What India-Mauritius treaty amendments mean for foreign investors

News: The India-Mauritius tax treaty amendments have been primarily targeted to curb “treaty shopping,”. This has significant implications for cross-border investment flows between India and Mauritius, particularly given Mauritius’ role as a major source of foreign direct investment (FDI) into India. What India-Mauritius treaty amendments mean for foreign investors ?

What are Tax Treaties?

Purpose of Tax Treaties: Tax treaties play a vital role in defining the tax treatment of incomes arising in one country and accruing to residents of another, impacting international investment dynamics.

Developing Countries’ Strategy: Often, developing countries, like India, cede greater taxing rights in exchange for anticipated higher foreign investments.

Historical Perspective on Treaty Shopping: The Indian Supreme Court, in the Union of India v. Azadi Bachao, once saw treaty shopping as a necessary trade-off for attracting FDI into a developing economy.

How did the International Tax Law on tax treaties evolve?

The OECD’s Base Erosion and Profit Shifting (BEPS) programme aimed to curb the use of low-tax jurisdictions for tax avoidance.

One of the key BEPS reforms was the Multilateral Instrument (MLI). It allowed countries to amend tax treaties to include provisions like the Principal Purpose Test (PPT) to prevent treaty abuse and treaty shopping.

Specific Amendments in the India-Mauritius Treaty

Introduction of Principal Purpose Test (PPT), designed to deny treaty benefits. The amendment allows Indian tax authorities to deny treaty benefits if the principal purpose of a transaction or arrangement is to obtain those benefits.

Assessment Beyond Residency Certificates: Amendments empower tax authorities to scrutinize the actual purpose behind transactions, moving beyond mere formal documentation like tax residency certificates.

Implications for Foreign Direct Investment (FDI)

Mauritius accounted for 16% of FDI inflows into India in 2021-22. The reform is expected to impact the composition of investment flows, similar to the effect of 2017 amendments that made the capital gains at source, taxable.

In 2017, General Anti-Avoidance Rule (GAAR) was introduced in Indian tax law in 2017 to respect the spirit of law and prevent abuse, providing a systematic framework to evaluate transactions.

What should be done?

After 2017 GAAR, there was a fear that the tax department may overreach excessively. However, to allay the fear, a panel-based approach to trigger GAAR was operationalized. A similar approach can be implemented for the trigger of this provision.

Implement a Global Minimum Tax. One such proposal is Subject to Tax Rule (STTR), that imposes a top-up tax on low-taxed transactions, attracting tax of less than 9%.