While the protocol signed by India and Mauritius to make capital gains of the Mauritius-resident companies taxable in India is a big achievement for the government, it also shows that the global exercise to weed out base erosion and profit shifting (BEPS) by the companies is gaining firm grounds.
Signing of the protocol at Port Louis on Tuesday for amending the double tax avoidance agreement (DTAA) between India and Mauritius is clearly one of the major breakthroughs for India as the 1983 tax treaty with the tiny island nation which has been the largest contributor of FDI in India has been considered the biggest stumbling block in tackling tax avoidance and black money.
The agreement was stuck after several rounds of talks over the years between the two countries, but thanks to the pressure generated by the OECD efforts to counter Base Erosion and Profit Shifting (BEPS) by the companies to avoid tax payments utilizing the zero tax norms in tax havens like Mauritius and also by prime minister Narendra Modi during his Mauritius visit last year, the DTAA changes required for making capital gains of the Mauritius resident companies taxable in India are now through.
BEPS is done by the companies to exploit the gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations like Mauritius where there is little or no economic activity, and even conservative estimates indicate annual losses of anywhere from 4 -10% of global corporate income tax (CIT) revenues ($100-240 billion) due to this.
While the Indian government had been pressing the Mauritian government for a change in the DTAA to tackle this problem for quite some time, even the April 2015 WTO Trade Policy Review report on India pointed out that between FY11 and FY14, Mauritius was the largest source of FDI in India followed by Singapore, except in FY14, and, the Indo-Mauritius DTAA attracted investors to route their investment through Mauritius to take advantage of the exemption from capital gains tax and a liberal tax regime.
With the decks now cleared for taking away this advantage, the Indian government expects that the long pending issues of treaty abuse and round tripping of funds attributed to the India-Mauritius treaty resulting in revenue loss due to the double non-taxation will streamline the flow of investment from Mauritius and the absence of any major reaction to the move in the stock market justifies this optimism.
The credit for this, though, largely goes to the negotiators of the two countries for agreeing on a prudent timeline for bringing in the changes in the DTAA.
The investments made before April 1, 2017, will enjoy the benefits of the existing DTAA and the Indian government gets the right to tax capital gains only from that date – also, between April 1, 2017 and March 31, 2019, the sale of shares of any company resident in India will be taxed at 50% of the applicable rate, and the full rate will be applied after that.
This will provide the entities making investments in India to adjust to the new realities, which will obviously include a rethink on continuing with this route as the DTAA till now allowed these firms to enjoy zero tax status both in India and Mauritius, even though the short-term capital gains are taxed at 10% in India, they are exempt in Mauritius.
As a measure to ensure that only the genuine investments get the benefit of this grandfathering exercise, under the Limitation of Benefit (LoB) clause, the treaty benefits will be available to only those firms resident in Mauritius which have spent more than Rs 27 lakh (or Mauritius rupees 15 lakh) in the immediately preceding 12 months in the country.
Under the new norms, interest arising in India to Mauritian resident banks will be liable to 7.5 % withholding tax in India in respect of debt claims or loans after March 31, 2017.
While the changes take care of India’s black money and tax avoidance concerns on investments from Mauritius, a crucial following benefit of the changes in the DTAA with Mauritius is that capital gains on shares for Singapore, the country has been the second largest contributor of FDI into India of $43.17 billion (16% of the total) between April ’00 and December 2015 behind only the highest $93.66 billion (34%) coming from Mauritius, will also come under the same rules due to the direct linkage of the Singapore DTAA Clause with Mauritius DTAA.
Indeed, it is a major gain for PM Modi dispensation, but the real credit goes to the global initiatives to weed out BEPS for taking advantage of the liberal laws in tax havens.