Protocol to India-Mauritius Tax Treaty, 2016 – An Analysis

The Indian Government has been negotiating a
revision of the treaty with the Mauritius government for a long time.
The Protocol is a result of the negotiations.

1. Background:

The
Mauritius Treaty has been in existence since 1983 and, over a period of
time, played a critical role in attracting investments into India.
Right from the inception, the focus of the Mauritian government has been
to develop a robust offshore financial centre regime that attracted
reputed financial investors to use Mauritius as a platform for
investment into India. The Indian government was also instrumental in
promoting the Mauritius route and vehemently defended the Mauritius
route before the Supreme Court in the Azadi Bachao Andolan case, besides
issuing circulars to ensure that treaty benefits on capital gains were
provided to Mauritian companies.

It must be recalled that during
the 1990s, when the treaty first began to be extensively used, the
capital gains tax rates in India were significantly higher than they are
today. Investors, especially those from the US, were concerned about
direct investment into India due to a credit mismatch issue that arose
due to differences in the source rules in India and US. The concern for
US investors was that the taxes paid in India on capital gains were not
available as a credit in the US. With time and the lowering of the
Indian tax rates, this has become less of an issue for investors

With
passage of time, the stance of the government in respect of the
Mauritius treaty has undergone a change and everyone has been expecting
an amendment to the treaty for quite some time. Therefore, the amendment
to the India-Mauritius Tax Treaty has not come as an absolute bolt out
of the blue.

The longest running saga in the Indian tax history
may well be at an end. After years of re-negotiations, the over
three-decade-old tax treaty between India and Mauritius has finally been
amended to remove the capital gains exemption, albeit in a phased
manner. In the last two decades, the world has changed considerably.
Then treaty shopping was the established norm, so much so that its
validity was upheld even by the Supreme Court in the Azadi Bachao
Andolan case. Global sentiment has decidedly changed, with the OECD
coming out strongly against treaty abuse in its Base Erosion and Profit
Shifting (BEPS) project. There is an increasing recognition that tax
treaties are intended to avoid double taxation, and that they should not
be used as a basis for double non-taxation (where income ends up not
being taxed in either the Source State or the State of Residence). The
modification of the India-Mauritius treaty seems to be in sync with the
global trends.

Further, despite the Supreme Court upholding the
availability of treaty benefits under the India-Mauritius treaty,
investors continued to face significant challenges in obtaining treaty
benefits at the grass root level. Litigation too, continued to fester on
this issue, which led to the provisions of the treaty being undermined
in practice. This led to significant uncertainty.

Significantly,
the 2016 Protocol has included a number of provisions for enhancing
source country taxation rights, such as inclusion of a Service Permanent
Establishment (Service PE) provision, fees for technical services
(FTS), source country taxation rights on capital gains from shares,
interest income of banks and other income. At the same time, a
limitation on source country taxation rights in respect of interest
income has been provided at the rate of 7.5%.

Importantly, the
2016 Protocol also provides for carving out of shares acquired on or
before 31 March 2017 from source country taxation rights. Transitory
provisions for reduced taxation by the source country on capital gains
from alienation of shares (taxation at 50% of domestic tax rates) has
also been provided for a limited period from 1 April 2017 to 31 March
2019. However, a limitation of benefits (LOB) provision has also been
included for availing transitory provisions. A carve-out (i.e. an
exclusion) has also been included for interest earned by banks from debt
claims existing on or before 31 March 2017. Provisions relating to
exchange of information (EOI) have been revamped in order to bring them
in line with existing international standards. Additionally, an Article
on “Assistance in collection of taxes” has been introduced. Let us now
discuss the Contents of the Protocol in some greater detail in the
following paragraphs:

2. Contents of the Protocol

2.1 Amendment of Article 5 – Insertion of Service PE Clause

Article
1 of the Protocol amends Article 5 (Permanent Establishment) of the
Treaty by inserting in paragraph 2 the following new sub-paragraph:

“(j)
the furnishing of services, including consultancy services, by an
enterprise through employees or other personnel engaged by the
enterprise for such purpose, but only where activities of that nature
continue (for the same or connected project) for a period or periods
aggregating more than 90 days within any 12-month period.”

