India-Mauritius Treaty Protocol 2024 — these are the main implications for foreign investors

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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India is now the global economic hotspot attracting unprecedented levels of Foreign Investments comprising or Foreign Direct Investment (FDI), Foreign Institutional Investors (FIIs) and Foreign Portfolio Investment (FPI). For the past 3 decades, Mauritius-based funds and holding companies have been one of the most preferred structures for investments in India due to overall regulatory framework in Mauritius and favourable Double Tax Avoidance Agreement (Treaty) between India and Mauritius.

The primary benefits of the Mauritius Treaty included exemption from capital gain arising in India in respect of investments made prior to March 31, 2017, and lower withholding tax on dividends and certain other types of income.

In this context, the recent Protocol dated March 7,  2024, signed between the Government of India and Mauritius limiting the benefit of the Treaty has sparked widespread discussions regarding potential implications on both the prospective as well as existing investments.

It is worth noting that while the protocol has been signed, the same is yet to be notified by both the countries and will come into effect from the later of the two dates. The Indian Finance Ministry has tweeted that further clarifications would be brought in this regard.

In this article, I am trying to provide a brief overview on the amendments made in the Protocol and their potential impact on existing and new investments.

The Proposed Amendments To The India-Mauritius Treaty (2024) Is In Line With Global Developments

The above Protocol must be viewed in the context of the increasing global movement towards prevention of treaty abuse such as Base Erosion Profit Shifting (BEPs), Principal Purpose Test (BPP), Economic Substance Test and Multi-Lateral Instruments (MLI). India-Mauritius Treaty was not under the purview of MLI and BEPS initiative as Mauritius had not notified its treaty with India as a Covered Tax Agreement (CTA) to which the MLI provisions would apply. 

Accordingly, the new Protocol to the Treaty modifies the preamble and incorporates the Principal Purpose Test (PPT) to the treaty. Such revision of the preamble as well as introduction of the PPT mechanism are both BEPS minimum standards and aligns the India–Mauritius tax treaty with Base Erosion & Profit Shifting (BEPS) Action Plan 6, which was developed to combat tax evasion.

Introduction of Principal Purpose Test (PPT)

The Principal Purpose Test (PPT) PPT seeks to deny the treaty benefits wherein one of the principal purposes of the arrangements or transactions is to avail a treaty benefit in a manner that is contrary to the object and purpose of the DTAA. 

Article 27B, a new addition to the treaty, outlines the conditions for entitlement to benefits under the PPT as follows:

Article 27B

Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.  This is not granted unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.

Once the PPT provisions take effect, the clarification of the CBDT Circular that a Tax residency Certificate would suffice as evidence for availing the treaty may no longer be valid. Accordingly, taxpayers may be required to substantiate the intent and commercial rationale for the arrangement/ transaction. 

Amendment to the Preamble

It is pertinent to note that the Preamble of the treaty has also been amended to focus on eliminating double taxation without creating opportunities for tax evasion or reduced taxation. 

The earlier emphasis on ‘mutual trade and investment’ has been replaced with a focus on to eliminate double taxation through tax evasion or avoidance that benefit third-party jurisdictional residents.

Key Amendments to the Capital Gains Tax Regime in the India-Mauritius Treaty (vide 2016 Protocol)

The India-Mauritius Double Taxation Avoidance Agreement (DTAA) was first signed in 1982 to promote bilateral trade and investment. Historically, the India–Mauritius treaty has long been significant in facilitating economic co-operation and the favourable tax treatment offered by the treaty both in terms of Dividend and Capital Gains made Mauritius a preferred route for foreign investors routing their investments into India. 

Owing to concerns pertaining to potential misuse of the treaty, it was significantly amended in 2016 and aimed at curbing any treaty abuse by way of tax evasion and round tripping of funds.

The initial significant change made in 2016 provided India with source-based taxation by way of taxing capital gains arising from alienation of shares acquired on or after 1st April 2017.

However, the Protocol offered protection to investments made prior to 1st April 2017 (grandfathering benefit), even if they resulted in capital gains upon sale after such date. Additionally, the concessional tax rate of 50% was made applicable during the transition mechanism. With the introduction of the recent potential amendments, it becomes impertinent to analyse its impact on such grandfathering benefit. 

Impact of the Amendmented Protocol on Capital Gains Tax Regime (such as Grandfathering Benefit, etc.) 

Article 3(2) of the Amended Protocol provides that “The provisions 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.”

This statement may be interpreted to mean that the regulations outlined in the Protocol will be enforceable starting from the date when the Protocol officially comes into effect, regardless of when the taxes are imposed or the taxable periods to which the taxes apply. Essentially, it indicates that the Protocol’s provisions take precedence once it is in force, regardless of the timing of tax imposition or the relevant tax periods.

As a result of the said Article, several concerns have been raised about the amended provisions of the Protocol (including PPT) being made applicable to the existing as well as past investments including the investments made before April 1, 2017 (protected by grandfathering benefit). 

Amended Protocol May Not Necessarily Impact Existing Investments or Past Years

In my view, the amendments provided in the protocol are in the nature of enabling provisions, which will empower the Indian government to regulate necessary treaty abuse.

However, given the government’s vision and commitment to maintaining and accelerating India’s growth, attract more foreign investment, (direct, institutional and portfolio) and Make in India initiative, the Indian authorities may not necessarily extend the amended provisions to the existing investments or past years. India would not like to erode the confidence of global investors and hence, we earnestly hope that:

• The amended Protocol is applied prospectively i.e., transactions taking place after the amended Protocol comes into effect.
• The benefit of capital gains in respect of investments made prior to April 1, 2017 which are protected by the grandfathering benefit should continue to enjoy the exemption.
• The benefit of lower withholding taxes for dividends should continue to apply to investments made on or before 31 March 2024.

The above moves would allay the apprehension of the global investors, would enhance India’s reputation as global investment destination and avoid the damage to reputation by applying provisions retrospectively.

In order for the Protocol to become enforceable, each of the treaty countries would be required to notify the other when it has completed the necessary procedures according to its own domestic laws for ratifying or bringing into force the protocol. This could include procedures such as legislative approval or executive action. Accordingly, the protocol will enter into force on the later of the dates when both states have completed their respective notification procedures.

—The author, Dr. Suresh Surana, is Founder, RSM India, a leading provider of audit, tax and consulting services to entrepreneurial growth-focused organisations globally. The views expressed are personal. 

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