[The following guest post is
contributed by Aarush Bhatia, who is
a 5th year B.A.LL.B (Hons.) student at CNLU, Patna]
contributed by Aarush Bhatia, who is
a 5th year B.A.LL.B (Hons.) student at CNLU, Patna]
Introduction
The protocol[i]
dated 10 May 2016 amending the Double Taxation Avoidance Agreement (DTAA)
between India and Mauritius is arguably the most significant changerelating to
direct taxes in India in recent years, considering that approximately a third
of all foreign investments into India are structured through Mauritius. The
shift to source based taxation of capital gains from the hitherto residency
based taxation is its most important feature.
dated 10 May 2016 amending the Double Taxation Avoidance Agreement (DTAA)
between India and Mauritius is arguably the most significant changerelating to
direct taxes in India in recent years, considering that approximately a third
of all foreign investments into India are structured through Mauritius. The
shift to source based taxation of capital gains from the hitherto residency
based taxation is its most important feature.
To summarize, capital gains arising on
sale of shares of an Indian company by a Mauritian resident shall be taxable in
India (where the source of income lies) as against the earlier position of
taxability in Mauritius (based on the residency of the seller). Since the
amended protocol refers to shares, both equity as well as preference should be
covered. The government has however, mitigated the immediate impact of the
protocol on investorsby grandfathering all
investments made through Mauritius in shares of Indian companies until 31 March
2017. The protocol provides for a relaxation in respect of capital gains
arising to Mauritius residents for shares acquired on or after 1 April 2017 and
sold before 1 April 2019, i.e. the transition period. The tax rate on any such
gains shall be limited to 50% of the domestic tax rate in India, subject to a
limitation of benefits (LOB) clause. The LOB clause states that the benefit of
the reduced tax rate shall only be available to such Mauritius resident who is:
sale of shares of an Indian company by a Mauritian resident shall be taxable in
India (where the source of income lies) as against the earlier position of
taxability in Mauritius (based on the residency of the seller). Since the
amended protocol refers to shares, both equity as well as preference should be
covered. The government has however, mitigated the immediate impact of the
protocol on investorsby grandfathering all
investments made through Mauritius in shares of Indian companies until 31 March
2017. The protocol provides for a relaxation in respect of capital gains
arising to Mauritius residents for shares acquired on or after 1 April 2017 and
sold before 1 April 2019, i.e. the transition period. The tax rate on any such
gains shall be limited to 50% of the domestic tax rate in India, subject to a
limitation of benefits (LOB) clause. The LOB clause states that the benefit of
the reduced tax rate shall only be available to such Mauritius resident who is:
(a) not a shell/conduit company; and
(b) satisfies the main purpose and
bonafide business test.
bonafide business test.
It
provides that a Mauritius resident shall be deemed to be a shell/conduit
company if its total expenditure on operations in Mauritius is less than INR
2,700,000 (approximately 40,000 US Dollars) in the 12 months immediately
preceding the alienation of shares. The capital gains tax shall be levied at
its full rate only after 1 April 2019.
provides that a Mauritius resident shall be deemed to be a shell/conduit
company if its total expenditure on operations in Mauritius is less than INR
2,700,000 (approximately 40,000 US Dollars) in the 12 months immediately
preceding the alienation of shares. The capital gains tax shall be levied at
its full rate only after 1 April 2019.
Impact Analysis
While
the manner in which the protocol is sought to be brought into effect is
venerable, a more detailed analysis is required in order to fully understand
its ramifications on foreign investors. Some of the protocol’s latent
ambiguities and wider impact have been scrutinized in this post.
the manner in which the protocol is sought to be brought into effect is
venerable, a more detailed analysis is required in order to fully understand
its ramifications on foreign investors. Some of the protocol’s latent
ambiguities and wider impact have been scrutinized in this post.