Impact of the Amendment:

The
service PE clause, while not included in the OECD Model Tax Convention
and expressly promoted by the UN Model Tax Convention, has been included
in a number of tax treaties concluded by India including tax treaties
with USA, UK and Singapore. While some of India’s tax treaties (for
instance with USA, UK, Singapore etc) specifically carve out an
exception for technical / included services from the service PE clause,
no such concession has been provided under the Protocol to the Mauritius
Tax Treaty. To this extent, the proposed clause is similar to the
Service PE clause provided in tax treaties with Iceland, Georgia, Mexico
and Nepal.

With increasing mobility of employees in
multinational organizations, this clause has been a matter of dispute in
a number of cases where employees are sent on secondment or deputation.

It is important to note that the words ‘within a contracting
State’ are missing from the service PE clause. The implication of this
could be that the source state could assert a service PE even if
services are rendered entirely from outside that state but cross the
period threshold. In 2008, OECD added paragraph 42.11 to 42.48 to the
Commentary on its Model Tax convention, dealing with taxation of
services.

Simultaneously, India expressed its position that it
reserves a right to treat an enterprise as having a Service PE without
specifically including the words ‘within a contracting state’. Hence,
this omission seems to be in line with the position taken by India on
the OECD commentary and could even expose taxpayers without any physical
presence to net income taxation in the source state and the resultant
challenges. However, depending upon the facts and circumstances of each
case, such a position would raise many issues regarding calculation of
no. of such days and hence, ensue litigation.

As a result of
inclusion of clause 5(2)(j), the term “PE” will include furnishing of
services, including consultancy services, by an enterprise of one State
through its employees or other personnel engaged by the enterprise for
such purposes, where such activities continue for the same or a
connected project for a period or periods aggregating more than 90 days
within any 12 month period. The United Nations Model Convention (UN MC)
includes this requirement in its Service PE provision contained in
Article 5(3)(b) of the UN MC. Additionally, the threshold is much lower
in the 2016 Protocol at 90 days, whereas it is 183 days in the UN MC.

2.2 Amendment of Article 11 – Taxability of Interest Income

Article 2 of the Protocol amends Article 11 (Interest) of the Treaty as under:

(i)
replacing paragraph 2 with the following: “However, subject to
provisions of paragraphs 3, 3A and 4 of this Article, such interest may
also be taxed in the Contracting State in which it arises, and according
to the laws of that State, but if the beneficial owner of the interest
is a resident of the other Contracting State, the tax so charged shall
not exceed 7.5 per cent of the gross amount of the interest,”;

(ii) deleting the paragraph 3(c); and

(iii)
inserting a new paragraph 3A as follows: “Interest arising in a
Contracting State shall be exempt from tax in that State provided it is
derived and beneficially owned by any bank resident of the other
Contracting State carrying on bona fide banking business. However, this
exemption shall apply only if such interest arises from debt- claims
existing on or before 31st March, 2017.”

Impact of the Amendment:

The
existing DTAA exempted interest income beneficially owned by taxpayers
engaged in a bona fide banking business of one State sourced from the
other State. The 2016 Protocol removes this generic exemption. However, a
carve-out has been included to continue to provide exemption from
taxation in the Source State on interest income arising from debt claims
existing on or before 31 March 2017.

Further, the existing DTAA
provided for unlimited taxation rights for source country on
non-exempted interest income. The 2016 Protocol restricts the source
country taxation rights on interest (including interest earned by banks)
to a maximum of 7.5% on the gross amount of interest. This is the
lowest tax rate cap agreed to by India on interest income for source
country taxation rights amongst all its DTAA s.

A tabular representation of the relevant changes is given below:

Ceiling
of tax rate on interest arising in the source state, coupled with the
additional requirement of such interest being ‘beneficially owned’ by
the resident state owner is in line with OECD and UN model tax
conventions. Further, most tax treaties entered into by India are on
similar lines. Indian tax treaties typically provide for a ceiling of
tax rate in the source state higher than 7.5 %. Currently, interest
income on instruments like compulsorily convertible debentures,
non-convertible debentures, or loans granted by a Mauritius entity to a
person resident in India was subject to tax at the full rate of 40% in
case of INR denominated debt or beneficial rate of 20% / 5% in specified
cases. Therefore, this is certainly a welcome development, and gives
the Mauritius treaty an edge above other treaties which India has signed
with other countries including Singapore, Cyprus and USA, where the
ceiling on rate of tax on interest income is in the range of 10% to 15%.

