[By Aayush Ambasht & Param Kailash]
The authors are students of Symbiosis Law School, Pune.
Introduction
On March 7, 2024, corporate entities stood to witness an extensive development in the Indo-Mauritius Tax Treaty, with an amendment to its preamble and the introduction of the Principal Purpose Test (PPT), implying the requirement for tax authorities to look beyond ‘Tax Residency Certificates’ produced before them by investors from Mauritius. In essence, the treaty aims to touch two primary objectives: the introduction of the Principal Purpose Test and alignment of the Indo-Mauritius Tax Treaty with the Base Erosion and Profit Shifting (BEPS) rights package put forth by the Organisation for Economic Co-operation and Development.
This piece seeks to provide deductions and key takeaways from the introduction of the PPT, potential implications to the money markets associated, as well as unaddressed concerns regarding the nature of investment discipline of the Foreign Portfolio Investor (FPI) landscape in corporate India.
Brief Background
On May 10, 2016, the amendment to the Indo-Mauritius DTAA brought about a degree of fine-tuning of the source country taxation, which paves a way for the inclusion of the Limitations of Benefits clause. This was followed by a 2017 press release allowing for the grandfathering of the agreement as well as ensuring standards applicable for future investors. Unlike the 2024 amendment, a 2017 press release by Mauritius clarified concerns regarding the inculcation and implementation of the BEPS minimum standards, by holding the matter to be an item of bilateral discussion between countries. However, deviating from the given stance, the Indo-Mauritius DTAA by way of amendment on March 7, 2024 (which got available to the public on April 11, 2024) chose to align the treaty in lines with OECD proposals concerning the BEPS, with specific emphasis on the introduction of the Principal Purpose Test (PPT).
Key Takeaways from the Amendment
Article 1 – Revision of the Indo-Mauritius DTAA
The binding nature of the Preamble of the Indo-Mauritius treaty stands revised following the amendment by omitting the phrase “for the purpose of mutual trade and investment” and replacing it by “without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.”
Through this development, an earnest attempt to delineate tax evasion vis-à-vis avoidance by way of treaty-shopping arrangements and indirect benefits of residents based out of foreign jurisdictions has been made.
Article 27B – Alignment with the Principle Purpose Test
Recognizing the pulse of “entitlement to benefits” in line with the “Principle Purpose Test” provided under Article 7 of the MLI for Prevention of Treaty Abuse, benefits accruing out of an item of income with the principle purpose of the transaction or arrangement which may have resulted in such a benefit; shall not be granted unless it is in accordance with the objects or purpose of the Indo-Mauritius Convention.
As an objective driven move, bridging the opacity between both monetary and non-monetary benefits basis the PPT has been sought. This shall minimize possible defaults and unregulated returns beyond the scope of the prescribed business purpose/commercial structure.
Taxation of Capital Gains
As far as capital gains for Indian investments parked through the Mauritius route subject to the 2016 amendment are concerned, capital gains earned by a tax resident of Mauritius on sale of shares of an Indian company were not taxable in India. This exemption had been withdrawn for benefits arising from sale of shares of an Indian company acquired by a Mauritian resident after March 31, 2017. Therefore, investments made prior to April 1, 2017 were grandfathered and sale of such grandfathered shares continued to benefit from the capital gains tax exemption under the tax treaty regardless of when such shares would be sold.
Keeping in mind the amendment at hand, moving the needle on fiscal evasion of taxes on capital gains and income before or after the effective date of this amendment would be privy to the PPT. This would ensure an imposition of a requisite litmus test given the complexities of grandfathering of shares and computation of capital gains on such equity variables.
