India and Mauritius have been engaged in protracted negotiations over the terms of the India-Mauritius tax treaty over the past few years. The negotiation effort recently culminated when the two countries signed a protocol amending the India-Mauritius tax treaty. While the actual text of the protocol hasn’t been made public yet, the Government of India has issued a press release which highlights the key changes to that have been brought about by the protocol. The Government of Mauritius, however, has released the actual text of the protocol to the India-Manutius tax treaty (“Protocol”) . In this article, analyse the key changes to the India-Mauritius tax treaty as result of the Protocol.
Phase out of capital gains tax exemption
The Protocol confers India the right to tax capital gains earned in India from the transfer of shares of an Indian company as per its domestic tax laws. However, in order to smoothen the transition to the new regime, the right to tax capital gains will be implemented in a phased manner as follows:
Investment in shares prior to April 1, 2017: Capital gains tax exemption under the India-Mauritius tax treaty will continue to apply to investments in shares acquired before April 1, 2017, irrespective of their date of transfer.
Concessional tax rate from April 1, 2017 to March 31, 2019: Capital gains arising from the transfer of shares acquired by the investor on or after April 1, 2017 will be taxed at 50 per cent of the domestic tax rate of India during the transition period from April 1, 2017 to March 31, 2019. The concessional rate of tax will be contingent on the taxpayer fulfilling the conditions set out in the Limitation of Benefits (“LOB”) clause.
Structured on the lines of the LOB clause under the India-Singapore tax treaty, this LOB clause provides that a resident of Mauritius (including a shell/ conduit company) will not be entitled to benefits of the concessional rate, if its affairs were arranged with the primary purpose to take advantage of such benefits. A shell/ conduit company has been defined to mean any legal entity falling within the definition of resident with negligible or nil business operations or with no real and continuous business activities carried out in Mauritius.
The LOB clause further provides that a Mauritian resident will be deemed to be a shell/ conduit company, if its total expenditure on operations in Mauritius is less than Mauritian Rupees 1,500,000 in the immediately preceding period of 12 months from the date the gains arise. However, a Mauritian resident will be deemed not to be a shell/ conduit company if it is listed on a recognized stock exchange in Mauritius or its expenditure on operations in Mauritius is Mauritian Rupees 1,500,000 or more in Mauritius in the immediately preceding period of 12 months from the date the gains arise.
Full taxation from April 1, 2019 onwards: Capital gains arising on alienation of shares acquired by the investor on or after April 1, 2017 will be taxed at the full domestic tax rate from April 1, 2019 onwards.
Withholding tax rate provided for interest income of Mauritian tax residents
Previously, India could tax Mauritian tax residents (except Government of Mauritius and its agencies and banks) on interest income arising in India as per India’s domestic tax rates. The Protocol amends the tax treaty to limit India’s right to tax such interest income by capping the withholding tax rate to 7.5 per cent of the gross amount of interest.
Further, the Protocol amends the tax treaty to withdraw the tax exemption accorded to Mauritian resident banks from interest income arising in India. Pursuant to the Protocol, interest income arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5 per cent in respect of debt claims or loans made after March 31, 2017. However, interest income of Mauritian resident banks in respect of debt-claims existing on or before March 31, 2017 will continue to be tax exempt in India.
Introduction of a permanent establishment (“PE”) clause for services
Previously, the India-Mauritius tax treaty did not have a specific clause in relation to a service PE. The Protocol amends the tax treaty to provide a specific clause in relation to a PE arising on account of services rendered by the Mauritian tax resident’s employees in India. Under such clause, a Mauritian tax resident will have a PE in India if it furnishes services (including consultancy services) through its employees or personnel if activities of such nature continue (for the same or connected project) for a period or periods aggregating more than 90 days within any 12 month period.
Introduction of an article on fee for technical services (“FTS”)
The Protocol amends the tax treaty to provide a specific article on FTS. India may now tax FTS income arising in India to a Mauritian tax resident at 10 per cent of the gross amount of the FTS. Further, FTS has been defined in accordance with India’s domestic law to mean consideration for any managerial or technical or consultancy services.
Source based taxation of ‘Other Income’
Previously, only the residence country had the right to tax income falling under the residuary category of ‘Other Income’. The Protocol amends the tax treaty to provide the source country the right to tax ‘Other Income’ arising in the source country.
Update of exchange of information provisions and insertion of article on assistance in collection of taxes
The Protocol to the India-Mauritius tax treaty also updates the exchange of information article as per international standards and inserts a new article on assistance in collection of taxes.
Date on which the Protocol comes into effect
The Government of India and Government of Mauritius are required to notify to each other that procedures required under their respective laws to bring such Protocol into force are complete. The Protocol will come into force on the date of the later of such notifications.
