The Government of India recently made bold moves to tackle long-lasting issues of treaty abuse, curbing tax losses, and took the decision to phase out tax exemptions. Some of these measures could have important repercussions on investments made through Mauritius.
The Mauritius route to India
Mauritius has been, for decades, considered as one of the preferred jurisdictions for investors channelling their investments into India. In force since 1982, the Mauritius-India double taxation avoidance agreement (DTAA) has played a pivotal role in popularising the “Mauritius route” to India. As a result, Mauritius has been one of the main contributors of foreign direct investment (FDI) into India for the last 20 years.
Under Article 13 of the Mauritius-India DTAA, capital gains on the sale of shares in India by a Mauritius resident company was taxable only in Mauritius. In Mauritius, capital gains are exempt from tax. Consequently, gains from alienation of shares held by a Mauritius entity in an Indian company were neither taxed in India nor in Mauritius.
Whilst the treaty fuelled FDI to India, the Indian Government was concerned about the loss of tax revenue due to the non-taxing of capital gains in India.
Introduction of GAAR
India attempted to redraw the historic double tax agreement to plug the loopholes but faced numerous challenges. In 2012, the Indian Government announced the introduction of a general anti-avoidance rule (GAAR) to curb tax evasion and cut down tax leakages. GAAR sought to empower Indian tax authorities to scrutinise transactions designed to avoid tax and have no commercial substance.
The introduction of GAAR, along with the growing resentment against companies failing to pay their fair share of taxes, pushed Mauritius to cooperate in subsequent negotiations. The Protocol amending the 33-year-old tax treaty was finally signed on 10 May 2016, after nearly a decade of negotiations.
The seismic amendment brought by the Protocol gave India the source-based right to tax capital gains arising on alienation of shares of an Indian company acquired by a Mauritius entity, on or after 1 April 2017.
Despite the renegotiation of the treaty, however, Mauritius today remains a solid and competitive platform for investing into India. The treaty with India is still in force and some terms, such as those relating to dividend income and interest income, are still advantageous. The Mauritius route is therefore far from being obsolete.
Abolition of DDT and introduction of withholding tax on dividend income
Another change brought by the Indian Government was the abolition of the Dividend Distribution Tax (DDT) on 1 April 2020. The Indian Government restored the classical system of taxing dividend; that is, the dividend income is subject to withholding tax (WHT) in the hands of investors.
Under the DDT regime, the obligation to pay the DDT liability was previously on Indian companies declaring dividends. Accordingly, a Mauritius company holding shares in an Indian entity would receive the dividend as declared by the Indian company.
Following adoption of the new regime, dividend income is now subject to WHT at 20% (plus applicable surcharge and cess) per the Indian domestic law. However, where India has signed a tax treaty with another country, the provisions of the tax treaty shall apply to the extent they are more beneficial.
Under the Mauritius-India DTAA, the WHT rate on dividend, provided the recipient is the beneficial owner of the dividend, is as follows:
- 5% if the shareholder holds directly at least 10% of the capital of the Indian company paying dividend
- 15% in any other case
Challenges by the Indian tax authorities
India’s Income Tax Department issued its Circular No. 789 on 13 April 2000 stating that a Certificate of Residence is sufficient to substantiate residential status and beneficial ownership for capital gains and dividend. The validity of the said Circular has been upheld by the Supreme Court of India, followed by certain other Courts.
Despite the above, the Indian tax authorities have consistently been raising questions on beneficial ownership and denying the treaty benefit on capital gains and dividend income in cases of Mauritian investments.
Beneficial ownership and commercial substance
The Indian tax authorities are predominantly examining beneficial ownership and substance prior to granting treaty benefits. Entities failing to substantiate the beneficial ownership test or unable to demonstrate commercial substance requirements are denied treaty benefits.
We understand that an entity in India is considered to satisfy commercial substance requirements if it has employees, holds office premises, conducts transactions and is being effectively managed locally. Further, the entity should be able to provide valid documents showing that it is the beneficial owner of the dividend income and is not only acting as a passthrough vehicle.
Evidently, evaluation of beneficial ownership conditions for Mauritian investments claiming treaty benefit is critical. The analysis in this regard would include detailed evaluation of facts and application of the principles laid out by the Judiciary.
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