New Chapter in the Saga of India – Mauritius Tax Treaty

CA. Hardik Mehta & CA. Arwa Mahableshwarwala

History of the India-Mauritius Tax Treaty (pre 2016 amendment)

India has close, longstanding relations with Mauritius owing to historic, demographic, and cultural reasons. Mauritius was one of the handful of important countries with which independent India established diplomatic relation in 1948, even before the independence of Mauritius. The leadership of the two countries enjoy a high level of trust and mutual understanding, which is reflected in the continued high-level political engagement. Further, since 2005, India has been among the largest trading partners of Mauritius1.

The Double-Taxation Avoidance Convention (‘DTAC’) between India and Mauritius is dated back to August 1982 and came into effect in December 1983. The agreement was primarily drawn with the aim of strengthening the flow of investments between the two countries, especially from India’s perspective, where India began the process of liberalizing its markets in 1991 and setting the stage for the international economy. Owing to the lucrative DTAC between India and Mauritius, Mauritius emerged as one of the largest foreign direct investors in India until the amendment of the Tax Treaty in 2016.

One of the key provisions of the India-Mauritius DTAC was the exemption of capital gains tax in India on the sale of securities (such as shares) by Mauritian residents. As per the erstwhile provision under Article 13(4) of the India-Mauritius DTAC, the taxing rights for capital gains on sale of shares of an Indian company were granted only to the Residence state i.e. Mauritius and the Source state i.e. India abstained from imposing any tax on capital gains. The Central Board of Direct Taxes (“CBDT”) vide Circular No. 682 dated 30th March 1994 had clarified that capital gains arising to any resident of Mauritius resident from alienation of shares of an Indian company shall be taxable only in Mauritius as per the domestic tax law of Mauritius. This beneficial provision coupled with no local taxes in Mauritius on capital gains made Mauritius a preferred route for foreign investors, particularly for investing in the Indian stock market, as they could route their investments through Mauritius to benefit from the tax exemption.

The Indian Revenue Authorities viewed the tax advantage in the form of capital gains exemption under the India-Mauritius DTAC as a means to evade tax by routing transactions through Mauritius. The India-Mauritius DTAC faced a lot of backlash from the Indian Revenue Authorities and they denied the benefits under the DTAC to investors claiming capital gains exemption on the grounds of lack of commercial substance, tax evasion, round tripping etc. To curb the panic created as a result thereof, CBDT issued another clarification vide Circular No. 789 dated 13th April 2000 wherein the CBDT clarified in the said Circular that possession of a valid Tax Residency Certificate by a Mauritian resident which is issued by the Mauritian Tax Authorities was a sufficient proof for the purposes of availing the benefits under the India-Mauritius DTAC and to be treated as the “beneficial owner” with respect to the income under consideration. Further, the Supreme Court in the case of Azadi Bachao Andolan v. Union of India (2004) 10 SCC 1 cleared the air of criticism on the India-Mauritius DTAC and recognised investments done in India through Mauritius as legitimate and affirming non-taxability of gains arising to a Mauritian resident in India from transfer of shares of an Indian company by virtue of Article 13(4) of the Tax Treaty.

Amendment of DTAC in 2016

It was observed that the DTAC was being misused as a means to evade tax through treaty shopping and round tripping. The Mauritius route became a crucial pathway for flow of unexplained money into India and significant loss of revenue for the Indian Government. In response to these concerns, the Government of both the countries renegotiated the terms of the DTAC in 2016 by way of a Protocol dated 10th May 2016 wherein India was granted the right to tax capital gains on transfer of shares of an Indian company acquired on or after 1st April 2017 thereby ensuring that the amendment does not have a retrospective impact on existing investments. Therefore, investments made prior to 1st April 2017 were grandfathered and sale of such grandfathered shares continued to benefit from the capital gains tax exemption under Article 13(4) of the India-Mauritius Tax Treaty regardless of when such shares would be sold. Further, with respect to shares acquired on or after 1st April 2017 but disposed of before 31st March 2019, capital gains arising on disposal of such shares were subject to a reduced tax rate of 50% of the domestic tax rate in India. The application of the reduced rate was subject to the fulfillment of conditions in the Limitation of Benefits (LOB) Article.