1. Taxation of
Hybrid Instruments
Hybrid Instruments
The
press release is silent about hybrid instruments like compulsory convertible
debentures and futures and options transactions. For instance, foreign
investors invest into Indian companies through convertible instruments, with
the most common being compulsorily convertible debentures. If such instruments
are converted after 1 April 2017, can it be said that the shares are acquired
after 1 April 2017 and accordingly taxed in India? It needs to be seen whether
any benefit can be obtained from the recently introduced Rule 8AA of the
Income-tax Rules, 1962 (which provides that the period of holding shall
include, the period for which debenture is held prior to conversion) for
determining the date of acquisition of shares.[ii] This
issue needs to be clarified under the
text of the protocol as and when it is released by the Central Board of Direct
Taxes (CBDT).
press release is silent about hybrid instruments like compulsory convertible
debentures and futures and options transactions. For instance, foreign
investors invest into Indian companies through convertible instruments, with
the most common being compulsorily convertible debentures. If such instruments
are converted after 1 April 2017, can it be said that the shares are acquired
after 1 April 2017 and accordingly taxed in India? It needs to be seen whether
any benefit can be obtained from the recently introduced Rule 8AA of the
Income-tax Rules, 1962 (which provides that the period of holding shall
include, the period for which debenture is held prior to conversion) for
determining the date of acquisition of shares.[ii] This
issue needs to be clarified under the
text of the protocol as and when it is released by the Central Board of Direct
Taxes (CBDT).
2. Impact On Other Beneficial DTAAs
The
protocol has a contagion effect on other DTAAs as well. The position on capital
gains under Article 6 of the India-Singapore DTAA is co-terminus with the
benefits available under erstwhile provisions on capital gains contained in the
treaty with Mauritius. Consequently, with the amendment in India- Mauritius
DTAA, alienation of shares of an Indian Company by a Singapore Resident after 1
April 2017 may not necessarily be entitled to obtain the benefits of the
existing provision on capital gains as the beneficial provisions under the
India-Mauritius DTAA would have terminated on such date. However, clarity is
required with regard to grandfathering and transition period provisions.[iii]Further,
India has asked the Netherlands to resume negotiations on amending their
bilateral tax treaty as the government extends its efforts to plug loopholes in
such accords to curb misuse. The Dutch tax treaty, which allows exemption from
capital gains and a lower rate of tax on dividends, has led to the
proliferation of holding company structures.[iv]
While Cyprus is the only other nation whose treaty presently offers capital
gains tax exemption to investors, it had been a notified non-cooperative jurisdiction
since 2013 for failure to share adequate data on tax evaders. The government has now got Cyprus to similarly
amend the India-Cyprus DTAA. According to the new agreement, Cyprus investors’
capital gains on investments made in Indian companies after March 31, 2017 can
be taxed in India. These provisional agreements are awaiting Cabinet approval.
protocol has a contagion effect on other DTAAs as well. The position on capital
gains under Article 6 of the India-Singapore DTAA is co-terminus with the
benefits available under erstwhile provisions on capital gains contained in the
treaty with Mauritius. Consequently, with the amendment in India- Mauritius
DTAA, alienation of shares of an Indian Company by a Singapore Resident after 1
April 2017 may not necessarily be entitled to obtain the benefits of the
existing provision on capital gains as the beneficial provisions under the
India-Mauritius DTAA would have terminated on such date. However, clarity is
required with regard to grandfathering and transition period provisions.[iii]Further,
India has asked the Netherlands to resume negotiations on amending their
bilateral tax treaty as the government extends its efforts to plug loopholes in
such accords to curb misuse. The Dutch tax treaty, which allows exemption from
capital gains and a lower rate of tax on dividends, has led to the
proliferation of holding company structures.[iv]
While Cyprus is the only other nation whose treaty presently offers capital
gains tax exemption to investors, it had been a notified non-cooperative jurisdiction
since 2013 for failure to share adequate data on tax evaders. The government has now got Cyprus to similarly
amend the India-Cyprus DTAA. According to the new agreement, Cyprus investors’
capital gains on investments made in Indian companies after March 31, 2017 can
be taxed in India. These provisional agreements are awaiting Cabinet approval.
