May 30, 2012 | By Keith Martin in Washington, DC

Mauritius hopes to finish rewriting parts of its income tax treaty with India by the summer.

More than 40% of foreign direct investment in India is invested through Mauritius.

The Indian government is unhappy that Indian companies have been using the treaty to avoid capital gains taxes on asset sales in India by “round tripping” where Indian companies establish residency in Mauritius and then invest in India under the guise of foreign investment. Under the income tax treaty between Mauritius and India, neither country can impose capital gains taxes on residents of the other country. Mauritius does not collect any capital gains taxes.

The treaty also limits India from collecting more than a 5% withholding tax on dividends, but India neutralized this benefit years ago by moving to replace its higher withholding tax on dividends with a tax on the Indian company when it distributes earnings.

India is also unhappy with the large number of foreign companies that use the Mauritius treaty to avoid capital gains taxes when they exit investments in India. Many foreign investors hold shares in Indian companies through Mauritius holding companies. However, the government seems inclined to attack this problem by tightening the requirements for accepting tax residency certificates from Mauritius rather than by amending the treaty. A finance bill that is expected to pass parliament by the summer will require that any residency certificate produced must contain “such particulars as may be prescribed.” This would give the government the tools to require that there be substance behind the claim to be a real tax resident of Mauritius.

Meanwhile, Mauritius adopted a new form of limited partnership in December that may appeal to foreign investors in place of offshore holding companies. Mauritius is also keen to become a gateway for foreign investment into Africa. It already has 12 income tax treaties with African countries, and another eight treaties are awaiting ratification.