Since the liberalization of India’s
economy in 1991, a substantial amount of foreign investment into India has come
in through Mauritius. This is essentially due to the favourable provisions of
the “Agreement for avoidance of double taxation and prevention of fiscal
evasion with Mauritius” (the “Mauritius Treaty”) that the Indian Government had
entered into way back in 1983. Under article 13(4) of the Mauritius Treaty,
capital gains derived by a Mauritius resident through sale of shares of an
Indian company has been subject to capital gains tax only in Mauritius and not
in India. Given the minimal tax rates in Mauritius, such a sale would attract
limited capital gains tax, thereby reducing the cost of investment and making
Mauritius an attractive geography through which investors from around the world
have been making investments into India.
economy in 1991, a substantial amount of foreign investment into India has come
in through Mauritius. This is essentially due to the favourable provisions of
the “Agreement for avoidance of double taxation and prevention of fiscal
evasion with Mauritius” (the “Mauritius Treaty”) that the Indian Government had
entered into way back in 1983. Under article 13(4) of the Mauritius Treaty,
capital gains derived by a Mauritius resident through sale of shares of an
Indian company has been subject to capital gains tax only in Mauritius and not
in India. Given the minimal tax rates in Mauritius, such a sale would attract
limited capital gains tax, thereby reducing the cost of investment and making
Mauritius an attractive geography through which investors from around the world
have been making investments into India.
At the same time, there was also
substantial criticism regarding the use of the “Mauritius route” in that it
deprived the Indian Government of revenue by discriminating between local
investors (who are liable to pay capital gains tax) and overseas investors
coming through Mauritius (who were exempt from such taxation). Added to this
was the concern regarding round-tripping of funds from India whereby Indian
investors unduly reaped the benefits of the Mauritius Treaty. Over a decade
ago, the use of the Mauritius route was mired in litigation, although it
withstood challenge before the Supreme Court in Union of India v. Azadi
Bachao Andolan (2003) 132 Taxmann 373. In recent years, however, there
has been significant talk about renegotiation of the Mauritius Treaty between
the two governments. Such a renegotiation has now come to fruition with the Indian
Government’s announcement
yesterday that it has signed a Protocol with the Government of Mauritius for
the amendment of the Mauritius treaty. As of this writing, only the Government’s
press release is available, and the Government is yet to release the specific
text of the amendments.
substantial criticism regarding the use of the “Mauritius route” in that it
deprived the Indian Government of revenue by discriminating between local
investors (who are liable to pay capital gains tax) and overseas investors
coming through Mauritius (who were exempt from such taxation). Added to this
was the concern regarding round-tripping of funds from India whereby Indian
investors unduly reaped the benefits of the Mauritius Treaty. Over a decade
ago, the use of the Mauritius route was mired in litigation, although it
withstood challenge before the Supreme Court in Union of India v. Azadi
Bachao Andolan (2003) 132 Taxmann 373. In recent years, however, there
has been significant talk about renegotiation of the Mauritius Treaty between
the two governments. Such a renegotiation has now come to fruition with the Indian
Government’s announcement
yesterday that it has signed a Protocol with the Government of Mauritius for
the amendment of the Mauritius treaty. As of this writing, only the Government’s
press release is available, and the Government is yet to release the specific
text of the amendments.
Progressive
Removal of Benefits for Capital Gains Tax
Removal of Benefits for Capital Gains Tax
Effective
Date
Date
According to the Protocol, the
Government of India will obtain the right to levy capital gains tax on
alienation of shares in Indian companies which have been acquired on or after 1
April 2017. This revised regime effectively withdraws the capital gains tax
benefits available under the Mauritius Treaty, but on a prospective basis. In
order not to surprise investors and to avoid any negative reactions in the
markets, the amendment has been introduced on a prospective basis. Through a “grandfathering”
approach, it protects investment made prior to 1 April 2017. In other words,
the effective date of the amendment applies with respect to the making of the
investment and not its disposal. Therefore, so long as investments are made
before 1 April 2017, the existing treaty benefits may be availed even if the
divestments occur after such date.