Earlier Mauritius was not a preferred jurisdiction for making
loans or debt investments as compared to other countries, except to the
extent of loans from a Mauritius resident bank. Thus, the change in the
tax rate to 7.5% on interest income should provide Mauritius a
competitive edge over other countries.

2.3 Insertion of New Article 12A – Taxability of Fees for Technical Services:

Article
3 of the Protocol inserts a New Article 12A concerning Taxation of Fees
for Technical Services as under:

“Article 12A
Fees for Technical Services

1.
Fees for technical services arising in a Contracting State and paid to a
resident of the other Contracting State may be taxed in that other
State.

2. However, such fees for technical services may also be
taxed in the Contracting State in which they arise, and according to the
laws of that State, but if the beneficial owner of the fees for
technical services is a resident of the other Contracting State the tax
so charged shall not exceed 10 per cent of the gross amount of the fees
for technical services.

3. The term “fees for technical
services” as used in the Article means payments of any kind, other than
those mentioned in Articles 14 and 15 of this Convention as
consideration for managerial or technical or consultancy services,
including the provision of services of technical or other personnel.

4.
The provisions of paragraph 1 and 2 shall not apply if the beneficial
owner of the fees for technical services being a resident of a
Contracting State, carries on business in the other Contracting State in
which the fees for technical services arise, through a permanent
establishment situated therein, or performs in that other State
independent personal services from a fixed base situated therein, and
the right or property in respect of which the fees for technical
services are paid is effectively connected with such permanent
establishment or fixed base. In such case the provisions of Article 7 or
Article 14, as the case may be, shall apply.

5. Fees for
technical services shall be deemed to arise in a Contracting State when
the payer is that State itself, a political sub-division, a local
authority, or a resident of that State. Where, however, the person
paying the fees for technical services, whether he is a resident of a
Contracting State or not, has in a Contracting State a permanent
establishment or a fixed base in connection with which the liability to
pay the fees for technical services was incurred, and such fees for
technical services are borne by such permanent establishment or fixed
base, then such fees for technical services shall be deemed to arise in
the Contracting State in which the permanent establishment or fixed base
is situated.

6. Where, by reason of a special relationship
between the payer and the beneficial owner or between both of them and
some other person, the amount of the fees for technical services exceeds
the amount which would have been agreed upon by the payer and the
beneficial owner in the absence of such relationship, the provisions of
this Article shall apply only to the lastmentioned amount. In such case,
the excess part of the payments shall remain taxable according to the
laws of each Contracting State, due regard being had to the other
provisions of this Convention.”

Impact of the Insertion of Article 12A:

As
per this new Article, both the Resident State as well as the Source
State will have the right to tax FTS. However, the Source State taxation
will be limited to 10% of the gross amount of FTS, where the FTS income
is beneficially owned by a resident of the other State. The rate of tax
is specified in the amended Treaty is at par with the tax rate
specified in Section 115A(1)(b)(B) of the Income-tax, 1961 For the
purposes of this Article, FTS has been defined in a wide manner as any
payment made as a consideration of “managerial or technical or
consultancy services”. It also includes payments made for the provision
of services of technical or other personnel. The definition of FTS is
broadly at par with the definition of the term FTS given in Section
9(1)(vii) of the Income-tax Act, 1961. The OECD MC does not have an FTS
Article.

Thus, the provisions of Article 12A are similar to the
provisions of other Indian tax treaties specifically including income by
way of FTS. It is pertinent to note that neither the OECD nor the UN
Model Tax Convention postulates taxability of FTS under a separate
Article. In the absence of a separate Article dealing with FTS, such
income would typically not be taxed in the source state, unless the
recipient of the income had a permanent establishment in that state.
With this change, any income paid by an Indian resident, to a resident
of Mauritius as FTS would now be taxable in India.

