Amendments to the India/Mauritius treaty

On 10 May 2016, India and Mauritius entered into a Protocol amending the terms of the India/Mauritius double tax treaty. This Protocol will introduce a source based method of taxing gains on shares in Indian companies, gradually removing the future benefits of routing investments into India through Mauritius. The changes will also affect the position under the India/Singapore Treaty, which is inextricably linked to the Mauritian Treaty.

Background

The existence of favourable terms in the India/Mauritius double tax treaty (the Treaty) has led to substantial amounts of foreign investment into India being routed through Mauritius. Over a third of all foreign investment into India between 2000 and 2015 was routed through Mauritius. In particular, article 13(4) of the Treaty provides that capital gains derived by a Mauritius resident through sale of shares of an Indian company are subject to capital gains tax only in Mauritius and not in India. Given the existence of minimal tax rates in Mauritius, in practice such a sale attracts very limited capital gains tax, making Mauritius an attractive jurisdiction through which investors can make investments into India.

The favourable capital gains tax provisions in the Treaty have led to perceived significant revenue loss for the Indian Government and the Protocol is designed to curb this situation.

New Protocol

The new Protocol signed on 10 May 2016 will transfer to India the right to levy capital gains tax on sale of shares in Indian companies with effect from financial year 2017-18. The right will, however, only apply to shares which have been acquired on or after 01 April 2017. Shares acquired before this date will benefit from “grandfathering” and will continue to be entitled to the existing Treaty benefits.

In addition, the Protocol contains a two year transitional period during which a reduced capital gains tax rate will apply. Under this transitional provision, the tax rate on capital gains between 01 April 2017 to 31 March 2019 will be limited to 50% of the domestic tax rate of India, subject, however, to the conditions in the Limitation of Benefits (LoB) Article. Under the LoB article, the reduced tax rate during the transition period will not be available if a resident of Mauritius (including a shell/conduit company) fails the main purpose test and the bona fide 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 (Mauritius Rupees 1,500,000 or approximately £28,000/$40,000) in the immediately preceding months. This is designed to ensure that the beneficial tax treatment is available only to Mauritius residents who have a substantial (and not merely formal) presence in that jurisdiction.

From the financial year 2019-20, all capital gains earned by a Mauritius resident through sale of shares in an Indian company acquired on or after 01 April 2017 will be liable to taxation in India. The reduced rates for long term capital gains (including for non-residents) should apply in these circumstances.

India/Singapore treaty

It has been indicated that similar amendments to the Treaty will also be made to the double tax treaty with Singapore, another popular jurisdiction for routing Indian investments. However, in any event, Article 6 of the Protocol to the Singapore Treaty states that the capital gains tax benefits will remain available only so long as the Mauritius Treaty provides that any gains from the alienation of shares in an Indian company will be taxable only in Mauritius. Accordingly, now that that benefit under the Mauritius Treaty is being removed, it will automatically bring to an end the benefits under the Singapore Treaty.

In addition, it is understood that the position in relation to the India/Cyprus treaty is under review.

Comment

A substantial part of existing foreign investment in India has come in through Mauritius, and more recently through Singapore, in large part due to the treaty benefits relating to capital gains tax. Although a window of opportunity may remain until April 2017, following the renegotiation of the India/Mauritius Treaty, foreign investors will need to reconsider their structures for investing into India. A number of detailed aspects will need to be considered, for example where follow-on investments are made post April 2017 in relation to existing holdings, or where convertible debt securities are currently held but the conversion does not occur until post April 2017. The position regarding indirect transfers of Indian companies will also require careful analysis.