke of Westminster principleï¿½ concluded that companies were entitled to structure their affairs so as to limit exposure to tax as long as the arrangements were within the law. "We are unable to agree with the submissions that an Act which is otherwise valid in law can be . . . (set aside) . . . merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudicious to the national interest as perceived by the respondents," said the Bench. çn the result, we are of the view that Delhi High Court erred on all counts in quashing the impugned circular. The judgment under appeal is set aside and it is held and declared that the circular No. 789ï¿½ is valid and efficacious.ï¿½
Another key case concerning the validity of a Mauritius TRC to claim a tax exemption in India has been the E*Trade case. E*Trade Mauritius, an indirectly owned subsidiary of E*Trade Financial Corporation (E*Trade US), was required to pay INR245m (USD50m) CGT on the sale of shares in IL&FS Investmart Limited (IL&FS) to HSBC Violet Investments (Mauritius) Limited (HSBC Mauritius) after being denied a nil withholding tax certificate by the tax authority. The tax authority attempted to argue that it could not be determined that the gains had arisen only to the Mauritius company and not its US parent. E*Trade subsequently approached the Authority for Advanced Rulings, which, following the principles set down in the Azadi Bachao Andolan case, decided that the TRC issued by the Mauritius Revenue Authority was evidence for residence in Mauritius, and therefore the capital gains from the sale of the India companyç´ shares were taxable in the hands of the Mauritius company, which was the legal owner of the shares. The Indian tax authorities challenged this interpretation, and in 2012 they filed special leave to appeal before the Supreme Court in an attempt to overturn it.
In August 2011, a ruling from the Mumbai High Court cast further doubt over the use of structures in Mauritius to mitigate tax paid in India. The case, Aditya Birla Nuvo Limited v The Deputy Director of Income Tax, relates to an Indian Joint Venture Company (JVC) established between AT&T, the Birla Group and the Tata Group. Under the terms of the JVC, shares in the company could be acquired by 100% subsidiaries of parties to the joint venture, which was said to be the structuring's primary flaw. AT&T USA, through its Mauritius subsidiary, AT&T Mauritius purchased shares in the joint venture, which were assigned to AT&T Mauritius. When AT&T sought to sell its stock to the Birla Group and Tata Group, no tax was withheld at source, as per the terms of the double tax agreement between Mauritius and India. AT&T Mauritius fulfilled the previously upheld requirement of holding a Tax Residence Certificate (TRC), obtained from Mauritian authorities. However, the Mumbai High Court ruled that despite the TRC, the deal was structured in such a way that the beneficial owner of the shares was AT&T USA, despite the purchase of shares being through its subsidiary, thereby negating the benefits of the Mauritius-India treaty.
Another area of uncertainty for investors into India via the Mauritius route is the proposed Indian General Anti-Avoidance Rule (GAAR) which could deny tax benefits resulting from arrangements which are structured in such as way so as to avoid tax and which lack commercial substance. The GAAR was originally going to be a part of the new Direct Taxes Code (DTC), tabled in parliament in 2010. The DTC has been postponed several times, with no specific timetable set for its introduction. The GAAR formed a key part of the 2012/13 Union Budget, but, in January 2013, the Finance Ministry announced that the introduction of the GAAR would be deferred until at least 2016 pending a review of its provisions, following the furor caused by the Vodafone tax case, and in the light of worries that it could deter foreign investment in India.
To summarize, while the Indian government has been unsuccessful in its attempts over the past decade to add clauses to the Indo-Mauritius tax treaty that will negate the tax benefits currently available to Mauritius-based entities, investors may still come under attack from the tax authorities which are continuing to test their own interpretation of the treaty in the courts. This makes the situation somewhat uncertain for investors considering the best FDI route into India via Mauritius, and businesses have been urged to structure their investments in such a way so as to reduce the risk of attack by the Indian tax authorities. Investors must also keep one eye on the Indian GAAR, which, if deployed, could add another weapon to the Indian tax authoritiesï¿½ arsenal, further blunting the effectiveness of the Mauritius treaty. Talks between the governments of India and Mauritius over changes to the treaty will likely be ongoing through 2013, and while there are few signs of a breakthrough, this is a situation that investors will also have to monitor.
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