It
is speculated that Cyprus has agreed to give India the right to tax capital gains
similar to the provision in the revised India-Mauritius tax treaty subject to
being removed from the blacklist.
is speculated that Cyprus has agreed to give India the right to tax capital gains
similar to the provision in the revised India-Mauritius tax treaty subject to
being removed from the blacklist.
3. Indirect Transfers
While
the direct transfer of Indian company shares by a Mauritius resident after 1April
2017 shall be taxable in India, indirect transfers may still remain out of the
Indian domestic tax net. To illustrate, in a structure where there are two
Mauritius companies say M Co 1 and M Co 2 wherein M Co 1 holds shares of M Co 2
which in turn holds Indian company shares and derives substantial value from
India. In such a situation transfer of shares of M Co 2 by M Co 1 leading to an
indirect transfer of Indian company shares may still not be taxable in India.[v]
the direct transfer of Indian company shares by a Mauritius resident after 1April
2017 shall be taxable in India, indirect transfers may still remain out of the
Indian domestic tax net. To illustrate, in a structure where there are two
Mauritius companies say M Co 1 and M Co 2 wherein M Co 1 holds shares of M Co 2
which in turn holds Indian company shares and derives substantial value from
India. In such a situation transfer of shares of M Co 2 by M Co 1 leading to an
indirect transfer of Indian company shares may still not be taxable in India.[v]
4. Group Reorganizations
A
clarification would also be required regarding application of grandfathering in
case of shares allotted to a Mauritius resident pursuant to a merger or
demerger in lieu of shares held in the merging or the demerged entity which
were acquired before 1 April 2017.[vi]
clarification would also be required regarding application of grandfathering in
case of shares allotted to a Mauritius resident pursuant to a merger or
demerger in lieu of shares held in the merging or the demerged entity which
were acquired before 1 April 2017.[vi]
5. Most Favoured Nation (MFN) Clause
The
lowering of withholding tax (WHT) on interest to 7.5% under the new protocol
has provided succour in favour of debt securities like CCDs. While the WHT of
7.5% is lower than the one provided in other DTAAs like Netherlands (10%),
Singapore (15%), UAE (12.5%), etc., most DTAAs entered into by India contain MFN
clauses, pursuant to which if India enters into a Convention, Agreement or
Protocol with another country which reduces the tax rate of items of income
like interest income, then such reduced tax rate shall apply in case of their
DTAA as well. It remains to be seen whether the rate of WHT under other DTAAs
will automatically reduce as a consequence of the protocol.
lowering of withholding tax (WHT) on interest to 7.5% under the new protocol
has provided succour in favour of debt securities like CCDs. While the WHT of
7.5% is lower than the one provided in other DTAAs like Netherlands (10%),
Singapore (15%), UAE (12.5%), etc., most DTAAs entered into by India contain MFN
clauses, pursuant to which if India enters into a Convention, Agreement or
Protocol with another country which reduces the tax rate of items of income
like interest income, then such reduced tax rate shall apply in case of their
DTAA as well. It remains to be seen whether the rate of WHT under other DTAAs
will automatically reduce as a consequence of the protocol.
6. Impact on Investment Through
Participatory Notes (P-Notes)
Participatory Notes (P-Notes)
P-Notes
are derivatives issued by FIIs to investors for the underlying securities
invested by the FIIs on the Indian stock markets. Mauritius was the most
suitable jurisdiction to invest through P-Notes as several FIIs were setup in
Mauritius to avail of the India-Mauritius tax treaty benefits. The P-Notes
enjoyed the same capital gains benefit as the FIIs enjoyed at the time of
transfer of shares by the FIIs on the Indian securities.This benefit would now
cease to be available. While it can be argued that GAAR would have checked
treaty abuse anyhow without amending the treaty, it is speculated that the real
reason behind this amendment seems to be to restrict investments through
P-Notes to prevent round-tripping of money. Withdrawal of the treaty benefits
would make this route unattractive for such investors.