It is
pertinent to note that the new article does not incorporate the ‘make
available’ criteria for characterization as FTS, unlike tax treaties
with the USA, UK, Singapore etc. resulting in widening the scope of
taxable FTS income to be at par with the provision of Income-tax Act,
1961.

Reading the new Article 12A along with the new service PE
clause, it seems that in the event services in the nature of managerial,
technical or consultancy are rendered by a Mauritius entity for a
period less than 90 days, income arising from such services would be
taxed as per the provisions of Article 12A. In other cases, income
arising from rendering of all types of services for a period exceeding
90 days would be taxable under Article 7 of the Mauritius Tax Treaty,
provided the services are for the same or connected projects. The
interpretation and implementation of these provisions may lead to
litigation.

2.4 Amendment of Article 13 and Introduction of LO B Clause – Rationalization of Capital Gains Tax Exemption

Article 4 of the Protocol amends Article 13 of the Treaty w.e.f. 01.04.2017 by inserting new paragraphs 3A and 3B as under:

“3A.
Gains from the alienation of shares acquired on or after 1st April 2017
in a company which is resident of a Contracting State may be taxed in
that State.

3B. However, the tax rate on the gains referred to
in paragraph 3A of this Article and arising during the period beginning
on 1st April, 2017 and ending on 31st March, 2019 shall not exceed 50%
of the tax rate applicable on such gains in the State of residence of
the company whose shares are being alienated”; and

Further, the Protocol replaces the existing paragraph 4 as follows:

“4.
Gains from the alienation of any property other than that referred to
in paragraphs 1, 2, 3 and 3A shall be taxable only in the Contracting
State of which the alienator is a resident.”

Impact of the Amendment

Capital
gains arising from the transfer of shares, until now, were subject only
to residence based taxation under the existing Treaty. The Protocol now
proposes to restrict this exemption for investments in shares acquired
up to 31 March 2017. The exemption will apply irrespective of the date
of subsequent transfer of such shares. Accordingly, taxation rights are
now also provided to the State of residence of the company whose shares
are alienated (Source State) on gains from alienation of shares acquired
on or after 1 April 2017. The Protocol also provides for a transitory
provision for gains arising during a window period of 1 April 2017 to 31
March 2019 in respect of shares acquired on or after 1 April 2017. Such
gains arising during the transitory period will be subjected to tax at
50% of the domestic tax rates as applicable in the Source State.

After
the amendment of the India-Mauritius DTAA by the 2016 Protocol, the
position of taxability of Capital Gains on Transfer of Shares may be
summarized as under:

However,
the new LOB Article 27A (inserted by the Article 8 of the Protocol)
applies only for transitory period benefit on capital gains income.
The LOB Article denies the transitory provision benefit in respect of
capital gains arising between 1 April 2017 and 31 March 2019, where the
LOB conditions are not fulfilled. The following tests are provided in
the LOB clause for a taxpayer to be eligible to claim the transitory
period benefits:

• Primary purpose/Motive test – Under
  this test, transitory period benefit is not available where the affairs
  of the taxpayer are arranged with the primary purpose of taking
  advantage of the transitory period benefit accorded by the 2016
  Protocol. It has also been clarified that legal entities not having bona
  fide business activities will be considered as having its affairs
  arranged with the primary purpose of availing the transitory period
  benefit.
• Activity test – This test requires that the
  transitory period benefit will not be available to a shell or conduit
  company. For this purpose, a shell or conduit company means a company
  which is a resident of a Contracting State, but which has almost
  negligible or nil business operations or no real and continuous business
  activities in such Resident State.
• Expenditure test
  – This test provides the circumstances in which a taxpayer would be
  deemed to be a shell or conduit company in its Resident State. As per
  the expenditure test, the taxpayer would be considered as a
  shell/conduit company if its expenditure on operations in the Resident
  State is less than Mauritian Rs. 1,500,000 or INR 2,700,000, as the case
  may be, in the 12 months immediately preceding the date on which the
  capital gain arises.

However, where the taxpayer is listed
on a recognized stock exchange of the Resident State or where its
expenditure on operations in the Resident State exceeds the above
threshold in the 12 months immediately preceding the date on which
capital gain arises, then such taxpayer will not be treated as a shell
or conduit company.

