Over the past several years, Mauritius has been used as a platform by investors to invest into India. Over 40 per cent of total foreign direct investment in India comes from Mauritius, a low tax jurisdiction. The Mauritius structure has also been very common with private equity funds investing in India.
Let us first look at the tax reason behind using Mauritius. Under the India-Mauritius tax treaty (tax treaty), India does not have a right to tax gains derived by a resident of Mauritius from the sale or disposal of shares of an Indian company. In other words, a Mauritian resident selling shares of an Indian company can take the benefit of the India-Mauritius tax treaty and not be liable to Indian capital gains tax. To add more flesh to this, the Supreme Court of India has held that tax residency certificate issued by Mauritius tax authorities is sufficient evidence to prove tax residency in Mauritius for availing tax treaty benefits. This has lent a lot of credibility to the Mauritius route.
Now, let us look at the concern which India has. As per Press reports, India is estimated to lose over $600 million a year in revenue on account of this benefit under the tax treaty. Further, concerns have also been raised that Mauritius may have been used for illegitimate purposes by Indian tax residents for ‘round-tripping transactions.’
India-Mauritius Tax Treaty Being Re-negotiated
In the backdrop of these concerns, India and Mauritius had set up a Joint Working Group (JWG) way back in August, 2006, comprising of senior officials to work on important issues in the existing tax treaty. Press reports indicate that JWG had met on several occasions in the past to discuss issues relating to adequate safeguards to be put in place to prevent misuse of the tax treaty and strengthening of the mechanism for exchange of information. However, it is understood that there was no consensus reached.
It is learnt that both the countries have recently agreed in principal to recommence discussions in this regard. Press reports indicate that the tax treaty may be revised to introduce:
1. Exchange of information on banking transactions (in addition to the existing information exchange article).
2. Limitation on benefits (LOB) clause to restrict the benefits of the treaty – this should provide guidance on meeting the substance test to qualify for treaty benefits.
Thus, under the revised treaty, a mechanism can be put in place to prevent its abuse. It remains to be seen the conditions which will be prescribed under the LOB clause.
While the above hit the news a couple of days ago, as per a Press report of today, the government has strongly denied holding any talks on revising the double tax avoidance agreement with Mauritius. Indian equity market has been witnessing a volatile bout of sell-offs post news that India and Mauritius are in talks to revise the existing tax treaty.
Introduction Of General Anti-Avoidance Rules (GAAR) In The Indian Tax Legislation
Some believe that a revision of the Mauritius treaty to prevent abuse may not be necessary now, given that anti-avoidance provisions are already proposed under the new Direct tax Code (DTC), to be effective from April 1, 2012.
GAAR is proposed as an anti-avoidance measure under the DTC. Under GAAR, the Indian tax authorities will be empowered to declare any ‘arrangement’ as ‘impermissible avoidance arrangement’, if part or a whole of a structure has been set up with the main purpose of obtaining ‘tax benefit’. An ‘arrangement’ will be presumed to be for obtaining tax benefit, unless the taxpayer demonstrates that obtaining tax benefit was not the main objective of the arrangement.
Under the DTC, GAAR is a tool available with the tax authorities to question any such structure, including the Mauritius structure.
In summary, under the DTC regime, commercial substance and bona fide business purpose test will be among the key requirements for availing treaty benefits.
Is Shifting To Any Other Favourable Jurisdiction A Solution?
Countries like Singapore and Cyprus also provide similar tax benefits as Mauritius. The India-Singapore tax treaty already has an LOB clause to prevent abuse. In any case, once GAAR is enacted under the DTC, substance requirements and bona fide business purpose test will have to be satisfied to claim treaty benefits, irrespective of whether the investor comes from Mauritius or any other jurisdiction. Once enacted, GAAR will not only impact the new structures but may also impact the existing structures, if there is a claim for capital gains exemption under the DTC regime.
The Way Forward
PE funds coming into India from Mauritius should take note of these developments, review its existing structure and perform an impact assessment. PE funds, which are likely to be impacted due to these proposals, should see if any corrective step can be taken, if necessary. Alteration of existing structure may, therefore, be on the cards for some of the PE funds. Based on the outcome of the impact assessment, some PE funds may also have to reconcile to the fact that tax cost may have to be factored in while making investment decisions going forward.
The government, of course, looks confident than ever and assumes that India’s strong economic fundamentals will continue to attract investments, notwithstanding the additional tax cost on investors.
Anil Talreja (Partner – M&A tax) & Jatin Kanabar (Sr. Manager – M&A Tax) co-authored the article. Views expressed are personal.