Analysis and Industry Implications for Indo-Mauritius Money Markets
A shift from the golden age of the Indo-Mauritius tax treaty where capital gains tax was effectively never paid merely by channelling money through Mauritius, demanded intervention from the government. The significance of the tax treaty and the pertinent role Mauritius has played in the Foreign Portfolio Investor (FPI) landscape in India stands under question through the introduction of the Principal Purpose Test. With a cursory construction of the PPT, the tax treaty is pivoted towards falling in line with Action 6 of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS), with the framework calling for the establishment of a minimum standard to prevent treaty shopping, thereby furnishing a commitment on behalf of both India and Mauritius Governments to eliminate opportunities for double taxation or tax evasion. While the test mentions about “non-taxation” and “reduced taxation,” more clarity on this conjoint adage must align with mutual benefits without deviating from the prescribed investment route between the two countries.
Further, the question of the grandfathering effect of the treaty also comes into the equation, considering the treaty shall be effective from the date of its entry into force, with no regard concerning the dates during which the taxes were levied or the taxable years the said taxes are concerned with. The ambiguous nature of the protocol calls for challenges arising from investments made prior to the 2017 amendment, keeping in mind the retroactive applicability of the PPT. Pursuant to this challenge, the grunt of regulatory blanks for transactional structures involving the direct or indirect sale of shares, movable assets, immovable assets and family trust funds; challenges shall be faced by investors and the tax authorities of the respective countries arising from its application. To summarize, the retroactive nature of the PPT calls for challenges arising, not only concerning potential fresh investments from Mauritius, but also existing historical structures, sheltered by tax benefits under the grandfathering treaty, thereby leading to an impediment manifesting from both ends of the transaction at hand.
With regards to Tax Residency Certificates (TRCs), the landmark ruling of Union of India v. Azadi Bachao Andolan underpinning the Indo-Mauritius regime and Double Tax Avoidance Agreements (DTAAs), upheld the conclusivity and admissibility of claiming honoured tax benefits by producing a TRC to show beneficial interest/ownership and receipt of residence evidence.
However, the recent amendment has raised adverse implications on the effective validity of a TRC as sufficient evidence to claim eligibility under the India-Singapore DTAA and consequently, enjoy its respective tax relaxations. The legislative intent behind the implementation of the PPT underlies the ability of authorities to pursue beyond TRCs, effectively making TRCs deficient evidence in ensuring benefits under the treaty, with the stipulation of a greater principal purpose. Post the amendment, Indo-Mauritius Investment outflow detrimentally increased, clearly indicating increased contentious feelings amongst investors.
This outcome stands well within foresight with established precedents such as Sapien Funds Ltd v. CIT (International Taxation) establishing that the sole validity of the TRC shall amount to sufficient evidence to claim eligibility under the DTAA. The case held Mauritian based Collective Investment Vehicles (CIVs), consequently being registered under as a “Foreign Portfolio Investor” by SEBI, were entitled to receive benefits under the DTAA. Since the amendment fails to shed light on the admissibility of TRCs in light of Indian holding structures domiciled in Mauritius for availing relaxations, clarity on the same is promptly awaited by foreign portfolio investors who have previously considered or aim to cushion future interest for parking monies through this route.
These aforementioned concerns raise questions regarding the 2024 amendment with regards to the end-use implications of the PPT, taxation of capital gains and validity of tax residency certificates. Therefore, it becomes crucial to navigate notable difficulties arising from the application of this amendment by delineating procedural bottlenecks and fructify resolution concerning issues from the purview of merited investment discipline as well as regulatory scrutiny.
Concluding Remarks
In conclusion, the revised treaty, while paving the path to prevent treaty shopping, potentially leads to the neglect of investors attracted to the treaty due to the grandfathered benefits. With a history of a fall in investments with introductions of tighter regulations, paired with the retroactive application of the Principal Purpose Test calls for implications concerning the effectiveness of the treaty. Although complete faith was never placed upon TRCs in the Indo-Mauritian DTAA history, international law impetuses for good faith in transactions.
All in all, while industry implications of this amendment’s implementation raise concerns from international investors and governmental authorities, the treaty provides for an increased role for tax authorities to analyze the commercial substance of cross-border investments as well as the feasibility of its taxation. This will help in larger consolidation of international fund flow and pave the way for a heightened standard of governing restructuring activity for corporate India through the Mauritius route.