Impact of the amendment on other types of Capital Gains:

The
finance ministry has clarified that under the revised India-Mauritius
tax treaty, capital gains tax (or tax on profit made) would apply only
in the case of share transactions in India, leaving out derivatives and
non-share securities such as debentures from its purview.

Mr.
Shaktikanta Das, Economic Affairs Secretary, also clarified that the
Derivatives and other forms of securities, such as compulsory
convertible debentures (CCDs) and optionally convertible debentures
(OCDs), will continue to be governed by the existing provision of being
taxed in Mauritius. He added that India had gained a source-based
taxation right only for shares (equity) under the treaty.
Residence-based taxation will continue for derivatives under the
Mauritius pact. Meaning, non-equity securities would be taxed in
Mauritius if routed through there. Since Mauritius does not have a
short-term capital gains tax, it would mean that investors using these
instruments would continue to escape paying taxes in both countries.
(Source: Business Standard dated 14.05.2016)

In addition, there
are also questions as to the potential interplay of General Anti
Avoidance Rules (“GAAR”) with the tax treaties, as well as issues around
grandfathering of treaty benefits in respect of shares acquired after
April 1, 2017 on account of conversion of convertible instruments like
convertibles preference shares and debentures. These issues need to be
clarified by the Finance Ministry to provide clarity and certainty, and
to avoid litigation on this score. There were also concerns on whether
Protocol could be used to bring transfer of Participatory Notes
(“P-Notes”) under tax net. In order to allay concerns regarding
taxability of P-Notes due to Mauritius Tax Treaty amendment, Revenue
Secretary Hasmukh Adhia, in an interview to Press Trust of India,
clarified that, ‘there is no linkage of Mauritius treaty with P-Notes.
P-Notes are issued by foreign companies and not Indian companies’.

Impact on India-Singapore DTAA

Article
6 of the protocol to the India-Singapore DTAA states that the benefits
in respect of capital gains arising to Singapore residents from sale of
shares of an Indian Company shall only remain in force so long as the
analogous provisions under the India-Mauritius DTAA continue to provide
the benefit. Now that these provisions under the India-Mauritius DTAA
have been amended, a concern that arises is that while the Protocol in
the Mauritius DTAA contains a grandfathering provision which protects
investments made before April 01, 2017, it may not be possible to extend
such protection to investments made under the India-Singapore DTAA .
Consequently, alienation of shares of an Indian Company (that were
acquired before April 01, 2017) by a Singapore Resident after April 01,
2017, may not necessarily be able to obtain the benefits of the existing
provision on capital gains as the beneficial provisions under the
India-Mauritius DTAA would have terminated on such date.

In this
respect, a senior official of the Government of India has stated that
the Indian government intends to renegotiate the treaty with Singapore
to bring it on par with the India-Mauritius treaty.

2.5 Amendment of Article 22 – Introduction of Source Rule for Taxation of “Other Income”

Article
5 of the Protocol amends Article 22 by inserting a new paragraph 3 as
under: “3. Notwithstanding the provisions of paragraphs 1 and 2, items
of income of a resident of a Contracting State not dealt with in the
foregoing Articles of this Convention and arising in the other
Contracting State may also be taxed in that other State.”

Impact of the Amendment:

Income
from sources which is not expressly dealt with any of the Articles in
the existing DTAA is presently subjected only to taxation in the
resident country, except in cases where such income is effectively
connected with the PE/ fixed base of the recipient in the other State.
The Protocol expands the source country taxation rights by providing
that such income can also be taxed in the Source State if it arises in
the Source State.

2.6 Replacement of Article 26 – On Exchange of Information

Article
6 of the Protocol replaces existing Article 26 with a new Article 26.
The same is not reproduced here for the sake of brevity.

