Should investors worry about India-Mauritius tax treaty amendments? Punit Shah answers

"There used to be the provisions like general anti avoidance rules like GAAR, which required the investors like FPIs who are based in Mauritius need to have substance in Mauritius in order to claim the benefit of India-Mauritius tax treaty," says Punit Shah, Partner, Dhruva Advisors.

Let us talk about this treaty and this change that we are making. What is the impact that one should actually expect from this? Is it too much of a worry for investors from Mauritius?
Essentially what it says is that India-Mauritius tax treaty was there for several years now. It provides capital gains tax exemption on the equity shares, on derivatives, on debt instruments. The treaty was amended in 2017 where the capital gains exemption on equity shares was taken away and the capital gains exemption on the derivatives and debt instruments did continue.

There used to be the provisions like general anti avoidance rules like GAAR, which required the investors like FPIs who are based in Mauritius need to have substance in Mauritius in order to claim the benefit of India-Mauritius tax treaty.

There is another provision like principal purpose test or MLI which further requires that the FPIs or any other investors which are based in Mauritius need to have a commercial rationale or a justification to be organised or to be based in Mauritius.

Now, this amendment is proposed in the India-Mauritius tax treaty and that could become effective any point of time now once the protocol is notified by both the countries.

Now, this PPT or MLI test is actually much stringent and has a much higher threshold of the commercial rationale to be based in Mauritius as compared to the GAAR provisions where only substance was required.

So, the impact could be that all the investors such as all the private equity investors, FPIs, they will have to now examine as to whether they have enough commercial substance, reason, rationale, justification to be based in Mauritius when the tax scrutiny happens and once they are able to convince the tax authorities about their presence in Mauritius, in that case they should be considered to be validly constituted there and the tax exemption should continue for them.

So, a possibility that this could come in even retrospectively is that something that you would say that this is, because the effective date is still not something that we have clarified on, so there is a possibility that this could be retrospective then?
It is retrospective in nature or rather it is retroactive in nature. The protocol itself says in Article 3(2) that this protocol, as and when it will be notified, it will be applied to every transaction which is entered into post that date and taxes levied on that transaction irrespective of the date of investment.

So, even if the investment was made, say in 1990 or 2000 or 2020, but the exit happens by the FPI or a private equity investor today, then the PPT would be applicable, this protocol would be applicable and therefore there will be scrutiny of that capital gains exemption if it is claimed by the private equity investor or the FPIs and the investor will have to prove the substance and prove the commercial rationale to be in Mauritius and claiming the capital gains exemption.

So, yes, to that extent, it is retrospective in nature and unlike GAAR, which was grandfathered when it was introduced in 2017, this is retrospective in nature and there could be some representation made to see that this is not retrospective in nature but it is prospective for all the investments made post the notification of protocol.