India Tax Insights – eighth edition
India—Mauritius tax treaty: the end for a new beginning
Keyur Shah, Tax Partner, EY India
Addressing Base Erosion and Profit Shifting (BEPS) is a key priority of governments around the globe. In 2013, OECD and G20 countries, working together on an equal footing, adopted a 15-point Action Plan to address BEPS. Beyond securing revenues by realigning taxation with economic activities and value creation, the OECD/G20 BEPS Project aims to create a single set of consensus-based international tax rules to address BEPS, and hence to protect tax bases while offering increased certainty and predictability to taxpayers. A key focus of this work is to eliminate double non-taxation. On 5 October 2015, the OECD released final reports on all 15 focus areas identified in its BEPS Action Plan. India has time and again shown support to the BEPS program and is fully committed to implementing a number of BEPS recommendations.
In line with this, over the past few years India has been re-negotiating tax treaties with various nations by introducing an anti-abuse or Limitation of Benefits (LOB) clause and providing for exchange of information between India and the other countries. Approximately 40 of India’s treaties with various countries (such as the UK, Finland, Norway, Mexico, Sri Lanka, Iceland and Switzerland) contain anti-abuse provisions.
Recently, India re-negotiated its tax treaty with Mauritius and Cyprus. The re-negotiated tax treaties inter-alia provide India the right to tax capital gains arising to a Mauritian/Cypriot resident (the text of the amendment to the India–Cyprus treaty has not been released by the Government). The amended India–Mauritius treaty also provides for an updated Exchange of Information clause as per international standards, which should aid in improving transparency in tax matters. The re-negotiation of the India–Mauritius tax treaty has had an impact on the India–Singapore treaty, which news reports indicate is also in the process of being re-negotiated. There have also been talks about re-negotiation of the India–Netherlands tax treaty. The re-negotiated tax treaties with Mauritius and Cyprus will take effect from 1 April 2017 — the date when the domestic General Anti Avoidance Rules (GAAR) become effective, thereby providing some relief to foreign investors from the impact of GAAR provisions going forward.
Talks about the re-negotiation of the India–Mauritius treaty have been going on since several years, specifically to address the use of Mauritius by companies as an investor friendly jurisdiction and for round-tripping of funds. The amendment to the India–Mauritius treaty cannot be said to be completely unanticipated, specifically given the fact that globally too there was widespread resentment against companies failing to pay their fair share of taxes.
Mauritius is the highest contributor of foreign direct inflows (FDI) into India, with a 33% share cumulatively from April 2000 to March 2016. The next in line is Singapore, with a 16% share during the same period. FDI inflows from Mauritius have grown over the last three years, from US$4,859 million in FY2013–14 to US$8,355 million in FY2015–161. The reason for the significant share of Mauritius and Singapore in FDI inflows into the country may be their use as investment jurisdictions. To cushion the impact of the amended India–Mauritius tax treaty on the investor community and the capital flows into India, the Government has provided sufficient notice of one year to enable foreign investors to go back to their drawing board and re-examine their structures. Also, the protection offered to investments made up to 31 March 2017 and the taxation of gains earned during 1 April 2017–31 March 2019 at 50% of the domestic tax rate, subject to the taxpayer meeting the LOB condition, would provide relief to the investors.
Though the amended tax treaty with Mauritius does put to rest several issues such as preventing double non-taxation (given that Mauritius did not tax the gains arising to a Mauritius tax resident), checking loss of revenue, and stimulating the flow of exchange of information between India and Mauritius, there continue to exist certain operational and compliance aspects on which immediate clarity is needed to be provided by the Government to ensure a smooth functioning of the capital markets when the new treaty becomes applicable.
One of the crucial operational aspects on which clarification is required is the impact of the amendment on shares allotted on group reorganizations, convertible instruments and bonus shares. A question may arise on the availability of capital gains exemptions under the India—Mauritius tax treaty on the transfer of shares allotted pursuant to group reorganizations, conversion of convertible instruments (preference shares/debentures) and bonus shares where the original shares/instruments are issued/acquired prior to 31 March 2017.
While it is not clear from the amended tax treaty, situations where shares are allotted pursuant to investments already made prior to 31 March 2017 should ideally be grandfathered. However, it is imperative that this is clarified by the Government at the earliest.
To address this issue, the Government has constituted a working group comprising of tax authorities, representatives of the Securities and Exchange Board of India, custodians, brokerage firms and fund managers. The working group has to submit its report to the Central Board of Direct Taxes within a period of three months. This step by the Government is in line with its approach to have consultations with various stakeholders in bringing about the much-needed clarity and certainty to the tax environment in the country.
Subsequent to the amendment of the Mauritius and Cyprus treaties and discussions being held to re-negotiate the Singapore and Netherlands treaties, it needs to be seen as to how the Government will approach several other treaties signed by India (particularly with a few European nations such as France, Belgium and Spain) that provide an exemption from capital gains on transfer of shares provided that the investor holds up to 10% of the Indian company. The full impact of the amended India–Mauritius tax treaty will be seen only on investments made on or after 1 April 2019. With short-term capital gains being subject to tax at full tax rates, the return on investment for foreign investors may decline. It will only be then that the attractiveness of India as an investment destination can be judged, particularly because several countries across the globe (including Denmark, Germany, France, Italy, Brazil, Canada, Hong Kong and Singapore) exempt capital gains arising on portfolio investments.
(Anahita Kodia, Senior Tax Professional, EY also contributed to the article)
- All statistics are based on the data available in the fact sheet on FDI published on the website of the Department of Industrial Policy and Promotion http://dipp.nic.in/English/Publications/FDI_Statistics/2016/FDI_FactSheet_JanuaryFebruaryMarch2016.pdf