There is no doubt that the protocol for amendment of the Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains signed between India and Mauritius on May 10 is a significant milestone for India’s tax treaties as well as its Foreign Direct Investment policy (FDI). This protocol did not happen overnight and was signed after years of talks and negotiations.
From April 2000 to June 2015, India received a total FDI of Rs 12,93,835.81 crore from more than 149 countries. Of this, Rs 4,38,892.83 crore (around 35% of the total FDI) came from Mauritius. Singapore was a distant second at Rs 1,90,477.19 crore (13.90% of total) and all the countries contribute less than 10% individually.
Surely there must be “something” about Mauritius that attracts such investments. That “something” is to get a Cat 1 Global Business Licence in Mauritius by paying a minimal fee of around $2,500. Companies holding Cat 1 Global Business Licence are resident in Mauritius for tax purposes and are not subject to capital gains taxation, there are no withholding taxes on the payment of dividends, interest or royalties nor are there stamp duties or capital taxes.
A logical question that crops up is why India can’t tax capital gains arising from sale of shares from Mauritius-based entities. Till now, India could not tax such capital gains because Clause 4 of Article 13 of the Double Tax Avoidance Agreement (DTAA) signed between India and Mauritius in 1982 which makes it clear that such capital gains can be taxed only in Mauritius (which does not have capital gains in its tax dictionary). Vodafone in the UK acquired Hutchinson Essar in India through an entity in Mauritius called CGP Holdings (there is an unpr-oved theory that CGP expands to Capital Gains Prevention). The protocol that has been signed makes this tax bonanza history by giving India the power to tax capital gains commencing from next year.
With this Protocol, India gets taxation rights on capital gains arising from alienation of shares acquired on or after April 1, 2017 in a company resident in India with effect from financial year 2017-18, while simultaneously protection to investments in shares acquired before April 1, 2017 has also been provided.
Further, in respect of such capital gains arising during the transition period from April 1, 2017 to March 31, 2019, the tax rate will be limited to 50% of the domestic tax rate of India, subject to the fulfillment of the conditions in the Limitation of Benefits( LOB) Article.
Taxation in India at full domestic tax rate will take place from financial year 2019-20 onwards. The benefit of 50% reduction in tax rate during the transition period from April 1, 2017 to March 31, 2019 shall be subject to LOB Article, whereby a resident of Mauritius (including a shell/conduit company) will not be entitled to benefits of 50% reduction in tax rate, if it fails the main purpose test and bonafide business test.
A resident is deemed to be a shell/conduit company if its total expenditure on operations in Mauritius is less than Rs 27 lakh in the immediately preceding 12 months. Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5% in respect of debt claims or loans made after March 31, 2017. However, interest income of Mauritian resident banks in respect of debt-claims existing on or before March 31, 2017 shall be exempt from tax in India.
The billion-dollar question is “Will the protocol reduce FDI investment into India through the Mauritius route?” It should not be forgotten that only short term capital gains are taxed in India while long term capital gains are exempt even in India.
Hence, entities based in Mauritius would need to change their investment strategies to avail of the zero tax regime that they were used to earlier. However, the grandfathering provisions in the protocol give them ample time to rethink their investment strategies from April 1, 2017. Hence, the protocol is expected to have a limited impact on genuine FDI investments.
Impact of the protocol
The protocol would certainly have some impact on round tripping. Round tripping is an Indian jugaad innovation wherein entities based in India who want to invest in Indian markets choose to send their money on a trip abroad and finally make the investment through a Mauritius-based entity to avoid Indian taxes.
Since round tripping is only a tax avoidance measure and not a strategic investment, these round trippers may now begin to think that this route doesn't make tax sense now and paying up the securities transaction tax and short-term capital gains in India may be easier.
Would the protocol move inbound investments from Mauritius to say, the Cayman Islands? Cayman Islands contributed only 0.47% of the FDI investments in the 200-2015 period. A significant shift in this is not expected due to the fact that the Cayman Islands is not as tax friendly as Mauritius. Also, the Organisation for Economic Cooperation and Development (OECD) is only a global mission through their Base Erosion and Profit Shifting (BEPS) project to ensure that individual countries do not miss out on their quota of taxes.
The only issue with the protocol could be that it has come too late, protects current investments and gives a window of 11 months for tax-savvy entities to plan their next moves. There has been talk in the air for a few years now (the Vodafone effect) about the tax treaty with Mauritius being altered to tax capital gains in India. May be this is the reason why the share of Mauritius in the FDI pie has come down from 40% in 2012 to 35% in 2015.
The tax department should take comfort in the fact that in the world of cross-border taxation, it is always better late than never.
(The writer is a Bengaluru-based tax expert)
Published 13 May 2016, 18:05 IST