India has comprehensive Double Taxation Avoidance Agreement (DTAA) with 88 countries. The India-Mauritius treaty (IM treaty) came into being in 1983 and in fact 39.6% of FDI to India came from Mauritius between 2001 and 2011.
Under the IM treaty, capital gains from sale of shares can be taxed only in the place where the holder of the shares is resident. Consequently, capital gains on sale of Indian shares by Mauritius entities are taxable only in Mauritius as per the DTAA, and as Mauritius generally does not levy capital gains tax, there is no capital gains tax on such transactions - this lead to structuring of investments into India through Mauritius.
The present government announced the signing of a protocol effectively withdrawing the most significant benefit enjoyed by the investor community, the exemption of capital gains on shares in Indian companies.
Now, all investments made through Mauritius in shares of Indian companies till 31st March, 2017, have been grandfathered, thus the existing interests of investors have not been infringed at all.
Further, it is proposed to introduce capital gains tax with respect to investments made in Indian shares on or after 1st April, 2017, in a phased manner. Between 1st April, 2017 and 31st March, 2019 50% of the tax for capital gains arising, subject to fulfilling the limitation of benefit clause; and post 1st April, 2019, capital gains tax shall be levied at full rate.
In a positive development, until the Protocol, the withholding tax on interest income paid to a Mauritian resident was liable to tax in India, at 40%. The new Protocol now, however, provides that the tax will not exceed 7.5% of the gross amount of interest. The new tax rate of 7.5% could see Mauritius becoming the ‘go-to’ destination for loans or debt investments.
The protocol is silent about capital gains on investments through hybrid instruments such as convertible debentures, derivative instruments etc as well as indirect transfers which could be potential structuring opportunities. The announcement also suggests that the government may negotiate the India Singapore and other similar treaties. How it affects foreign flows into India, only time will speak!