Salient features of the new Article 26 vis-à-vis the existing provisions are given below:

• In
  addition to the taxes covered under tax treaty, scope for EOI has been
  enhanced to ‘taxes of every kind and description’, insofar as such taxes
  are not contrary to the provisions of the tax treaty ?
• The
  information may not anymore be ‘necessary’ but it would be sufficient
  if it is ‘foreseeably relevant’ for the purpose of the tax treaty
• Information
  / documents received under the tax treaty, can also be shared with
  authorities or persons having an ‘oversight’ over the assessment,
  collection and enforcement of taxes or prosecution in respect of such
  taxes or appeals in relation thereto. Information so disclosed can also
  be used for ‘other’ purposes if permitted by laws of both states and
  authorized by the supplying state. The provision enabling disclosure of
  information to the person to whom it relates has been deleted.
• The
  requested state cannot deny collection or supply of information on the
  ground that it does not need such information for its own tax purposes.
  Further, a requested state cannot decline to supply information solely
  because the information is held by a bank, other financial institution,
  nominee or person acting in an agency or a fiduciary capacity or because
  it relates to ownership interests in a person.

Suffice it
to say that the scope of the EOI Article in the existing DTAA has been
enhanced to fall in line with international standards on transparency.
The EOI Article is largely in line with the 2014 OECD MC and extends to
information relating to taxes of every kind and description imposed by a
State or its political subdivisions or local authorities, to the extent
that the same is not contrary to the taxation as per the existing DTAA .
EOI would also be possible in respect of persons who are not residents
of the Contracting State, as long as the information requested is in
possession of the concerned State. Specifically, information held by
banks or financial institutions can be exchanged under the EOI Article.

2.7 Insertion of new Article 26A on “Assistance in Collection of Taxes”

Article
7 of the Protocol inserts a New Article 26A on “Assistance in
Collection of Taxes”. The same is not reproduced here for the sake of
brevity. Some salient features are as under:

• Both countries shall lend assistance to each other in the collection of ‘revenue claims’ arising out of any taxes.

• ‘Revenue
  claims’ means amount owed in respect of taxes of every kind and
  description (including interest, administrative penalties and costs of
  collection or conservancy related to such taxes), insofar such taxation
  is not contrary to the provisions of the tax treaty or any other
  instrument signed by both.
• Both countries will be obliged
  to accept and collect revenue claims of the other and take measures for
  conservancy, subject to fulfillment of certain conditions.
• Revenue
  claims accepted by a country shall not be subject to time limits or
  accorded any priority applicable to a revenue claim under the laws of
  such country or accorded any priority applicable in the other country.
  No proceedings with respect to the existence, validity or the amount of a
  revenue claim can be brought before courts etc in the country accepting
  the revenue claim.

This new Article is largely in line
with the one provided in the 2014 OECD MC. Broadly, this Article enables
the revenue claims of one State to be collected through the assistance
of the other Contracting State, subject to fulfilment of certain
conditions and requirements. Revenue claims for this purpose means the
amount payable in respect of taxes of every kind and description and
which is not contrary to the existing DTAA or any other instrument to
which the States are a party. Assistance would also involve undertaking
measures of conservancy by freezing assets located in the requested
State, subject to the laws therein.

In an era of globalization,
traditional attitudes towards assistance in the collection of taxes have
changed. This change was to some extent influenced by the development
of electronic commerce and the concerns about the ability to collect VAT
on such activities. The 1998 OECD report, Harmful Tax Competition: an
Emerging Global Issue, also highlighted concerns about increased tax
evasion if one country will not enforce the revenue claims of another
country. The Report thus recommended that ‘countries be encouraged to
review the current rules applying to the enforcement of tax claims of
other countries and that the Committee on Fiscal Affairs pursue its work
in this area with a view to drafting provisions that could be included
in tax conventions for that purpose’.

As a result of such
concerns, the OECD Council approved the inclusion of a new Article 27 on
assistance in tax collection in the 2003 update of the OECD model tax
Convention. The new Article 26A is in pari materia with Article 27 of
the OECD model tax convention and can help the Indian Government to
recover tax dues from willful defaulters. India has also inserted a
similar provision for assistance in collection of taxes in recent tax
treaties with Sri Lanka, Fiji, Bhutan, Albania, Croatia, Latvia, Malta,
Romania and Indonesia. Further, tax treaties with UK and Poland have
been amended to insert such an Article.

Both India and Mauritius
have also signed the ‘Convention on Mutual Administrative Assistance in
Tax Matters’. Moreover, similar to the proposed Article 26 on EOI,
assistance in collection of taxes is not restricted by Article 1 and 2
of the tax treaty.

