India-Mauritius tax treaty amendment: What could be the impact on key stakeholders
May, 16th 2016
After long-drawn negotiations between the governments of India and Mauritius, the tax treaty between the two countries has finally been amended. Mauritius has contributed to about a third of the foreign direct investment (FDI) in India over a 15-year period between 2000 and 2015, which is a significant share. The second closest inflow is routed from Singapore, which constituted about 16% of the total inflows during the same period. If Mauritius and Singapore contributed to about half of all investments made between 2000 and 2015, then why did the government believe it was imperative to amend the tax treaty?
Impact on private equity funds and holding companies: Under the current tax treaty between India and Mauritius, gains arising from the sale of investments in shares of companies resident in India by a Mauritius resident were subject to tax only in Mauritius. Now, Mauritius does not levy capital gains tax under its domestic tax laws. Thus, the transaction resulted in a nil tax liability and double non-taxation. However, now with the amendment in, the capital gains exemption has been withdrawn, in a phased manner. The Protocol shared by the Central Board of Direct Taxes (CBDT) amending the treaty has introduced two new paragraphs—3A and 3B—to Article 12.
w Investments made before April 1, 2017: The Protocol to the tax treaty is clear that investments made prior to April 1, 2017 will be grandfathered.
w Investments made after April 1, 2017: Gains arising from the transfer of shares in companies resident in India between April 1, 2017, and March 31, 2019, will be subject to capital gains tax in India; however, it will be at 50% of the normal capital gains tax rates. Additionally, the Mauritius resident is required to fulfil certain conditions to avail the 50% reduction in rate—the Mauritius resident should either be listed on a recognised stock exchange in Mauritius or it should incur expenditure in operations equal to or more than R2.7 million (Mauritian Rupee 1.5 million).
In other words, if unlisted shares acquired after April 1, 2017, are sold within two years but before March 31, 2019 (per the proposed Budget 2016 amendment) from the date of investment, then the tax rate will be 15%. w Gains after March 31, 2019: Any gains after March 31, 2019, will be subject to regular Indian capital gains tax.
Impact on shares held by FPIs
In case of listed shares, the impact in principle will remain the same; however, the tax rates vary. The period of holding for short-term capital asset is one year and the tax rate is 15%. Thus, during the transitionary period, it will be 7.5%. In case of a long-term capital asset (held for more than one year), there should not be any tax incidence assuming the transaction has suffered a Securities Transaction tax (STT).
Off-market transactions (not sold through stock exchange) will have an impact post amendment to the tax treaty. Any gains arising on these transactions will be subject to capital gains in India.
Impact on P-Notes
When the amendment was announced there was a lot of doubt raised on the impact on Participatory Notes (P-Notes are essentially derivative instruments deriving value from listed securities). The names of the holders are kept anonymous. However, subsequently, a day later, the government clarified that the withdrawal of capital gains exemption will not apply to P-Note holders.
Impact on the India-Singapore tax treaty
One the important ramifications of this amendment is that it directly impacts the investments made from Singapore. The India-Singapore tax treaty provides that the capital gains exemption in India will be available only till such time the India-Mauritius treaty provides for the benefit.
Given that the India-Mauritius tax treaty has been amended, it is unclear whether the India-Singapore tax treaty will be renegotiated. This leads to more questions. Will grandfathering provisions be applicable for Singapore-routed investments too? Will the transitionary provisions continue to apply here as well?
Even assuming the treaty is not renegotiated, from a technical reading of the press release issued by CBDT together with the India-Singapore tax treaty, applying a literal interpretation one may take a view that the capital gains under India-Singapore should not be available. However, since the India-Mauritius treaty has transitionary positions and grandfathering of investments have been provided, it is logical and fair to expect the same benefit will be extended for Singapore residents as well. Further, it should also be noted that a Singapore resident cannot be at a disadvantageous position compared to a Mauritius resident due to an amendment in the Mauritius tax treaty.
The government lists that the key reasons for the amendment are to tackle treaty abuse and round-tripping issues. There is also another list of items which include curbing revenue loss, preventing double non-taxation, streamlining the flow of investment and stimulating the flow of exchange of information between India and Mauritius.
One of the important agendas of the Base Erosion and Profit Shifting (BEPS) project is to prevent double non-taxation and treaty abuse. By amending the India-Mauritius tax treaty and allowing grandfathering of investments, the government has addressed both issues appropriately. The government perhaps is of the view that India will continue to receive good FDI inflows despite the amendment, considering it is providing certainty in tax regime.