DTAA : India-Mauritius tax treaty amended

Mauritius has long been the favoured route for investment into India, because of the beneficial capital gains tax treatment offered under the India-Mauritius Double Tax Avoidance Agreement (“DTAA”). In a far-reaching change that will perhaps re-write the way investments come into India, the Indian and Mauritian governments have now renegotiated the DTAA. The protocol amending the DTAA (“Protocol”) has been signed by both countries, marking the end to a long standing stalemate between investors and Indian tax authorities on a thorny issue – capital gains tax exemption for Mauritius tax residents. Some key changes are discussed below:

Capital gains

Prior to the Protocol, investments into India were routed through Mauritius because under the DTAA, the right to tax capital gains arising from transfer of Indian investments, held by a Mauritian resident, was with Mauritius. However, since Mauritius does not have a capital gains tax regime, ensured that Mauritius became a favourable jurisdiction to invest into India. The Protocol now, however provides that gains from alienation of shares of an Indian company, acquired on or after April 1, 2017 by a Mauritian resident, will be taxable in India. In a bid to soothe investors’ nerves, the Protocol, however grants a two year concession (where shares are acquired after April 1, 2017 and sold by March 31, 2019) that the tax rate in India will not exceed 50% of the tax rate applicable on such gains under Indian domestic laws. This is however subject to certain limitation of benefits (“LOB”) which provide that the beneficial 50% treatment will not apply to shell/conduit companies i.e. A company having nil or negligible business operations. An expenditure threshold too has been prescribed, where a company will be deemed to be shell/conduit if its annual expenditure in the 12 months preceding the date the gains arise, is less than Mauritian Rs. 1,500,000 (INR 2,700,000). Listed entities will however not be considered shell/conduit.

One will have to wait and watch to see how the Protocol impacts FDI in India. Mauritius brings in the maximum amount of investment into India. India has one of highest corporate tax rates in the world. Added to this, the high tax cost of repatriation and now, high cost for exits as well, may not be seen too kindly. Thankfully, the Indian government has kept its promise of not resorting to nasty retrospective amendments, by exempting investments made prior to April 1, 2017 from tax. The Protocol, however, puts to rest long years of debate, on the sanctity of the Mauritius route.

Service Permanent Establishment (“Service PE”)

It is interesting to note that a new service PE clause has been introduced into the DTAA, which provides that the furnishing of services, including consultancy services by an enterprise through employees or other personnel, where the activities continue for a period exceeding 90 days. Such activities may be for the same or connected project, within any 12 month period. It may be recalled that often consultancy companies with residence in Mauritius, send employees to India to undertake consultancy services, and have argued that in the absence of a service PE clause under the DTAA, they could not constitute a PE in India. With the insertion of the new clause, such an argument will no longer hold water.

Interest

Until the Protocol, the withholding tax on interest income paid to a Mauritian resident was liable to tax in India, at 40%. The new Protocol now, however, provides that the tax will not exceed 7.5% of the gross amount of interest. The new tax rate of 7.5% could see Mauritius becoming the ‘go-to’ destination for loans or debt investments.

Further, prior to the Protocol, interest payments made to banking companies, engaged in bona fide banking business, was exempt from withholding tax. The Protocol no longer allows such beneficial treatment for banking companies and interest payments made to a banking business too will be liable to tax withholding at 7.5% (except where the debt claims exist on or before March 31, 2017).

Fees for technical services (FTS)

The DTAA also has no provision for taxation in relation to FTS. In line with India’s treaties with other countries, FTS under the DTAA will also be liable to tax at 10%. Not surprisingly, the definition of FTS is defined as payments of any kind, as consideration for managerial, technical or consultancy services, including the provision of services of technical or other personnel.

Other income

Under the DTAA, when the taxability of a particular source of income is not provided for, the taxability would be based on the residency of the person earning the income. For e.g. If a Mauritian resident company were to receive a gift of shares of a closely held Indian company, under the Indian domestic tax laws, the Mauritian entity would have been liable to tax in India. However, since the DTAA gives the taxing rights to Mauritius, such a transaction would not be liable to tax in India.

The Protocol has now been amended to give the state in which the income is sourced, also the right to tax such income – i.e. In the aforesaid scenario India too has been given the right to tax the Mauritian entity.

The Protocol clearly gives impetus to source based taxation. Since the DTAA is also linked to the India-Singapore tax treaty, offering a similar capital gains tax benefit, an amendment to that treaty is definitely in the anvil.