Paradise lost

On 10 May, when it was announced that India was to regain the right to tax capital gains on investments made through Mauritius, India’s ministry of finance said the move would “curb revenue loss, prevent double non-taxation” and help “curb tax evasion and tax avoidance”.

None of this will have come as a surprise as there have long been calls to amend the India-Mauritius double taxation avoidance agreement (DTAA) signed in August 1982. Allegations of treaty abuse and round-tripping have increasingly marked the discourse between both countries, and India has been working to tighten up the agreement since around 2001.

In Mauritius, the signing of the protocol to amend the DTAA was acknowledged to bring an end to the uncertainty that prompted investors to vote with their feet. Reports say the share of Mauritius in foreign direct investment (FDI) going into equity in India halved from 42% in 2012 to 21% in 2015, while that going into Singapore almost quadrupled in the same period.

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REASSERTING RIGHTS

Now that India has pushed through the amendments to the tax treaty, commentators in India have been applauding the prospective nature of the amendments.

As such, investment made prior to 1 April 2017 will continue to profit from the benefits of the DTAA, while capital gains on equity investments made after 1 April 2017 will be taxable in India – for the first two years at 50% of the domestic tax rate, and thereafter at the full domestic tax rate.

However, the lower tax rate for the first two years is available only for Mauritius tax residents of substance: those that have a total expenditure in Mauritius for the preceding 12 months of more than ₹2.7 million (US$40,000).

Speaking to The Financial Express on 14 May, India’s revenue secretary clarified that the amended DTAA will not apply to short-term capital gains arising out of investments in derivatives and debt instruments such as debentures.

The amendment to the DTAA will also result in interest arising in India on loans made after 31 March 2017 by banks in Mauritius being subject to a withholding tax of 7.5% in India.

UPSETTING THE APPLE CART

While investors are expected to benefit from the certainty provided by the amendment, it has opened up questions about the viability of other routes used by investors.

Talk has resurfaced of attempts to renegotiate India’s tax treaties with Cyprus, the Netherlands, and crucially with Singapore, which had recently overtaken Mauritius as a source of investment inflow into India.

The DTAA between India and Singapore, which was signed in 1994, states that capital gains tax benefits are to be on par with those available in the India-Mauritius treaty. This would imply that India can assume the right to tax capital gains on equity investments made after 31 March 2017.

Investors are concerned and are urging the Indian government to take into account the more rigorous conditions – expenditure of more than S$200,000 (US$145,000) in the preceding 24 months – that an entity must meet in order to benefit from the treaty.

India’s finance minister, Arun Jaitley, recently said that the current India-Singapore tax treaty will be renegotiated before the end of March 2017.

TROUBLE IN PARADISE

Meanwhile, in Mauritius the amendment to the DTAA is prompting disquiet, despite the benefits of the so-called grandfathering of the treaty provisions – the maintenance of status quo until 31 March 2017 – which is credited for preventing a rush by investors to exit existing structures.

Writing in the Mauritian newspaper L’ Express, Rama Sithanen, a member of parliament and former finance minister, said that while Mauritius had “no choice than to share taxing rights with India, as the days when all such rights rest with the resident country are numbered,” the decision to give away taxing rights altogether would be disastrous.

Crucially, there are concerns over the failure of the Mauritius government to get India to agree to a most favoured nation clause in the amended agreement. In a press release issued a day after the amended agreement was signed, Global Finance Mauritius, a coalition of financial services industry providers, said, “there is the possibility that India could be signing more favourable DTAAs with other countries in the future”.

If this happens, it could spell the end of the Mauritius route into India, and there is little the island-nation will be able to do.

“India gained, they are the winners, it is Mauritius which has lost its taxing rights,” remarks Muhammad Uteem, a Port Louis-based barrister and member of parliament.

ADVANTAGES REAPED

Be that as it may, the DTAA between India and Mauritius has proved its worth for both countries. The Mauritius route accounted for about 35% of FDI into India between 2000 and 2015. It provided investors with the confidence to invest in India as the country’s stock markets began opening up to foreign funds and portfolio investors in the 1990s. Several high-profile investments into India, including Vodafone’s acquisition of a 33% stake in Vodafone Essar in 2011 and Vedanta’s purchase of a 51% stake in Cairn India in 2010, have been channelled through Mauritius-based entities.

Mauritius has also been used by Indian companies looking to raise capital on global markets. When Azure Power, one of India’s leading solar power developers, filed a draft red herring prospectus with the Securities and Exchange Commission in the US in December 2015, it did so through a company it set up in Mauritius, Azure Power Global.

This in turn has brought opportunities to Mauritius and led to the creation of a robust financial services industry on the island, which today contributes over 10% of its GDP. It is estimated that one in 900 of the 1.3 million people in the country is an accountant and one in 2,500 is a lawyer.

More importantly it has been recognized that despite the recent push to establish Mauritius as a provider of financial services for Africa, it will be a challenge to continue to develop the country as an international financial centre without business from India. Business on account of the DTAA with India is said to account for at least two-thirds of what the financial services industry does.

“It is so clear that we have cut the branch of the tree on which we are sitting” wrote Sithanen in L’Express.

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