As per the LOB clause, the benefit of the reduced tax rate during the transition period shall not be granted to a Mauritius resident company if it fails to fulfill the main purpose test and bona fide business 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 (Mauritian Rupees 1,500,000) in the immediately preceding 12 months.

It is noteworthy that the capital gains exemption was withdrawn only with respect to shares. The capital gains on derivatives and fixed income securities continued to be exempt. In addition to the above amendment, there were other impact areas of the Protocol to the India-Mauritius Tax Treaty which inter alia included the following:

  • Interest arising in India to Mauritian resident banks were subject to withholding tax in India at 7.5 per cent after 31st March 2017.
  • An additional category of Service PE clause was introduced under Article 5 of the Tax Treaty
  • Article 6 of the Protocol to the India- Singapore Tax Treaty provides that the capital gains tax benefits will remain available only so long as the India- Mauritius Tax Treaty provides that any gains from the alienation of shares in an Indian company will be taxable only in Mauritius. Accordingly, since the benefit under the India-Mauritius Tax Treaty was removed, the benefits under India- Singapore Tax Treaty were likely to be affected.

Interplay of Tax Treaty amendment in 2016, introduction of GAAR in 2017 and Multilateral Convention in 2019

In a parallel development during this period, the Indian Government introduced ‘General Anti-Avoidance Rules’ (GAAR) in the Indian domestic tax law with effect from 1st April 2017 introducing the ‘substance over form’ approach. The introduction of GAAR was in line with Base Erosion and Profit Shifting (‘BEPS’) measures by the Organisation for Economic Co-operation and Development (‘OECD’) to ensure that companies are responsible for taxation generated by their activities where those activities are carried out. GAAR equips Indian tax authorities with the power to deny tax benefits, including, tax treaty benefits, where the ‘main purpose’ or even one of the principal purposes of an arrangement (or any step thereof) is to obtain a tax benefit and the arrangement lacks commercial substance. GAAR requires the fulfillment of the Main Purpose Test as well as one of the Tainted Element Tests. The implementation of GAAR by the Indian Government was in pipeline since 2012 but was deferred until 2017. The announcement by the Indian Government regarding applicability of GAAR from 1st April 2017 was also a compelling factor for Mauritius to agree for amendment of its DTAC with India in 2016. However, gains from transfer of investments acquired prior to 1st April 2017 were specifically excluded from the purview of GAAR2.

India signed the ‘Multilateral Convention’ (MLI) in 2019 to implement the Tax Treaty Related Measures to prevent Base Erosion and Profit Shifting on 5 July 2017. The key changes for Tax Treaties amended by the MLI were (i) inclusion of a new preamble which states that the purpose of the Tax Treaty is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance and (ii) inclusion of a ‘principal purpose test’ provision which is an anti-abuse rule to deny Tax Treaty benefits in abusive cases. The MLI only modifies Tax Treaties that are ‘Covered Tax Agreements’ (CTA). Thus, a Tax Treaty shall be treated as CTA if both the Contracting States list the respective tax treaties as a CTA in their MLI positions. Countries may sign up to the MLI or choose to bilaterally renegotiate their tax treaties to incorporate BEPS minimum standards and other treaty anti- avoidance provisions.

It is pertinent to note that Mauritius did not include its Tax Treaty with India as a CTA and therefore, the provisions of MLI were not incorporated into the India-Mauritius Tax Treaty. Thus, the India-Mauritius Tax Treaty requires bilateral negotiations for amendments in the Tax Treaty to prevent tax evasion, tax avoidance or treaty abuse.

Impact on Foreign Direct Investment

Investments from Mauritius were impacted by the threefold effect of the amendment of the India-Mauritius Tax Treaty in 2016, introduction of GAAR in 2016 and MLI ratification by India with other neighboring countries in 2019. Mauritius was one of the major contributors of Foreign Direct Investment (‘FDI’) in India until 2017-18 after which the quantum of investments started declining on account of abrogation of the capital gains tax benefit under the India- Mauritius Tax Treaty. In contrast, the share of FDI from Singapore witnessed an increase. The amendment of the India-Mauritius DTAC changed India’s equation with Mauritius and created a negative perception among existing and new investors regarding their investment strategies from India’s perspective since taxation of capital gains would ultimately increase their cost of doing business in India.

