In order to plug loopholes in the existing bilateral treaty that inhibit steps to curb black money, India has signed a protocol agreement with Mauritius to prevent evasion of taxes on income and capital gains by entities of either side.
According to the amended treaty, India gets taxation rights on capital gains arising from sale of shares in an Indian firm on or after April 1, 2017, while, also protecting investments in shares that were acquired before that date. This is going to impact US investors as they are doubly taxed on capital gains for their Indian investments because of peculiar feature in the US domestic laws restricting credit on this income and the India US treaty does not have any resourcing provision.
Currently, the source rules in the US prevent US resident from claiming credit for the Indian capital gains taxes against the US capital gains tax liability. Routing through Singapore or Mauritius becomes a necessity in such a case and now this route is closed for them.
Impact of the protocol
Thoseshares acquired before 1 April 2017 will not be taxed by Indian authorities anda two-year transitionary phase has been provided wherein the capital gains willbe taxed at a concessional tax rate. Underthe amended treaty, only those Mauritius-based companies that have a totalexpenditure of more than Rs.27 lakh in the preceding 12 months will be able tobenefit from the tax treaty. The Protocol will tackle the long pending issuesof treaty abuse
and round tripping of funds attributed to the India-Mauritius treaty, curb revenue loss, prevent double non-taxation, streamline the flow of investment and stimulate the flow of exchange of information between India and Mauritius. It will improve transparency in tax matters and will help curb tax evasion and tax avoidance. Revenue Secretary, Hasmukh Adhia said “The treaty amendment brings about a certainty in taxation matters for foreign investors. It reinforces India’s commitment to OECD-BEPS (Base Erosion of Profit Sharing) initiative to stop ‘double non-taxation’ enjoyed by companies.” He further added that Capital Gain on shares for Singapore can also now become source based due to direct linkage Singapore DTAA clause with Mauritius DTAA.
The key features of the protocol are as under
Source-based taxation of capital gains on shares: With this Protocol, India gets taxation rights on capital gains arising from alienation of shares acquired on or after 1st April, 2017 in a company resident in India with effect from financial year 2017-18, while simultaneous protection to investments in shares acquired before 1st April, 2017 has also been provided. Further, in respect of such capital gains arising during the transition period from 1st April, 2017 to 31st March, 2019, the tax rate will be limited to 50% of the domestic tax rate of India, subject to the fulfillment of the conditions in the Limitation of Benefits Article. Taxation in India at full domestic tax rate will take place from financial year 2019-20 onwards. However, the press release is silent about hybrid instruments like compulsory convertible debentures and Futures and Options transactions. Hence, it seems that these shall be out of the impact of the amendment in protocol. However, clarity would arise only once the text of the protocol is released.
Limitation of Benefits (LOB): The benefit of 50% reduction in tax rate during the transition period from 1st April, 2017 to 31st March, 2019 shall be subject to LOB Article, whereby a resident of Mauritius (including a shell / conduit company) will not be entitled to benefits of 50% reduction in tax rate, if it fails the main purpose test. A resident is deemed to be a shell/ conduit company, if its total expenditure on operations in Mauritius is less than Rs. 2,700,000 (Mauritian Rupees 1,500,000) in the immediately preceding 12 months.
Source-based taxation of interest income of banks: Interest arising in India to Mauritian resident banks will be subject to withholding tax in India at the rate of 7.5% in respect of debt claims or loans made after 31st March, 2017. However, interest income of Mauritian resident banks in respect of debt-claims existing on or before 31st March, 2017 shall be exempt from tax in India.
The Protocol also provides for updation of Exchange of Information Article as per international standard, provision for assistance in collection of taxes, source-based taxation of other income amongst other changes.
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