2.8 Effective Date

Article 9 of the Protocol provides as under:

1.
“Each of the Contracting States shall notify to the other the
completion of the procedures required by its law for the bringing into
force of this Protocol. This Protocol shall enter into force on the date
of the later of these notifications.

2. The provisions of Article 1, 2, 3, 5 and 8 of the Protocol shall have effect:

a)
in the case of India, in respect of income derived in any fiscal year
beginning or after 1 April next following the date on which the Protocol
enters into force;

b) in the case of Mauritius, in respect of
income derived in any fiscal year beginning on or after 1 July next
following the date on which the Protocol enters into force;

3.
The provisions of Article 4 of this Protocol shall have effect in both
Contracting States for assessment year 2018-19 and subsequent assessment
years.

4. The provisions of Article 6 and 7 of this Protocol
shall 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 taxable
years to which the taxes relate.”

 Thus, the Protocol will be
effective in India and Mauritius only after completion of the procedures
in both the countries for bringing it into force.

Once the procedures are completed, the various clauses of the 2016 Protocol would apply in India as follows:

• Changes to the Capital Gains Article for assessment year 2018-19 and onwards.
• Article on EOI and inclusion of assistance in collection of taxes, from the date of entry into force of the 2016 Protocol.
• Other
  provisions for fiscal year beginning on or after the first day of the
  fiscal year (i.e., 1 April for India) following the year in which the
  2016 Protocol enters into force.

3. Concluding Remarks

This
is a landmark move by the Indian Government which finally claims
victory over the long drawn negotiations of the Mauritius Tax Treaty,
over last several years. Taking a myopic view, as a result of the
proposed amendment, Mauritius may lose its sheen as a preferred
jurisdiction for investments into India with additional tax cost for
Mauritius investors. However, in the larger scheme of things and in the
long run, the foreign investors would welcome the certainty of tax
regime and to that extent, grandfathering of capital gains under
India-Mauritius protocol sends out a positive signal that India is not
going to introduce any retroactive taxing provisions.

Both the
governments need to be complimented for ensuring that there is an
orderly phasing out of the capital gains tax exemption over a period of
three years without unduly burdening the investors who invested in India
relying on the treaty. This has ensured that there is no knee-jerk
reaction, unlike in the past, due to the revisions in the treaty.

Thus,
the manner in which the capital gains exemption has been withdrawn/
rationalized is indeed commendable. Instead of an abrupt shift in tax
policy, the Protocol proposes to grandfather all existing investments.
This means that only investments made after April 1, 2017 will be
subject to capital gains tax (that too after a two year transition
period during which a concessional rate at 50% of the prevailing
domestic tax rate will apply subject to satisfying Limitation on
Benefits (LoB) criteria contained in Article 8 of the Protocol). This
provides significant reassurance to existing investors and provides a
clear roadmap for the taxation of future investments. One area where
further clarity is needed is with regard to the position under the
India-Singapore treaty. This treaty provides for a capital gains
exemption, which is co-terminus with the capital gains exemption under
the India-Mauritius treaty. Given the proposed grandfathering of
pre-2017 investments from Mauritius and the twoyear transition period,
there is an urgent need to clarify whether these will apply to
investments from Singapore as well. The government seems to be cognizant
of this and hopefully, one can expect clarity on this soon. Another
area which the government would do well to clarify is that the
provisions of the General Anti Avoidance Rule (GAAR) will not apply if
the LoB conditions are satisfied.

The changes to the treaty
will, of course, lead to some short-term impact on investments in India.
There are unresolved tax issues that especially arise in the context of
P-Notes issued by FPIs/FIIs. Further, today, unfortunately, there is an
artificial characterisation of business income of the FPI/FIIs being
treated as capital gains. This leads to a situation where even portfolio
trading investors who would have otherwise not been taxable in India
are being subject to tax here. Hopefully, the government will revisit
this issue and align the position with other countries so that mere
trading in Indian securities should not give rise to tax implications in
the country, absent a permanent establishment in India. This
artificiality is unfair and also gives rise to possible non-availability
of tax credits in the home country. While the government has
renegotiated the treaty with Mauritius, it is also hoped that they
continue on the path of tax reforms to ensure that investors are not put
off by constant adverse changes to tax policy.