Government of India will obtain the right to levy capital gains tax on
alienation of shares in Indian companies which have been acquired on or after 1
April 2017. This revised regime effectively withdraws the capital gains tax
benefits available under the Mauritius Treaty, but on a prospective basis. In
order not to surprise investors and to avoid any negative reactions in the
markets, the amendment has been introduced on a prospective basis. Through a “grandfathering”
approach, it protects investment made prior to 1 April 2017. In other words,
the effective date of the amendment applies with respect to the making of the
investment and not its disposal. Therefore, so long as investments are made
before 1 April 2017, the existing treaty benefits may be availed even if the
divestments occur after such date.
Transition
Period
Period
In order to soften the blow for
investors, the Protocol contains a two-year transition period during which a
reduced tax rate would apply for capital gains. It provides that “in respect of
capital gains arising during the transition period from 1 April 2017 to 31
March 2019, the tax rate will be limited to 50% of the domestic tax rate of
India, subject to the fulfillment of the conditions in the Limitation of
Benefits Article”. The language of the press release is unclear as to whether this
would apply to investments made during this period or divestments made then.
Interestingly, the concept of Limitation of Benefits (LoB) has been introduced
for the capital gains benefit during the transition period. Such an LoB was not
present in the Mauritius Treaty for capital gains prior to this amendment,
although an LoB requirement has been contained in the double taxation avoidance
agreement between India and Singapore.
investors, the Protocol contains a two-year transition period during which a
reduced tax rate would apply for capital gains. It provides that “in respect of
capital gains arising during the transition period from 1 April 2017 to 31
March 2019, the tax rate will be limited to 50% of the domestic tax rate of
India, subject to the fulfillment of the conditions in the Limitation of
Benefits Article”. The language of the press release is unclear as to whether this
would apply to investments made during this period or divestments made then.
Interestingly, the concept of Limitation of Benefits (LoB) has been introduced
for the capital gains benefit during the transition period. Such an LoB was not
present in the Mauritius Treaty for capital gains prior to this amendment,
although an LoB requirement has been contained in the double taxation avoidance
agreement between India and Singapore.
Under the LoB provision, the
reduced tax rate during the transition period will not be available if a
resident of Mauritius (including a shell/conduit company) “fails the main
purpose test and the bonafide test. A resident is deemed to be a shell/conduit
company, if its total expenditure on operations in Mauritius is less than Rs.
2,700,000 (Mauritius Rupees 1,500,000) in the immediately preceding months”.
This would ensure that the beneficial tax treatment is available only to Mauritius
residents who have a substantial (and not merely formal) presence in that
jurisdiction.
reduced tax rate during the transition period will not be available if a
resident of Mauritius (including a shell/conduit company) “fails the main
purpose test and the bonafide test. A resident is deemed to be a shell/conduit
company, if its total expenditure on operations in Mauritius is less than Rs.
2,700,000 (Mauritius Rupees 1,500,000) in the immediately preceding months”.
This would ensure that the beneficial tax treatment is available only to Mauritius
residents who have a substantial (and not merely formal) presence in that
jurisdiction.
Post-Transition
From the financial year 2019-20,
all capital gains earned by a Mauritius resident through sale of shares of an
Indian company would be liable to taxation in India in accordance with the
prevailing tax regime.
all capital gains earned by a Mauritius resident through sale of shares of an
Indian company would be liable to taxation in India in accordance with the
prevailing tax regime.
Implications
on the Indo-Singapore Treaty
on the Indo-Singapore Treaty
Although the renegotiation relates
to the Mauritius Treaty, it has a domino effect on the
to the Mauritius Treaty, it has a domino effect on the
“Agreement Between the Government of
the Republic of Singapore 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” (the “Singapore Treaty”). By way of a protocol entered into between
India and Singapore in 2005 that amended the Singapore Treaty, residents of
Singapore were provided with similar capital gains tax benefits as Mauritius
when they invested in shares of an Indian company. Due to this reason,
Singapore too became an attractive destination for foreign investors investing
into India.
the Republic of Singapore 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” (the “Singapore Treaty”). By way of a protocol entered into between
India and Singapore in 2005 that amended the Singapore Treaty, residents of
Singapore were provided with similar capital gains tax benefits as Mauritius
when they invested in shares of an Indian company. Due to this reason,
Singapore too became an attractive destination for foreign investors investing
into India.
