Mauritius Tax Pact tweaked

India has wrested the power to tax capital gains on the sale of shares of domestic companies by entities based in Mauritius, a move that may have a “significant impact“ on investments routed through the tax haven. The two countries amended their 33-year-old tax treaty, bringing the curtains down on the Mauritius route, which government revenue officials and critics said had become synonymous with tax avoidance and abusive practices such as treaty shopping and round-tripping. The new regime will apply on shares acquired on or after April 1, 2017. Investments made before that date will not be affected.
There will be a transition period from April 1, 2017, to March 31, 2019, during which capital gains will be taxed at half the domestic rate. The decision, partly driven by the urgency to increase tax revenue, may temporarily weaken rupee and make Dalal Street nervous. Foreign Portfolio Investors ­ the largest investor group ­ will now have to pay 15% tax on short-term capital gains on listed shares.
Mauritius is the biggest source of foreign direct investment and portfolio investment into India because of the bilateral tax treaty that exempted such fund flows from capital gains tax. The island nation accounts for over 34% of FDI into India, while Singapore contributes 16%.
The amendment of the treaty also brings the regime in line with India's plan to introduce general anti-avoidance rules from 2017.The move changes the dynamics for private equity and foreign portfolio investors and asset managers not just from Mauritius but also from Singapore. India had linked the continuance of capital gains tax exemption in its treaty with Singapore to the agreement with Mauritius. The protocol will tackle the long-pending issues of treaty abuse and round-tripping of funds attributed to the India-Mauritius treaty, curb revenue loss and prevent double non-taxation, the finance ministry said in the statement.
The revised protocol, which was signed in the Mauritius capital of Port Louis on Tuesday , provides for grandfathering to provide stability to investments made so far. Investments made before April 1, 2017, will not be subject to capital gains tax in India. Further, a transition period has been provided for investors meeting certain conditions in the Limitation of Benefits clause.
In the transition phase, the tax rate will be limited to 50% of the domestic tax rate in India if it has a bona fide business. A resident would be deemed to be a shell or a conduit company if its total expenditure in Mauritius is less than Rs.2.7 million, or 1.5 million Mauritian rupees, in the preceding 12 months.
Interest arising in India to Mauritius resident banks will be subject to withholding tax in India at 7.5% on debt claims or loans made after March 31, 2017. However, the interest income of Mauritius resident banks in respect of debt claims before March 31, 2017, will be exempt from tax in India.
The new protocol also provides for updating of the information exchange agreement in line with international standards.
The Mauritius route for investment has been under the spotlight for long and New Delhi's attempts to amend the treaty for the past 10 years have not been very successful.
The change became possible under the global Base Erosion and Profit Sharing framework agreed by countries to contain abuse of tax treaties. Under those rules, India would have the power to unilaterally suspend treaty benefits if Mauritius did not agree to amend the tax accord.