In Context: Recent Amendments to India's Tax Treaties

04 Oct, 2016    ·   5142

Prerana Priyadarshi analyses the motivations for and the benefits of the recent amendments to India's tax treaties with various countries 

Prerana Priyadarshi
Prerana Priyadarshi
Senior Researcher, Centre for Internal and Regional Security (IReS), and Manager, Operations and Outreach
After signing a protocol to amend the Mauritius Tax Treaty on 10 May 2016, India is now renegotiating its tax treaty with Singapore. Additionally, on 24 August 2016, the Indian Union Cabinet approved the signing of a revised India-Cyprus tax treaty. Can these amendments be seen as India’s attempt to plug tax evasion and black money? Will it bring Foreign Direct Investments (FDIs) to India under stress?

The Treaties: A Brief Overview
As a common practice, countries enter into tax treaties to avoid or mitigate double taxation. India has comprehensive Double Taxation Avoidance Agreements (DTAAs) with 88 countries.

Under the 1982 India-Mauritius DTAA, New Delhi did not have the right to tax capital gains (profit from the sale of property or an investment) arising to a Mauritius-based tax resident on the sale of shares of Indian companies. This, coupled with the fact that Mauritius does not levy a capital gains tax, made Mauritius a favourable jurisdiction for investing into India. On 27 May 1994, India and Singapore signed a DTAA with a provision that the India-Singapore treaty will be co-terminus with India-Mauritius treaty.

Trigger for Amendment
As India opened the doors of its economy for foreign investments in 1991, it triggered the round-tripping of funds wherein money from India was exiting through unofficial channels and being invested back into the country from outside via the Mauritius route to avail tax benefits under the DTAA. Also, Indian tax officers did not appreciate the prospect of shell companies in Mauritius claiming tax exemptions and sending tax bills to them and thus alleged misuse of treaty. But in 2000, India, concerned about the implications of actions of the tax officers on the FDIs, issued a circular to halt tax officers’ actions and justified the practice of treaty shopping. Consequently, the golden tap kept flowing, with Mauritius and Singapore accounting for USD 17 billion of the total USD 29.4 billion FDIs in India during April-December 2015 alone.

After toiling for almost a decade to redraw the tax treaty with Mauritius, India - on the basis of the Organisation for Economic Co-Operation and Development (OECD) and the G20 countries’ action plan on Base Erosion and Profit Shifting in 2016 - finally renegotiated with Mauritius with an aim to exploit gaps and mismatches in tax rules.

The key features of the Protocol signed by the Mauritius are as under:

1. With this Protocol, India gets taxation rights on capital gains arising from alienation of shares in a company resident in India acquired on or after 01 April 2017 and grandfathering (protection) of investments made prior to 01 April 2017. The tax rate during the transition period from 01 April 2017 to 31 March 2019 will be limited to 50 per cent of India's domestic tax rate, subject to the fulfillment of the conditions in the Limitation of Benefits (LOB) Article specified in the protocol. Taxation in India at full domestic tax rate will take place from financial year 2019-20.

2. Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5 per cent with respect to debt claims or loans made after 31 March 2017.
3. The protocol also provides for update of Exchange of Information (EOI - tool for prevention of fraud or evasion of taxes) article as per international standard. A provision for assistance in collection of taxes, source-based taxation of other income, is a part of the protocol.

The revisions in the Cyprus treaty signed in 1994 are on the lines of the recent changes notified in the India-Mauritius tax treaty. However, unlike the treaty with Mauritius, the 50 per cent capital gains tax exemption for two years from 01 April 2017 to 31 March 2019 is absent in the revised treaty with Cyprus. By defaulting on the EOI, Cyprus was notified as Non Jurisdictional Area (NJA) on of 01 November 2013; and India will consider the removal of Cyprus from the NJA with retrospective effect.

Complementing the government’s efforts to plug tax evasion and tax avoidance and its fight against black money, the amendment will help curb revenue loss emerging due to round tripping of funds and treaty abuse; prevent double non-taxation; streamline the flow of investment; and stimulate the flow of exchange of information. It will also improve transparency in tax matters.

Impact on Foreign Investments
Since the implementation of the amendment is on a prospective basis, the economy will soak in short term tremors in the foreign investor community looking at India. Considering the certainty attached to the amended tax regime, India will continue to receive good FDI inflows despite the amendment. The Indian economy is now strong enough to depend on any tax-incentivised route and in the medium-long term, will contribute to attract acting foreign investments. Stable environments will auger well for the Indian rupee, which would make the tax cost look insignificant.

Lastly, although the amendments may have closed few windows for tax exemptions and black money, impish investors will sooner or later find new routes to counter these steps undertaken by the government. Policymakers therefore need to also assess the competitiveness of India’s taxation system vis-à-vis other economies.