are derivatives issued by FIIs to investors for the underlying securities
invested by the FIIs on the Indian stock markets. Mauritius was the most
suitable jurisdiction to invest through P-Notes as several FIIs were setup in
Mauritius to avail of the India-Mauritius tax treaty benefits. The P-Notes
enjoyed the same capital gains benefit as the FIIs enjoyed at the time of
transfer of shares by the FIIs on the Indian securities.This benefit would now
cease to be available. While it can be argued that GAAR would have checked
treaty abuse anyhow without amending the treaty, it is speculated that the real
reason behind this amendment seems to be to restrict investments through
P-Notes to prevent round-tripping of money. Withdrawal of the treaty benefits
would make this route unattractive for such investors.
Conclusion
The
protocol seems to be the final chapter in along drawn tussle between investorsand
the revenue. The phased manner of withdrawal of benefits by the government is
laudable, especially after its retrospective taxation misadventure post the
Vodafone case. While the press release clears the air regarding treaty benefits
in no uncertain terms, its collateral impact as analyzed would be clear only
after the text of the protocol is releaased. The details of the ‘main purpose’
test and the ‘bona fide purpose’ test stated in the press release too are
unclear. There is a possibility that these tests may be subjective and lead to
some uncertainty regarding the taxability of investments made during the
Interim Period.
protocol seems to be the final chapter in along drawn tussle between investorsand
the revenue. The phased manner of withdrawal of benefits by the government is
laudable, especially after its retrospective taxation misadventure post the
Vodafone case. While the press release clears the air regarding treaty benefits
in no uncertain terms, its collateral impact as analyzed would be clear only
after the text of the protocol is releaased. The details of the ‘main purpose’
test and the ‘bona fide purpose’ test stated in the press release too are
unclear. There is a possibility that these tests may be subjective and lead to
some uncertainty regarding the taxability of investments made during the
Interim Period.
–Aarush Bhatia
[i]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 between India and
Mauritius available at http://incometaxindia.gov.in/Lists/Press%20Releases/Attachments/468/Press-release-Indo-Mauritius-10-05-2016.pdf
Convention for the avoidance of double taxation and the prevention of fiscal
evasion with respect to taxes on income and capital gains between India and
Mauritius available at http://incometaxindia.gov.in/Lists/Press%20Releases/Attachments/468/Press-release-Indo-Mauritius-10-05-2016.pdf
[ii]Sahil
Aggarwal, Protocol to India-Mauritius DTAA: A move towards avoidance of double
non-taxation, available at taxmann.com
Aggarwal, Protocol to India-Mauritius DTAA: A move towards avoidance of double
non-taxation, available at taxmann.com
[iii] Ibid
[iv]DeepshikhaSikarwar, After Mauritius,
now government wants to amend Dutch tax treaty; asks Netherlands to resume
talks, (Economic Times, May 30th 2016) available at http://economictimes.indiatimes.com/news/economy/policy/after-mauritius-now-government-wants-to-amend-dutch-tax-treaty-asks-netherlands-to-resume-talks/articleshow/52495938.cms
now government wants to amend Dutch tax treaty; asks Netherlands to resume
talks, (Economic Times, May 30th 2016) available at http://economictimes.indiatimes.com/news/economy/policy/after-mauritius-now-government-wants-to-amend-dutch-tax-treaty-asks-netherlands-to-resume-talks/articleshow/52495938.cms
[v] Amit Bahl, Harsh Biyani and
SurbhiBagga, Protocol amending
India-Mauritius DTAA: Key changes and their impact, available at taxmann.com
SurbhiBagga, Protocol amending
India-Mauritius DTAA: Key changes and their impact, available at taxmann.com
[vi]Ibid
OFFHAND
The mooted discussion, as read and understood by one, forebodes THE INTENT OF OUR LAW MAKERS BEHIND TO ROLL BACK, to some extent the policy decision (s) rolled out / road-map announced, in recent times. As to the 'impact' of it, more so in the near or far-off future, has to be left, as ever, only to the future, naturally replete with uncertainties galore.
May be, optimists at large, in a likely majority, have a different perspective, to share!