The amendments relating to service PE, withholding tax on interest, FTS, Other Income and LOB clause will be effective in India in respect of income derived in any financial year, which begins following the date on which the Protocol comes into force. For instance, if the Protocol comes into force on June 4, 2016, such amendments will be effective from April 1, 2017.
The amendments relating to capital gains tax will be effective from assessment year 2018-2019 (i.e., financial year 2017-2018) onwards.
Finally, the amendments relating to exchange of information and assistance in collection of taxes will have effect from the date of entry into force of the Protocol, without regard to the date on which the taxes are levied or the tax years to which the taxes relate.
The Protocol does impact the tax competitiveness of Mauritius as a jurisdiction for routing investments into India. We set out below our key takeaways in connection with the amendments made by the Protocol to the India-Mauritius tax treaty.
Grandfathering of investments: Grandfathering of investments made prior to April 1, 2017 reflects the Indian government’s commitment to provide certainty to taxpayers. Moreover, the phased withdrawal of capital gains tax exemption will give time to investors to reassess their investment structures in relation to India.
Impact on India-Singapore tax treaty: A key fallout of the withdrawal of the capital gains tax exemption under the India-Mauritius tax treaty will be its impact on the capital gains tax exemption accorded with respect to transfer of shares of an Indian company under the India-Singapore tax treaty. The exemption under the India-Singapore tax treaty is co-terminus with the exemption under the India-Mauritius tax treaty, and thus will remain in force only so long as India-Mauritius tax treaty exempts such capital gains.
Given the withdrawal of the capital gains exemption under the India-Mauritius tax treaty, the withdrawal of the exemption under the India-Singapore tax treaty seems a fait accompli. However, the timing of such withdrawal is unclear. This creates ambiguity as regards the benefits available under the India-Singapore tax treaty until the Indian Government issues clarification in this respect. To illustrate, one isn’t certain if the benefit of the grandfathering provisions will be read into the India-Singapore tax treaty as well. Further, there is no clarity as regards the date from which the capital gains tax exemption under the India-Singapore tax treaty will cease to apply (i.e., May 10 2016 or April 1, 2017 or any other date)
Preparatory steps for BEPS (Base Erosion and Profit Shifting) Initiative and General Anti Avoidance Rules (“GAAR”): The protocol to India-Mauritius tax treaty comes against the backdrop of the BEPS initiative, which is gaining increased momentum internationally, and GAAR that will come into force from 2017 onwards. All such measures, viewed cumulatively, signal India’s serious resolve to curb tax avoidance. Foreign investors should re-look their investment structures in view of these developments.
Withholding tax rate on interest income: Previously,the India-Mauritius tax treaty did not limit India’s right to tax interest income arising to a Mauritian tax residents (except Government of Mauritius and its agencies and banks). This was a drawback for debt structured through Mauritius (in comparison to other treaty countries such as Singapore) as the domestic tax rate on interest income of non-residents ranged from 5 per cent -40 per cent , depending on the status of the creditor, currency of the debt, purpose of debt, etc. The Protocol now amends the tax treaty to limit Indian’s right to tax interest income to 7.5 per cent, which should make Mauritius a favourable destination for strutting debt investments into India.
Source based taxation of “Other Income”: Previously, India did not have the right to tax any residuary income, i.e. “Other Income”, of a Mauritian tax resident, arising in India. This was beneficial for Mauritian tax residents who could claim treaty benefit when exposed to Indian taxes on account of acquiring shares in India below their book value. However, the Protocol amends the tax treaty to provide India rights to tax “Other Income” arising to a Mauritian tax resident in India. Accordingly, a Mauritian tax resident may be susceptible to Indian taxes in situations where he acquires shares in India for a consideration below their book value. .
Taxation of FTS: The India-Mauritius tax treaty also loses some of its shine on account of inclusion of a specific article on FTS. India may now tax payments categorized as FTS in the hands of a Mauritian tax resident at 10 per cent.
Capital gains tax exemption with respect to other property: Gains arising from the transfer of capital assets (other than shares) such as option rights, non-convertible debentures, derivatives and intangible rights will continue to be tax exempt from Indian taxes. Finally, the amendments made by the Protocol also raises the issue of whether shares acquired upon the conversion of a convertible instrument will be entitled to capital gains tax exemption if the convertible instrument was acquired before April 1, 2017 but the conversion occurred post April 1, 2017.
The text of the protocol as released by the Government of Mauritius is available at http://mof.govmu.org/English//DOCUMENTS/PROTOCOL%20TO%20THE%20MAURITIUS%20-%20INDIA%20DTAC%20SIGNED%20ON%2010%20MAY%202016.PDF
Authors: Amit Singhania - Partner, Shardul Amarchand Mangaldas & Co.
Gouri Puri - Senior Associate, Shardul Amarchand Mangaldas & Co.