The much-awaited talks between India and Mauritius over renegotiation of their tax treaty may begin soon, with India pushing for changes in the clause on the treatment of the capital gains tax. The agenda for the discussion has broadly been finalised -- and India has prepared a list of items proposed to be reviewed when the two countries meet in the second week of December.

Nonetheless, theres a catch: the renegotiated treaty may prove to be a damp squib if Mauritius does not agree to review the clause on the capital gains tax. Besides, India itself may not ask for completely eliminating the capital gains exemption, as that might hurt genuine investors as well as capital inflows from Mauritius that account for about 40 per cent of the total foreign direct investment into India.
 
A finance ministry official says Mauritius has agreed to renegotiate the treaty in December. From our side, everything is on the agenda...including better exchange of information and treatment of capital gains tax. But, ultimately they should agree to it.

The Double Taxation Avoidance Agreement (DTAA) between India and Mauritius provides for capital gains tax only in the country of the residence of the investor. A person routing investments through the tax haven to India does not pay tax, as such income is tax exempt under the domestic laws of Mauritius.

So, what purpose does a renegotiated treaty serve when the clause on capital gains tax is not changed? It would still provide for exchange of banking information and assistance in collection of taxes, says the official. Though Mauritius has already agreed to provide such information to India, bringing that under the treaty would strengthen the process further.

To tighten noose on treaty shopping and check tax evasion, India has been pushing Mauritius for long to revise the agreement. This would change the way foreign investors structure their investment in India. After years of persuasion, Mauritius had finally agreed to start the talks by the middle of this year, but it got postponed as a political upheaval in the country in August led to a Cabinet reshuffle.

As Mauritius is a friendly country with a huge Indian population, the tax exemption on capital gains was given under the DTAA to benefit investors there, but this was misused. And many companies started channelling their investments through the island to get tax benefit. The finance ministry wants to tax fly-by-night companies which do not have their management and control in Mauritius.

India has already starting raising tax demands against many such companies. Many of these cases are being disputed in various courts. India has also set up an overseas income tax unit in Mauritius.

Besides, the Direct Taxes Code, which is proposed to be implemented in April 2012, will introduce general anti-avoidance rules to override provisions of tax treaties under specific situation.