However, unlike the Mauritius
Treaty, the protocol made available the treaty benefits only subject to a LoB
clause that required that the Singapore resident not be a shell/conduit based
on a stipulated annual expenditure requirement. More importantly, Article 6 of
that protocol stipulated that these capital gains tax benefits will remain available
only so long as the Mauritius Treaty provides that any gains from the alienation
of shares in an Indian company will be taxable only in Mauritius. In other
words, the fate of the capital gains tax benefit is inextricably linked to that
the Mauritius treaty. Now that that benefit under the Mauritius Treaty is
falling away, it will automatically bring to an end the benefits under the
Singapore Treaty. Any tax or regulatory arbitrage that may have operated
between Mauritius and Singapore would no longer be good in the renegotiated
regime.
Treaty, the protocol made available the treaty benefits only subject to a LoB
clause that required that the Singapore resident not be a shell/conduit based
on a stipulated annual expenditure requirement. More importantly, Article 6 of
that protocol stipulated that these capital gains tax benefits will remain available
only so long as the Mauritius Treaty provides that any gains from the alienation
of shares in an Indian company will be taxable only in Mauritius. In other
words, the fate of the capital gains tax benefit is inextricably linked to that
the Mauritius treaty. Now that that benefit under the Mauritius Treaty is
falling away, it will automatically bring to an end the benefits under the
Singapore Treaty. Any tax or regulatory arbitrage that may have operated
between Mauritius and Singapore would no longer be good in the renegotiated
regime.
At the same time, there could be
some issues in operationalizing the termination of the capital gains tax benefits
under the Singapore Treaty. Given that the Mauritius Treaty operates on a
prospective basis (with investments made up to 1 April 2017) being
grandfathered, and with a transition period of two years at a reduced tax rate,
it is not clear whether the Singapore Treaty benefits would terminate at once,
and that too without prospective effect. An alternative interpretation would be
that the Singapore Treaty benefits also ought to be withdrawn on a similar
basis as the Mauritius Treaty, i.e. prospectively and with grandfathering
effect. These issues will surely be the subject matter of great debate and interpretation
in the days and weeks to come.
some issues in operationalizing the termination of the capital gains tax benefits
under the Singapore Treaty. Given that the Mauritius Treaty operates on a
prospective basis (with investments made up to 1 April 2017) being
grandfathered, and with a transition period of two years at a reduced tax rate,
it is not clear whether the Singapore Treaty benefits would terminate at once,
and that too without prospective effect. An alternative interpretation would be
that the Singapore Treaty benefits also ought to be withdrawn on a similar
basis as the Mauritius Treaty, i.e. prospectively and with grandfathering
effect. These issues will surely be the subject matter of great debate and interpretation
in the days and weeks to come.
Conclusion
A substantial part of foreign investment
in India in the last three decades has come in through Mauritius, and more
recently through Singapore. This is not surprising given the benefits relating
to capital gains tax. Although the renegotiation of the Mauritius Treaty has
been in the offing for a while, foreign investors would need to rethink their
investment structuring strategy now that the changes have become a reality.
While some may argue that this is disastrous from a foreign investment perspective,
it might be the case that it sets at rest past uncertainty and clarifies
matters, which may allow investors and the market to price these accordingly by
incorporating the additional tax burden.
in India in the last three decades has come in through Mauritius, and more
recently through Singapore. This is not surprising given the benefits relating
to capital gains tax. Although the renegotiation of the Mauritius Treaty has
been in the offing for a while, foreign investors would need to rethink their
investment structuring strategy now that the changes have become a reality.
While some may argue that this is disastrous from a foreign investment perspective,
it might be the case that it sets at rest past uncertainty and clarifies
matters, which may allow investors and the market to price these accordingly by
incorporating the additional tax burden.
