India-Mauritius treaty amended to tax capital gains on Indian shares
INSIGHT ARTICLE |
On 10th May 2016, India and Mauritius announced a protocol to amend their tax treaty restoring India’s right to tax capital gains. Pursuant to this amendment, capital gains arising from sale of shares of an Indian resident company acquired after April 1, 2017 will be taxed by India. Existing investors, who acquired shares before April 1, 2017 will not be taxed by the Indian authorities and also a two-year transitional phase has been provided when capital gains will be taxed at a concessional tax rate.
As per the current tax treaty between the two countries, Mauritius was granted the right to tax capital gains. Under the domestic tax laws of Mauritius, capital gains are effectively tax free. This provided an attractive investment route into India resulting in a significant portion of the foreign investment being routed through Mauritius with India not allowed to tax the gains. After toiling for almost a decade to redraw the tax treaty with Mauritius, the Indian government has finally been able to plug this loophole through this amendment. Following up on the Finance Minister’s announcement to implement general anti avoidance rules (GAAR) from 2017, this amendment aims to limit abuse of the tax treaty, prevent round-tripping of funds into India, curb revenue loss, prevent double non-taxation and improve transparency.
The main amendments contained in the protocol amending the India-Mauritius tax treaty are listed below:
- Prospective Change in the Taxation of Capital Gain: Capital gain arising on sale of shares shall be subject to tax in India on a prospective basis. Capital gain arising in India on shares acquired before 1st April, 2017 will not be impacted.
- Concessional Rate of Tax on Capital gain during FY2017-19: A concessional tax rate (i.e. 50% of the domestic tax rate of India) shall be levied on gains arising during the transition period from 1st April, 2017 to 31st March, 2019, subject to the fulfillment of the conditions in the Limitation of Benefits Article. Gains arising after 1st April 2019 will be taxed at the full domestic tax rate.
- Introduction of Limitation of Benefits (LOB) clause: A LOB will be introduced in the India-Mauritius tax treaty. According to this, a resident must incur a minimum of INR 2.7 million (approx. USD 40,000) on operations in Mauritius in the immediately preceding 12 months in order to take advantage of the concessional tax rate during the transition period from 1st April, 2017 to 31st March, 2019.
- Other: Consistent with the source based taxation of shares, the protocol also introduces articles dealing with services permanent establishments, fees for technical services and other income that grant India the right to tax these items if they arise in India. Further, interest income arising in India will be subject to a 7.5% withholding tax.
Mauritius has traditionally served as the primary investment route into India. Other jurisdictions such as Singapore, Cyprus, Luxembourg and Netherlands have also served as tax friendly jurisdictions for investments into India.
The India -Singapore tax treaty specifically refers to the India-Mauritius tax treaty providing that so long as the capital gain tax is exempt under the India-Mauritius tax treaty, the exemption shall also continue under the India-Singapore tax treaty. The passage of the amendment to the India-Mauritius tax treaty will therefore affect the capital gain tax exemption currently available under the India-Singapore tax treaty
Pursuant to the Indian government’s focus on anti-avoidance and the ongoing worldwide attention on Base Erosion and Profit Sharing (BEPS), India may increase its focus on economic substance in these countries prior to honoring any tax structures through these countries. The Indian government has already commenced negotiations with Cyprus and Netherlands to amend the respective tax treaties and protect its tax base from “shell companies” involving these countries, and we expect the governments to amend the treaties currently in place consistent with the amendments to the India-Mauritius treaty.