New India-Mauritius tax treaty protocol closes capital gains tax loophole

On May 10, 2016, India and Mauritius signed a new protocol (the “Protocol“) amending the existing Convention between the Government of Mauritius and the Government of the Republic of India for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains (The “Treaty“).

The treaty entered into force on December 6, 1983, with the main purpose of encouraging mutual trade and investment between countries, as well as avoiding double taxation and tax evasion. The treaty played a crucial role in establishing Mauritius as a financial hub, home to some of the largest investment funds and a major source of investment destined for India. “Mauritius contributed about a third of foreign direct investment (FDI) in India over a 15-year period between 2000 and 2015, which is a significant share. The second closest influx comes from Singapore, which accounted for around 16% of the total inflow during the same period. “[1] However, the treaty has come under intense scrutiny and criticism from the Indian tax administration as well as the OECD.

The treaty generally granted all taxing rights to the country of residence with respect to income from capital gains on the sale of shares in an Indian company. Thus, foreign investments entering India have used Mauritius as the preferred country of residence for investment vehicles to invest in India. Because Mauritius does not impose capital gains tax on foreign investors, this paves the way for potential double non-taxation. Given the absence of limitation of benefits in the treaty, Mauritius has become the favorable jurisdiction as a gateway to India.[2]

The new protocol aims to restrict the possibility of entering into such non-tax transactions by imposing a capital gains tax. In accordance with Article 13 (3B) of the Protocol, capital gains from an investment in India will be subject to tax in India (as the source country). The Protocol provides that capital gains derived by a resident of Mauritius from the alienation of shares of an Indian company, acquired on or after April 1, 2017, may be taxed at 50% of the Indian tax rate. However, capital gains from the alienation of shares acquired from April 1, 2019 will be taxed at the full applicable tax rate.

The Protocol also introduces a new benefit limitation provision under Article 27A, limiting the right to the reduced tax rate applicable to capital gains only to companies which (i) meet the primary purpose test and (ii) are not conduits or shell companies. The protocol does not define the term “primary objective” but provides that a Mauritius company will not be considered a conduit or a shell company if it is listed on the Mauritius Stock Exchange or if its expenses for operations in Mauritius are equal to or greater than $ 42,500. in the 12 months preceding the date of realization of the capital gain.

In addition, the protocol amends the existing tax exemption on interest income from India for banks carrying out good faith banking activities, introducing a new limitation in Article 3A. The new condition imposed by article 3A provides that the exemption only applies if the interest income comes from debts existing on March 31, 2017 or before. Interest income on receivables or loans granted after March 31, 2017 will be subject to withholding tax in India at the rate of 7.5%.

In addition, Article 12A of the Protocol now aligns with the United Nations Model Treaty by imposing a 10% tax on technical service charges originating in India, provided that the beneficial owner is a resident of India. Maurice.

Finally, a new subparagraph has been added to paragraph 2 of Article 5 (Permanent establishment), which introduces the notion of a service permanent establishment, under which an enterprise is deemed to have a permanent establishment if it provides services, including consultancy services, in a Contracting State through employees or other personnel engaged by the enterprise for that purpose, if such activities continue in that State for a period or periods of time. periods totaling more than 90 days in a 12 month period.

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