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TII SPECIAL
PPT finally finds its space in Indian-Mauritius Tax Treaty
By Pratap Singh, Pr CIT
Apr 15, 2024

FOREIGN Portfolio Investments (FPIs) through Mauritius enjoyed distinct tax advantages until recently in terms of lower withholding tax @ 5% on dividends, interest and fee for technical services pay-outs and long-term capital gains on sale of shares of Indian companies being tax-free. No wonders that a record 50.20 billion investments (as of March 2024) has flown into India from Mauritius in last few years, which is about 6% of total Foreign Portfolio Investments (FPI investments Investment) into India. However, as part of inclusive framework on (BEPS Base Erosion and Profit Shifting), India-Mauritius signed a protocol on March 7th, 2024 at Port Louis, amending its tax treaty with an aim to plug treaty abuse for tax evasion and avoidance. The text of the amended treaty, which became public only on 10th April 24, however, has raised concerns of greater scrutiny on investments, and led to a sell-off in stock markets by Foreign Portfolio Investors (FPIs) on April 12th 2024. This announcement increased worries of FPIs based at Mauritius, as there has been speculation with respect to past investments, before March 2017, and taxability thereof. It may be stated that DTAA between India and Mauritius was originally signed in 1982, to avoid double taxation, which was quite beneficial to the investors based at Mauritius and therefore lot of investments flown to India from Mauritius because of distinct tax advantages. To plug the loopholes the treaty was first amended in May 2016, as per which long-term capital gains on sale of shares became taxable. However, investments made up to 31.03.2017, were exempted from such capital gains tax, by introducing a grandfathering clause. The recent amendments, apparently do not talk about grandfathering the old investments and may be applicable with retrospective effect, which is causing major concerns among FPIs.

The latest amendments introduces Principal Purpose Test (PPT) in the form of clause 27B in the DTAA, which is in line with the global effort against treaty abuse under BEPS inclusive framework, as per which if the principal purpose of a transaction is availing a treaty benefit or tax benefit, and as such does not make a commercial sense, the tax officer can deny the treaty benefit, resulting into higher tax or higher withholding tax rate. The PPT has been in line with global understanding to curb tax evasion under BEPS inclusive framework, through multi lateral instruments, which automatically amend the tax treaty. So what India has done is in line with global efforts to curb tax evasion. However, it has created concerns to many funds, who until now were investing through Mauritius route, just to avail tax benefits. In fact, FPIs sold shares worth about Rs. 9000 cr on 12th April 24. To allay any fears, CBDT issued a clarification that amendments are yet to be notified and ratified by both the Governments and queries if any in this regard can be addressed, after ratification. The investors are however awaiting clarity whether past investments, especially those made before March 2017, will be grandfathered or not.

It is seen that not only PPT clause has been introduced, but even the preamble of DTAA is amended to incorporate the thrust on tax avoidance and evasion. The earlier objective of "mutual trade and investment" has now been replaced with an intent to "eliminate double taxation" without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance including through "treaty shopping arrangements" aimed at obtaining relief provided under this treaty for the indirect benefit of residents of third jurisdictions, giving a clear indication that tax avoidance or lesser tax rate will not be permissible. This may over ride any other provision in the treaty.

A revised tax treaty between India and Mauritius will come into effect only once the two countries notify and ratify the agreement. The new provisions in the treaty will include a principle purpose test, which will be used to judge whether tax benefits under the treaty will apply to investments or not, according to the text of the treaty released by India's foreign ministry. As per the amended treaty, tax benefits for investments will not be granted if it is ascertained that availing tax benefits was one of the reasons of the transaction.

The recent amendment reflects India's intent to align with global efforts against treaty abuse, under the BEPS framework - an international framework to combat tax avoidance by multinational enterprises using base erosion and profit shifting tools i.e "shifting" profits to higher tax to lower tax jurisdictions. Though India is yet to make any announcements regarding Pillar Two amendments (a minimum 15% corporate tax on income) in its domestic tax laws, experts said it is anticipated this may be announced sooner.

The text of the protocol amending the treaty states that the "provisions of the protocol shall have effect from the date of entry into force of the protocol, without regard to the date on which the taxes are levied or the taxable years to which the taxes relate". This suggests that the PPT may apply to all transactions after the treaty gets notified, irrespective of the date of the investment itself.

Investors are apprehensive that this will result in greater scrutiny of the capital gains tax levy and exemption, as the PPT will be applicable to past investments where investors have not made an exit yet.

It may be mentioned that the DTAA was a major reason for a large number of FPIs and foreign entities to route their investments in India through Mauritius, as there was no capital gains tax on sale/transfer of shares. The March 2017 timeline is significant in the context that the treaty was last amended in May 2016 allowing the right to tax capital gains arising from sale or transfer of shares of an Indian company acquired by a Mauritian tax resident. However, the government at that time had grandfathered, or in other words, exempted investments made until March 31, 2017 from such taxation.

Mauritius remains India's fourth largest source of FPI investments, after the US, Singapore, and Luxembourg, which is 6 per cent of the total FPI investment of Rs 69.54 lakh crore in India, as of March 2024. Introduction of PPT is a measure implemented to align the tax treaty with BEPS Action Plan 6, which was developed to combat tax evasion. The newly introduced PPT test, will enable tax authorities in India to examine and deny the benefit of India-Mauritius tax treaty if it is reasonable to conclude that obtaining the treaty benefits was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly such tax benefit. The experts feel that this may give rise to some litigation, specially in respect of old investments made until March 2017, which were grandfathered at the time of earlier amendment in treaty in May 2016. Some media reports suggested that these changes likely to have no retrospective taxation effect. The CBDT has clarified that the amendments are yet to be ratified and any queries in this regard may be addressed thereafter. Therefore, the finer details will be known only after amendments in DTAA are ratified by both the Governments. Till then people should wait rather than speculate.

 
 
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