On 10 May 2016, the Government of India issued a press release1 stating that India and Mauritius have signed a protocol (New Protocol) amending the double tax avoidance treaty between the two countries (the Treaty). Based on the press release and the New Protocol, following are the key changes to the Treaty:
Article 5 of the Treaty has been amended to include a paragraph on service PE with a threshold of a period/periods aggregating to more than 90 days within any 12-month period.
Interest arising to the resident banks will be subject to withholding tax at the rate of 7.5% in respect of debt claims or loans made after 31 March 2017. However, interest income of resident banks in respect of debt-claims existing on or before 31 March 2017 is exempt from tax (provided that the resident bank is carrying on a bona fide banking business).
Fee for Technical Services
A new article has been inserted in relation to fee for technical services, which provides, amongst others, that the tax so charged on fee for technical services shall not exceed 10% of the gross amount.
Capital Gains Taxation
The Treaty earlier provided for a residence-based tax regime wherein gains arising from alienation of shares of an Indian resident company were not taxable in India. As per the New Protocol, India will have the right to tax capital gains arising from alienation of shares of a company resident in India acquired by a Mauritian tax resident (and vise-versa).
The New Protocol provides for grandfathering of investments and shall be applicable to investments made on or after 1 April 2017. There will also be an interim period from 1 April 2017 to 31 March 2019, wherein the capital gains on such transactions will be taxed at a discounted rate of 50% of the applicable domestic tax rate in India, subject to fulfilment of conditions in the limitation of benefits clause.
Limitation of Benefits
A new limitation of benefits provision has been introduced, which shall be a prerequisite for such reduced rate of tax. As per the press release, the benefit of the discounted tax rate shall not be available to a resident if such person:
- is a shell/conduit company; or
- does not satisfy the main purpose test and bona fide business test.
A shell/conduit company is any legal entity falling within the definition of resident of a state with negligible or nil business operations or with no real and continuous business activities carried out in that state. Further, a resident will be deemed to be a shell/conduit company if its total expenditure on operations in the resident country is less than INR2,700,000 (USD40,500) in the immediately preceding 12 months.
A resident will not be considered as a shell/conduit company if:
- it is listed on a recognized stock exchange; or
- it meets the expenditure criteria as stated above.
The protocol also provides for a source-based taxation of other income.
Exchange of Information and Assistance in Collection of Taxes
The New Protocol also provides for an updated of the Treaty with respect to the following:
- exchange of Information Article as per international standard; and
- provision for assistance in collection of taxes.
New Protocol will come into force once India and Mauritius complete their domestic procedures.
Articles on permanent establishment, interest income, fee for technical services, other income and limitation of benefits shall have effect as follows:
- India - April 1 post the date on which the New Protocol comes into force.
- Mauritius - July 1 post the date on which the New Protocol comes into force.
Amendments to the capital gains article will be in effect from financial year 2017-18.
Articles on exchange of information and assistance in collection of taxes will come into effect from the date the New Protocol comes into effect.
The New Protocol marks an end to the uncertainty around the future of investments into India through Mauritius, as the talks on renegotiation of the Treaty has been going on for many years now. The intent of the Indian government to bring out these changes on a prospective basis and with certain safe harbors (for the transition period) is welcomed.
While the New Protocol is in relation to India-Mauritius structures, it will also impact India-Singapore structures. As a background, the protocol2 to the India-Singapore tax treaty provides that the exemption from capital gains tax arising to Singapore residents (from sale of shares of an Indian company) shall be applicable only till such exemption is available under the India-Mauritius tax treaty.
Two key issues arise as regards the Singapore structures:
- While the New Protocol (for India-Mauritius tax treaty) provides for a safe harbor period (investments made before April 1, 2017 can still enjoy capital gain exemptions); such a benefit may not be available under the India-Singapore tax treaty.
- Benefit of a discounted tax rate may not be available under the India-Singapore tax treaty for the period from April 1, 2017 till March 31, 2019.
Talks are already surfacing that India may be looking at renegotiating its tax treaty with Singapore to bring it on similar lines. Further, the New Protocol only addresses capital gains in relation to alienation of shares. It is not clear how capital gains arising from other financial instruments will be treated.
The Indian government has said that these amendments are designed to curb treaty abuse, tax evasion and round-tripping of funds. As per the press release, the New Protocol will help improve transparency in tax matters and will help curb tax evasion and tax avoidance. Thus, these changes seem to also be motivated by India's commitment to the OECD/G20 Base Erosion and Profit Shifting project. The comprehensiveness of the articles on exchange of information and assistance in collection of taxes also point in this direction.