India’s Central Board of Direct Taxes (CBDT) issued a press release on May 10, notifying of a new Protocol amending the 33-year-old India Mauritius Double Taxation Avoidance Agreement (DTAA). The Indian government is now starting talks with Singapore to introduce similar amendments in its DTAA with the nation. The two developments address the longstanding issues of tax treaty abuse and round tripping of funds. They also bear testament to India’s commitment to the Base Erosion and Profit Shifting (BEPS) Action plan proposed by the Organization for Economic Co-operation and Development (OECD).
Key features of the Protocol to the India Mauritius DTAA (Protocol), as stated in the press release, are:
Capital Gains Taxation
- With effect from Financial Year (FY) 2017-18 (tax year April 1, 2017 to March 31, 2018), India shall have taxation rights on capital gains arising from alienation of shares of an Indian resident company, acquired on or after April 1, 2017.
- For shares acquired before April 1, 2017, the exemption from tax in India as currently available would continue to apply.
- For a transition period of April 1, 2017 to March 31, 2019, the tax rate will be limited to 50 percent of the domestic tax rate of India, subject to the fulfilment of the Limitation of Benefits (LOB) article as introduced by the Protocol.
- Taxation in India at the full domestic tax rate will take place from FY 2019-2020 onwards.
Limitation of Benefits
- A Mauritius resident (including a shell/conduit company) will not be eligible for the benefit of 50 percent reduction in tax rate during the transitory period if it fails to fulfil the main purpose test and the bonafide business test.
- A resident is deemed to be a shell/conduit company if its total expenditure on operations in Mauritius is less than U.S. $40,370 (Rs 2.7 million/Mauritian Rupees 1.5 million) in the immediately preceding 12 months.
- Mauritian resident banks earning interest from India will be subject to withholding tax at the rate of 7.5 percent with respect to debt claims/loans made after March 31, 2017. Interest income earned prior to that shall be exempt from tax in India.
Exchange of Information
- The Protocol also provides for updating the Exchange of InformationArticle per international standards, provision for assistance in collection of taxes, and source-based taxation of other income, amongst other changes.
It is clear that India is keen to plug tax loopholes that have so far led to great loss of revenue for the state, a fact underlined by the OECD’s BEPS Project. In fact, India’s beneficial tax arrangement with Mauritius and Singapore is what led to the two countries becoming the top sources for foreign direct investment (FDI) into India. This in turn motivated the Indian government’s plans to revamp its respective tax treaties with them, further assisted by the BEPS’ goals.
At the same time, the new amendments to the India Mauritius DTAA is reflective of the government’s concern to ensure stability for investors. In this context, the biggest positive in the Protocol is that there will be no ‘retroactive’ impact as investments made prior to April 1, 2017 will be ‘grandfathered’. Further, the Protocol will also have ramifications for investments into India from Singapore. This is because the benefits of residence-based taxation of capital gains, on sale of shares under the India Singapore Protocol/DTAA, will be linked to the India Mauritius DTAA.
However, it is interesting to note that the Protocol does not incorporate ‘main purpose test’ and ‘bona fide business test’ explicitly, as mentioned in the government’s press release. It only says that the benefits of reduced capital gains taxation on sale of shares (available from April 2017 to March 2019) will not be available if the affairs were arranged with the primary purpose to take advantage of such benefits (or if it is a ‘shell/conduit company’). This appears to be a subjective test and no criteria have been laid down to be fulfilled.
The new Protocol to the India Mauritius DTAA is thus a significant tax development. It will have a major impact on numerous institutional funds, asset managers, and private companies that have used the Mauritius route to invest into India. Singapore, too, will become a less attractive destination for investment into India because the capital gains tax exemption under the Singapore treaty may also automatically end as negotiations are now ongoing for the same.
Finally, the impact of these developments will be felt maximally by Participatory Note (P-Note) investors, short-only funds such as hedge funds and high frequency traders, and particularly, investments from low cost borrowing nations since tax cost will now be majorly factored into the cost benefit analysis.
This article was first published May 2016.
Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, we are your reliable partner for business expansion in this region and beyond.