A little after Prime Minister Narendra Modi visited Mauritius in March 2015, India’s negotiators were at work on redrawing a historic agreement signed over 30 years ago between the two governments. That was the Convention for Avoidance of Double Taxation and Prevention of Fiscal Evasion, relating to taxing income and capital gains, which was signed in August 1982, and notified by the Indian government in December 1983, when Indira Gandhi was Prime Minister and Pranab Mukherjee her Finance Minister. The double taxation avoidance agreement, which provides for exemption from capital gains tax in Mauritius, has been at the centre of negotiations between the two countries for close to two decades — with concerns over the abuse of the treaty, and round-tripping of funds of Indians through Mauritius back to their home country in the form of foreign investment.
But this was perhaps not what the two countries had bargained for in the early 1980s, when India started opening up to Non-Resident Indians for the first time. In 1982, Mukherjee announced liberalisation of investment norms for NRIs, including buying into stocks of listed firms in India. Months later, fearing a coup in the island nation with which India has had close historical and cultural links, India sent its troops to support Prime Minister Anerood Jugnauth. It is in keeping with the strategic interests of India in the Indian Ocean that the 1982 agreement was signed. As India opened up its stock markets to foreign funds and portfolio investors in 1992, many of them progressively started routing their investments through Mauritius. Inflows started rising towards the end of that decade, and in the early part of the NDA government headed by Atal Bihari Vajpayee. But in April 2000, there was controversy after foreign institutional investors received notices from the Income-Tax Department demanding payments even though these investors argued that they were exempt under the tax treaty.
With FIIs selling and the government worried over stock markets tanking and the rupee taking a hit, the Central Board of Direct Taxes under the Finance Ministry headed then by Yashwant Sinha, issued a circular to clarify the law and virtually negate the Income-Tax orders. A little later, a media report claimed the circular was issued to help Sinha’s daughter-in-law, a fund manger with an overseas entity. The government issued strong denials, but both it and the Minister took a hit.
The Mauritius tax treaty came into sharper focus in 2001 when the stock market scam linked to Ketan Parekh blew up, leading to a probe by a Joint Parliamentary Committee. After the JPC report and criticism, the government started negotiations with the Mauritius government to review the double taxation avoidance agreement in an effort to plug some of the loopholes. India wanted its bilateral partner to put an end to what were known as “post-box companies”, which just served as addresses to help investors take advantage of the treaty to make substantial gains. While the Finance Ministry’s concern then and later was over the loss of revenue and misuse of the treaty, the Ministry of External Affairs had diplomatic and strategic interests in Mauritius as the gateway to Africa — leading to a pushback every time the issue was sought to be forced.
After the UPA government came to power in 2004, policymakers decided to take another hard look at the tax treaty. Prime Minister Manmohan Singh assigned a group of officials headed by a senior Indian diplomat, Jaimini Bhagwati — who had worked earlier in the Ministry of Finance as a joint secretary handing the capital markets division — to discuss the issue with Mauritius. The team, which had representatives from the Revenue Department and tax officials, went to Mauritius for a couple of days, and submitted a report to the PMO on the provisions of the treaty including grandfathering or phasing out progressively the capital gains tax treatment so as not to rock the stock markets, and to avoid uncertainty.
Yet, and despite senior delegations led by the CBDT chief also visiting Mauritius later for negotiations, there was resistance on a review of the agreement — with Finance Ministry officials hinting often that their stance was at variance with that of the External Affairs Ministry. Through the decade of the UPA government, the final step couldn’t be taken. What may have added to the caution was the fact that Mauritius had, over a decade or more, emerged as the top FDI destination for India, and as India’s top trading partner.
But the difference this time may be the fact that the Modi government, which succeeded the UPA in 2014, had promised at the start of its poll campaign to address the issue of black money. And with an adverse global environment on tax avoidance, illegal funds and terror funding, many counties which in the past have been viewed as tax havens or soft on tax dodgers, have been forced to fall in line. That certainly would have helped influence the outcome. Yet, it signals a major political achievement by the government. It is also a signal that India, now a $ 2 trillion economy with foreign exchange reserves of over $ 350 billion, doesn’t need hot money flows, and is more confident of attracting FDI. The new arrangement, marked by a concessional capital gains regime for two years, kicks in in 2017, and a new agreement by 2019. That will be the true test of capital flows and investment and investor confidence.