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 investments between the countries, as well as to avoid double taxation and fiscal evasion. The Treaty played a crucial role in the establishment of Mauritius as a financial hub, home to some of the largest investment funds and a significant source of investments going into India. “Mauritius has contributed to about a third of the foreign direct investment (FDI) in India over a 15-year period between 2000 and 2015, which is a significant share. The second closest inflow is routed from Singapore, which constituted about 16% of the total inflows during the same period.” However, the Treaty was subject to scrutiny and criticism by the Indian tax authority as well as the OECD.
The Treaty generally granted full taxing rights to the country of residence with respect to income from capital gains on the sale of shares of an Indian company. Thus, foreign investments coming into India have used Mauritius as a preferred residency country for investment vehicles to invest in India. Because Mauritius does not impose capital gain tax on foreign investors, that set the grounds for a potential double non-taxation. Given the lack of a limitation on benefit provision in the Treaty, Mauritius became the favorable jurisdiction as the gate to India.
The new protocol aims to restrict the ability to enter into such double non-taxation transactions by imposing tax on capital gains. Pursuant to 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 percent of the Indian tax rate. However, capital gains from the alienation of shares acquired on or after April 1, 2019 will be taxed at the full applicable tax rate.
The Protocol also introduces a new limitation of benefit provision under Article 27A, limiting the entitlement of the reduced tax rate applicable to capital gains only to companies who (i) satisfy the main purpose test and (ii) are not conduits or shell companies. The protocol does not define the term “main purpose” but it provides that a Mauritian company will not be considered a conduit or a shell company if it is listed in the Mauritian stock exchange or if its expenditures on operations in Mauritius are equal or exceed $42,500 in the 12 months preceding the date the capital gains occurred.
Additionally, the protocol amends the existing tax exemption on interest income arising in India to banks that conduct bona fide banking business, by introducing a new limitation in Article 3A. The new condition imposed by Article 3A states that the exemption applies only if the interest income arises from debt-claims existing on or before March 31, 2017. Interest income in respect of debt claims or loans made after 31 March 2017 will be subject to withholding tax in India at the rate of 7.5%.
Additionally, Article 12A of the Protocol now aligns with the UN Model treaty by imposing a 10% tax on fees for technical services arising in India provided that the beneficial owner is a resident of Mauritius.
Finally, a new sub paragraph has been added under paragraph 2 of Article 5 (Permanent Establishment), which introduces the service PE notion, under which an enterprise shall be deemed to have a permanent establishment if it furnishes services, including consultancy services, within a contracting state through employees or other personnel engaged by the enterprise for such purpose, if activities of that nature continue within that state for a period or periods aggregating more than 90 days within any 12 month period.