Insights into Editorial: Closing the tax bolthole
13 May 2016
India and Mauritius recently signed a landmark protocol to amend the Double Taxation Avoidance Agreement (DTAA) treaty.
What the protocol says?
The protocol confers India with taxation rights on capital gains arising on the sale of shares acquired on or after April 1, 2017, in a company resident in India. This is effective from financial year 2017-18.
- The protocol also provides for a ‘limitation of benefit’ clause for the transition period (April 1, 2017 to March 31, 2019), during which the capital gains tax rate will be 50% of the normal rate. This clause also requires companies based in Mauritius to spend at least Rs.27 lakh in the preceding one year to benefit from the tax treaty. There was no such clause earlier.
- Under the amended treaty, the right to tax capital gains will be available to the country where the income arose. With this, both countries are now moving into a source-based taxation of capital gains from the adopted residence-based taxation methodology for capital gains taxation.
What is DTAA and what was the problem with Mauritius?
DTAAs are bilateral treaties signed between governments to prevent companies from being taxed twice over.
- Mauritius, and other tax havens, has almost negligible taxes. This was encouraging companies to route their investments in India through “shell” companies (those that exist only on paper) in Mauritius and avoid paying taxes.
What’s good about this treaty?
The treaty amendment brings about a certainty in taxation matters for foreign investors. It reinforces India’s commitment to OECD-BEPS (Base Erosion of Profit Sharing) initiative to stop ‘double non-taxation’ enjoyed by companies.”
- With this, capital gains on shares for Singapore can also now become source-based due to the direct linkage of the Singapore DTAA Clause with the Mauritius DTAA. This would also lead to a surge in investment flow.
- The move is expected to prevent misuse of the three-decade-old pact from paying taxes, curb round tripping of funds, prevent double non-taxation, streamline investments and lift tax uncertainty.
- Singapore and Mauritius, the two most popular jurisdictions for routing investments, would lose their advantage. This is expected to impact funds and companies from the US who used to come through Singapore/Mauritius to avoid double taxation.
- Many foreign investors will have to redraw their strategies. The incentive to route investments through Mauritius will cease to exist once the new rule kicks-in. This could raise their tax outgo.
- It could hurt short-term foreign investor inflows into India, particularly from companies whose investment strategies are guided by minimising taxes. This could pull down markets initially.
- With this, Mauritius will lose its edge as a popular jurisdiction for routing investments into India. Mauritius currently has ‘nil’ tax rate on capital gains.
Why this amendment was necessary?
DTAA had made Mauritius the biggest source of foreign direct investment into India. According to data from the Department of Industrial Policy and Promotion, India received about $93.6 billion of FDI from Mauritius between April 2000 and December 2015. This is 34% of the total FDI inflows into India. Many private equity and venture capital firms also invest in India through funds registered in Mauritius.
- Mauritius-registered entities account for a fifth of the assets held by foreign portfolio investors in the country and about a third of all FDI received since 2000.
- People used this route to avoid taxes. This was done through round tripping and treaty shopping.
For a country keen to play a greater role in global decision-making, the move to seal a key route for the round-tripping of capital generated out of tax-dodging enterprises will help boost both revenue and confidence in the rule of law in India. It is beyond doubt that ensuring a level playing field for all international investors, irrespective of domicile, can only serve to enhance India’s attractiveness as an investment destination in the long run.