The news of the amended India – Mauritius Double Taxation Avoidance Agreement (Treaty) vide a Protocol (Protocol) has taken centre-stage in the realm of international taxation; a Press Release dated 10 May 2016 was released as a precursor briefly giving the gist of enumerating the changes that the Protocol would usher in (please click here). The Protocol, officially released by the Government of Mauritius1, includes other key changes that shall greatly influence how inbound investments into India are structured, especially equity versus debt.
A Snapshot of the Protocol to the Treaty
Debt is the new Equity? From 1 April 2017 onwards, interest income arising in India to a Mauritian resident would be subjected to a withholding tax in India that shall not exceed 7.5% of the gross amount of interest. However, the tax on such interest income shall be exempt in cases where the beneficial owner deriving the interest income is (a) a Government or a local authority; (b) an agency or entity created or organised by the Government of the other State. A bank which is a resident of the other State and is carrying on bona fide banking business, the interest is exempt from tax in the source State if the debt-claims existed on or before 31 March 2017.
Currently, under (Indian) Income Tax Act, 1961 (Act) interest income earned in India and payable to a Mauritian resident is subject to an Indian withholding tax at the rate of 20% or 40% depending upon the currency of debt (unless a lower 5% rate is applicable in some cases). The beneficial withholding tax rate of 7.5% is lower than the rates negotiated with most other countries. This lower rate should not trigger a chain reaction since the most-favoured-nation clause may not be triggered as Mauritius is not a member of the OECD.
Good-bye capital gains tax benefit! Capital gains arising from the alienation of shares of an Indian company acquired prior to 1 April 2017 shall be exempt from tax in India, irrespective of when they are sold. Capital gains arising from the alienation of shares acquired on or after 1 April 2017 and sold by 31 March 2019 (Transition Period), shall be taxed in India at a rate not exceeding 50% of the tax rate applicable in India, at the point in time of gain recognition. However, this 50 % rebate is available only if certain terms of the Limitation of Benefits (LOB) are met. All other gains on shares (other than dealt with above) would be taxable in India at the applicable tax rates. A residuary clause that deals with the gains arising from the alienation of any other property (which would include debentures) shall be taxed only in Mauritius and not in India.
The changes made to the capital gains tax provision will take effect from 1 April 2017.
- It is important to note that taxation of capital gains from securities (including debentures) and other capital assets alienated remain intact. Further, the capital gains tax exemption has been phased out during the Transition Period to ensure that the change is gradual.
'Limitation of Benefits': The LOB provisions state that:
- Purpose & Business test - The alienator shall not be entitled to the benefits of 50% lower tax rate, if its affairs were arranged with the primary purpose to take advantage of the such 50% lower tax rate in the Treaty. Therefore, legal entities must have bona fide business activities to avail of the said lower rate.
Similarly, shell or conduit companies, viz., resident legal entities with negligible business operations, without any real or continuous business activities are disentitled from availing the lower tax rate during the Transition Period; and
- Expenditure test – Companies with an expenditure (in the residence State) of less than Indian Rupees 2,700,000 (in case of an Indian resident) or Mauritian Rupees 1,500,000 (in case of a Mauritian resident) in the immediately preceding period of 12 months from the date the gains arise, will be deemed to be shell or conduit companies, unless they are listed on a recognised stock exchange (in the residence State).
- Therefore, according to the LOB provision, in addition to satisfying the expenditure test, companies must also satisfy the purpose test.
Service Permanent Establishment introduced: The definition of a Permanent Establishment (PE) as provided in Article 5 of the Treaty shall now include an additional category of service PE. This PE clause shall be triggered by the furnishing of services (including consultancy services) through employees or other personnel engaged by an enterprise for a period or periods aggregating more than 90 days within any 12 month period.
- Interestingly, the language which requires furnishing the services in the source country (typically included in most tax treaties) as well as the lower threshold for related enterprises has not been included.
Fees for Technical Services included within the Treaty fold: In addition to the provision relating to income from 'royalties', a new provision dealing with 'Fees for Technical Services' (FTS) has been introduced whereby FTS arising in a State (say India) and paid to a resident of other State (say Mauritius) is now taxable in both States (India as well as Mauritius). However if the beneficial owner of the FTS is a resident of the other State, then a tax of 10% shall be charged on the gross amount of FTS. Additionally, if the FTS paid exceeds the amount that independent parties would have agreed upon, such excess would continue to be taxed as per the laws of each State.
FTS has been widely defined to mean payments made as consideration for managerial or technical or consultancy services, including the provision of services of technical or other personnel. Certain standard exceptions to the above rule have been provided for in cases where (a) the beneficial owner receiving the FTS carries on business through a PE or if the FTS is effectively connected with such PE in the source State; and (b) the payer is the State itself or a political sub-division or local authority of the State.
- This insertion provides clarity on how technical services rendered by companies shall be taxed in light of the past issues surrounding whether tax should be withheld in India.
Taxation of 'Other Income': A non-obstante clause has been included whereby income not dealt with expressly in the Treaty, may be taxed in the source State (i.e. India, for inbound investments).
- This alters the current distribution of taxing rights, wherein the residuary category of 'other income' allows only the resident State to tax such income.
'Exchange of Information' (EOI): The Protocol introduces the current provisions with a detailed EOI provision whereby, competent authorities of India and Mauritius shall exchange information as is reasonably foreseeable treating such information as secret. However, the Protocol enables the information to be disclosed in public court proceedings. Additionally, EOI provision now requires India and Mauritius to use its information gathering measure even in the absence of domestically requiring the information sought by the other State. Similar to the extant India – Singapore tax treaty, bank secrecy, information held by agent or nominee in fiduciary capacity shall not hinder the supply of information requested. An additional provision is also provided detailing the mechanism for the assistance in collection of taxes.
The provisions relating to EOI shall be effective from the date of force of the Protocol.
Debt is the new Equity? Largely, the international taxpayer community is perhaps overwhelmed and only digesting news of the Protocol. Traditionally, for the greater part of the past two decades, equity investments have been routed through Mauritius. The Protocol somewhere chimes in with the Government's intention of bringing in more debt investments into the country rather than equity by gently withdrawing the capital gains tax exemption by a reduced withholding tax on interest income. The lower withholding rate for interest income certainly is a shot in the arm for investors. On the capital gains side, interestingly, the Indian Government in the recently amended Finance Bill, 2016 extended a lower rate of 10% tax on the long term capital gains arising from the sale of shares of a closely held company (including a private company) to non-residents, thus reducing the sting from levy of capital gains tax.
Squeezing in indirect transfers: Given that the scope of the capital gains tax provision does not include within its ambit indirect transfers of Indian assets, perhaps a two-tiered Mauritius structure may now be considered provided it meets GAAR challenges.
Committed to BEPS: By amending the residuary provision governing 'other income', introducing a clause to tax FTS, and the gradual phasing out of the capital gains, India has stayed true to its commitment to prevent base erosion and implement taxes based on the 'nexus' approach.
Enhancing EOI: A detailed and robust EOI clause allows the Treaty to remain at par with newer treaties that are being negotiated with India. Further, this change clearly signifies the global trend towards transparency.
All in all, amending the Treaty gradually and providing for a concessional tax rate during the Transition Period, coupled with grand-fathering of investments made till 31 March 2017 is a very thoughtful and fair approach of the Indian Government, in line with its commitment to promote a non-adversarial and stable tax regime in India.
1 http://mof.govmu.org/English//DOCUMENTS/PROTOCOL% 0TO%20THE%20MAURITIUS%20-%20INDIA%20DTAC% 20SIGNED%20ON%2010%20MAY%202016.PDF
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