India-Mauritius Tax Treaty Amendment: Why It Needs Clarifications

The two countries signed a protocol to amend the double taxation avoidance agreement, which included a principal purpose test to decide whether a foreign investor is eligible to claim treaty benefits.

NDTV Profit spoke to tax experts, Dinesh Kanabar and Pranav Sayta, to decode the impact of the amended law, especially on foreign investors.

The Indian and Mauritian governments inked a pact to amend the double taxation avoidance agreement between the two countries. Therefore, investments coming into India via Mauritius will now face closer scrutiny.

Investors have to invest through a Mauritius entity to avail benefits of the treaty.

This means that any foreign investor who is investing in India with a Mauritius entity, will now have to demonstrate that the principal purpose of investing in India was not for tax mitigation, explained Pranav Sayta, India national leader, international tax and transaction service at Ernst & Young.

The intention is to avoid creating opportunities for non-taxation or reduced taxation, particularly through treaty shopping arrangements aimed at obtaining treaty benefits for residents of third jurisdictions.

A principal purpose test has been introduced in the amendment, to decide whether a foreign investor is eligible to claim treaty benefits.

As per the amending protocol, benefits of the India-Mauritius tax treaty will not be available to a taxpayer routing investments through Mauritius if it can be reasonably concluded.

The introduction of the PPT aims to curtail tax avoidance by ensuring that treaty benefits are only granted for transactions with a bona fide purpose. It also brings the treaty in line with the base erosion and profit shifting minimum standard.

Investments through Mauritius in India have declined, and an urgent clarification to say that there is no retrospective intended is going to be very critical, said Dinesh Kanabar, chief executive officer, DhruvaAdvisors LLP.

The amendment may not have significant impact on public markets as most grandfather investments could have exited by 2024, according to Sayta. "There is some uncertainty whether some grandfathering was guaranteed when the GAAR provisions were introduced, if those would continue despite this PPT now being introduced."

The investments from Mauritius via units will also be impacted by the new protocol.

Any capital gains accruing through sale of investments after the date of the protocol being signed and becoming effective only will be impacted and not any exits.

According to experts, there is uncertainty on two fronts: date of deeming effective and whether it would even protect grandfather investments — investments made before March 31, 2017.

"Clarity and certainty on that front would be very welcome," Sayta said.

Wordings of the protocol suggests that this amendment will apply to all existing investments and to all the past years as well, according to Kanabar.

All FPIs could get very significantly impacted as a result of this amendment as tax officials are likely to implement it, even if the investments were made way back. Tax officials are likely to implement the amendment by going back to investments in earlier years with no grandfathering protection, he said.

"I would strongly feel that this was unintended, that they intended to be applicable only prospectively. However, the language leaves much to be desired, and I hope there is some clarification promptly issued," Sayta said.

Mauritius has been a preferred jurisdiction for engaging in investments in India due to the non-taxability of capital gains from the sale of shares in Indian companies until 2016.

In 2016, India and Mauritius signed a revised tax agreement, which gave India the right to tax capital gains in India on transactions in shares routed through the island nation beginning April 1, 2017. However, investments made before April 2017 were grandfathered.

Since 2016, FDI inflows from Mauritius have dropped from $15.72 billion in FY17 to $6.13 billion in FY23.