Tax pact with Mauritius to get GAAR-like teeth

By: | Published: July 17, 2015 1:29 AM

India and Mauritius are set to limit the benefits of their double taxation avoidance agreement (DTAA) to only genuine businesses...

FATCAThe revised treaty, however, is likely to allow existing investments in India by Mauritius-based entities to exit without any tax liability in India. (PTI)

India and Mauritius are set to limit the benefits of their double taxation avoidance agreement (DTAA) to only genuine businesses bringing foreign direct investment (FDI) to India by inserting a new clause in the treaty straight from New Delhi’s yet to be implemented General Anti-Avoidance Rules (GAAR), reports Gireesh Chandra Prasad in New Delhi.

The revised treaty, however, is likely to allow existing investments in India by Mauritius-based entities to exit without any tax liability in India under what is referred to as a grandfathering clause, subject to certain riders.

Prime Minister Narendra Modi had in March assured Mauritius that while working to prevent treaty abuse, India would not do anything that would harm the island nation’s financial sector.

According to sources, the amended DTAA would have ‘limitation of benefit’ clause that would deny the benefit of zero capital gains tax to Indian investments of a Mauritius-based entity, ‘the main purpose or one of the main purposes of which is to avoid taxes’.

This clause represents the core principle of India’s anti-avoidance rules that would be implemented from 2017 to prevent treaty abuse by shell companies in other countries through which unaccounted foreign wealth of some Indians flow back into India under the guise of FDI. India had introduced such a provision in the recently revised DTAA with Poland.

The sources added that it may also be specified in the modified bilateral treaty that only those Mauritius-based entities that invest about 1.5 million Mauritian rupees in that country annually and, therefore, can be considered genuine businesses can avail of the treaty benefits.

Reports from Mauritius suggested that in the revised treaty, India would have the right to charge capital gains tax on transfer of assets and shares of Mauritius-based firms in India; this privilege currently is with the government of the island nation. When contacted, finance ministry officials however declined to comment, citing ‘confidential matters of the treaty’.

Under the India-Mauritius DTAA, foreign institutional investors (FIIs) participating in India’s equity markets get taxed for short-term capital gains only in Mauritius. Since the tax rate there is zero, Mauritius-incorporated FIIs’ trading income in India goes untaxed. Not paying tax in either of the countries results in the abuse of a treaty that was meant only to prevent taxation in both countries on the same income or capital gain.

India, which levies a 15% short-term capital gains tax on listed securities, had tried several ways to check this problem including the introduction of GAAR. Under investor pressure, India had deferred its implementation from April 1 this year by two years and made its application prospectively to investments made on or after April 1, 2017.

‘It is a real challenge for any developing country to find the right balance between the conflicting pressures of increasing revenue receipts and of encouraging investments. In the process of curbing treaty abuse, the economy should not be impacted more than the revenue that could be realised,’ said SP Singh, senior director, Deloitte.

Once GAAR is in force, the tax department would be able to lift the corporate veil of entities, go deeper into ownership structures, beneficial ownerships, voting rights, etc, and see if a particular entity is an artificial structure without any real economic activity and is meant to avoid taxes. Like these anti-avoidance rules, the revised tax treaty too would try to deny tax benefits to arrangements that are only on paper so that incentives go only to genuine FDI inflows.

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