India rewrites tax treaty with Mauritius
Mauritius will no longer be as good a gateway for investments into India after the two countries agreed to amend a tax treaty.
According to an August 2013 report by the India Department of Industrial Policy, 38% of foreign direct investment into India comes through Mauritius. Singapore, which also has a favorable tax treaty, accounts for 11%.
The Mauritius treaty has been in effect since 1983.
It provides two benefits. Foreign investors using Mauritius companies to hold investments in India can avoid capital gains taxes upon sale of the investments. The treaty also limits India from collecting more than a 5% withholding tax on dividends paid by Indian companies, 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.
A protocol to the Mauritius treaty released on May 12 will allow India to tax Mauritius residents on gain on the sale of shares in Indian companies acquired on or after April 1, 2017. Gains on sales of shares acquired before that date will remain exempted from Indian taxes, regardless of when they are sold. Indian capital gains rates range from 15% to 20%. A transition tax rate at 50% of regular levels will apply to taxable share sales for the first two years from April 1, 2017 through March 31, 2019.
However, the transition rate is available only if the Mauritius company can satisfy a “limitation of benefits” clause in the protocol. The Mauritius company cannot have been formed with the primary purpose to take advantage of the treaty. A shell company with no or negligible real business operations in Mauritius will not be able to satisfy this test. A Mauritius company will automatically be considered a shell if its spending on operations in Mauritius was less than 1.5 million Mauritian rupees (about US$22,500) in the 12 months preceding the share sale. However, it will not be considered a shell if its spending was more than this figure.
In a helpful change, the protocol caps withholding taxes that can be collected on interest at 7.5% of the gross interest amount. There had not be a limit earlier. Indian withholding taxes on interest range from 5% to 40%, depending on the lender.
This should make Mauritius more attractive for lending into India.
Capital gains from asset transfers other than shares will remain exempted from taxes under the treaty.
The protocol will let India tax “other income” that was previously exempted from tax. This may let India collect taxes where a Mauritius company acquires shares in an Indian company for less than their value. India has been asserting the right to tax multinational corporations that make capital contributions in exchange for shares in Indian subsidiaries to the extent the shares are worth more when issued than the contributed capital. Both Vodafone and Shell have been hit with such tax claims. For prior coverage, see "India" in the November 2014 NewsWire.
Singapore has a similar exemption from capital gains taxes in its treaty with India, but it is harder to qualify as a resident of Singapore due to the limitation-of-benefits language in its treaty. Nevertheless, that treaty is also now expected to be amended to drop the capital gains tax exemption in line with the changes in the Mauritius treaty.