Increase in debt investments into India

Although the equity investment route was not the preferred route for many Mauritius investors in view of withdrawal of the capital gains exemption, Mauritius investors continued to explore the debt market in India considering the concessional rate on interest income under Article 11 of the India-Mauritius Tax Treaty. The withholding tax rate under the India- Mauritius Tax Treaty is 7.5% of the gross amount of interest provided that the Mauritius entities / residents are the beneficial owners of such interest income.

In an atmosphere of economic uncertainty and market fluctuations, international investors are increasingly looking for alternative investment routes. Given the unprecedented growth of the private debt market in India, Mauritius was one of the ideal jurisdictions to structure debt investments into India to gain foothold into the emerging debt market.

Protocol to India – Mauritius Tax Treaty

Following the series of controversies and amendments to the India-Mauritius Tax Treaty, the Governments of India and Mauritius signed a second amending protocol to the India- Mauritius Tax Treaty on 7th March 2024 to align it with the minimum standards under the OECD BEPS initiative. It will enter into force when ratified by both treaty partners. The salient features of the protocol are as under3:

  • The inclusion of a new preamble which states that the purpose of the DTAA is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance through treating shopping aimed at obtaining tax reliefs provided in the convention for the indirect benefit of residents of third jurisdiction.
  • The inclusion of a ‘principal purpose test’ which is an anti-abuse rule as per which benefit under the India-Mauritius Tax Treaty shall not be granted in respect of any item of income, if it is reasonable to conclude having regard to the facts and circumstances that obtaining such tax benefit was one of the principal purpose of such transaction that has resulted directly or indirectly in such benefit unless it is established by the tax-payer that the tax benefit is in accordance with the object and purpose of the Treaty (hereinafter referred to as ‘Principal Purpose Test’)..
  • A new article has been added “Article 27B – Entitlement to Benefits”. As per the new article, treaty benefits such reduced withholding tax on interest, royalties and dividends can be denied where it is established that obtaining that treaty benefit is one of the principal purposes for the party engaged in the transaction. In such case, even TRC issued by the Mauritius tax authority shall not suffice to claim the benefit under the India- Mauritius Tax Treaty.
  • The Protocol states that the amendment will be effective from the date when a formal notification is issued by the respective bodies of India and Mauritius, however, it has been further stated in Article 3(2) of the Protocol that such amendment shall have effect without regard to the date on which taxes are levied or the taxable years to which the taxes relate.

Concluding Thoughts

After the Protocol was signed, the CBDT issued a message on X (Twitter) on 12.04.2024 addressing the queries raised in connection with the Protocol which read as under:

“Some concerns have been raised on the India Mauritius DTAA amended recently. In this context, it is clarified that the concerns /queries are premature at the moment since the Protocol is yet to be ratified and notified u/s 90 of the Income-tax Act, 1961. As and when the Protocol comes into force, queries, if any, will be addressed, wherever necessary”.

However, there are already a lot of ambiguities among taxpayers and investors post the signing of the Protocol wherein one of the major concerns raised is regarding applicability of the Protocol to grandfathered investments i.e. investments made on or before 31.03.2017. Based on the CBDT announcement on Twitter, it appears that the queries / concerns shall be addressed by the CBDT in due course.

If the Protocol has retrospective effect, it would have a far-reaching impact among investors and portrays India as a country playing with the legitimate expectations of its investors who once promised capital gains tax exemption when it was in need of foreign investments. It would be unfair to treat investors as guinea pigs who bear the brunt of a retrospective amendment in law. Further, there are a plethora of judgements which state that unless a contrary intention appears, a legislation is presumed not to be intended to have a retrospective operation since a current law cannot govern events of the past.

Considering the above, the investors are hopeful that CBDT issues a clarification at the earliest in order to end the panic and prevent investors from liquidating their investments in anticipation of payment of capital gains tax that could be levied pursuant to notification of the Protocol by both the countries.

All investments made in India by Mauritius investors shall continue to be guided by the present law till the Protocol comes into effect.

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  1. https://www.hcimauritius.gov.in/
  2. Circular No. 7 of 2017 issued by the Central Board of Direct Taxes
  3. Adapted from Taxmann Article – [2024] 161 taxmann.com 500 (Article)