[Opinion] Implication of the Protocol Signed for Amending the Tax Treaty with Mauritius

Ved Jain – [2024] 161 taxmann.com 500 (Article)

A. Introduction

A Protocol has been signed by the Government of India and Mauritius on 07.03.2024 to amend its Tax Treaty so as to prevent tax evasion with respect to capital gain income arising to the resident of Mauritius from the sale of shares of an Indian Company. The amendment proposed may result in denial of exemption in respect of capital gains tax arising from the transfer of investments made in India through Mauritius on or before 31.03.2017 and will have far-reaching implications as Mauritius is currently the fourth largest source of Foreign Portfolio Investment flows with funds from the island nation owning shares worth Rs 4 lakh crore (or 6 per cent of total FPI assets) in India. In FY23 itself, Mauritius was the second largest source of FDI with inflows to a tune of $6.1 billion.

B. Capital gain exemption in respect of investments made prior to 01.04.2017

As per the present provisions of the Tax Treaty with Mauritius, which were amended with effect from 01.04.2017, capital gains arising from the transfer of shares acquired on or before 31.03.2017 are taxable only in the country where the seller is resident. Thus, on the investment made in India by a Mauritius resident in an Indian company, no tax is leviable on the sale of such investment. Capital gain arising in respect of shares acquired on or after 01.04.2017 can be taxed by India consequent to the amendment made in 2016 w.e.f. 01.04.2017.

Accordingly, the transfer of investments made by a tax resident of Mauritius in an Indian company on or before 31.03.2017 is not taxable, irrespective of the date when such shares are transferred. This exemption is available based on the Tax Residency Certificate (‘TRC’) issued by the Mauritius Tax Authority, which is considered to be sufficient evidence for claiming the exemption.

C. Proposed amendment under the Protocol – Principle Purpose Test

Now, by signing this Protocol, the Tax Treaty with Mauritius is being amended to provide that benefit under the India-Mauritius Treaty shall not be granted in respect of any item of income, if it is reasonable to conclude having regard to the facts and circumstances that obtaining such tax benefit was one of the principle purpose of such transaction that has resulted directly or indirectly in such benefit unless it is established by the tax-payer that the tax benefit is in accordance with the object and purpose of the Treaty (hereinafter referred to as ‘Principle Purpose Test‘).

Further, the object and purpose of the Tax Treaty are also being amended by the Protocol. As per the amended objects and purpose, the Treaty between India and Mauritius is entered into to eliminate the double taxation with respect to the taxes covered by the Treaty without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance through treating shopping aimed at obtaining tax reliefs provided in the convention for the indirect benefit of residents of third jurisdiction.

D. Amendment to affect exemption in respect of investments made prior to 01.04.2017

The implication of this amendment in the Treaty will be that even in respect of investment made on or before 31.03.2017, as and when capital gain arises in the hands of the Mauritius resident investors in respect of investment made in India through Mauritius, the Indian Tax Department will be entitled to challenge the exemption claimed by the taxpayer on the reasoning that obtaining tax benefit was the principle purpose of such investment made in India through Mauritius. Further, other benefits under the Treaty, such as concessional rate of tax in respect of dividend and interest income, etc., can also be denied on this reasoning.

Thus, the TRC issued by the Mauritius authority will not be sufficient evidence to claim the benefit under the India-Mauritius Treaty. Accordingly, as and when such investment is sold, the Indian Tax authority may deny the exemption by applying this amendment to the Tax Treaty, which clearly states that a resident of the third country cannot avail of the benefit under the Treaty unless it is established by the taxpayer that the investment was for the purpose of promoting trade between Mauritius and India and not for tax evasion or avoidance through treating shopping for benefit of residents of third jurisdiction (i.e. neither of India and Mauritius). The matter of fact is that most of the investments in India through Mauritius have come from investors who are by and large residents of the third country i.e. neither India nor Mauritius. And hence, most of these investors, despite having a Mauritius resident certificate issued by the Mauritius Tax Authority, may not be able to pass the Principle Purpose Test considering the amended object and purposes of the Treaty. Apparently, this is going against the accepted position of allowing Treaty benefits on the basis of the TRC issued by the Mauritius Tax Authority, as explained hereinafter.

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