Talks to bring changes in Indo-Mauritius Tax Treaty makes the market tumble

The speculation of resuming talks on the Indo-Mauritian Double Taxation Avoidance Agreement (DTAA) to alter the current tax treaty on capital gains in relation to investments from Mauritius, has created a stir in the market resulting in Indian stocks facing downwards fluctuation on Monday..The speculation of resuming talks on the Indo-Mauritian Double Taxation Avoidance Agreement (DTAA) to alter the current tax treaty on capital gains in relation to investments from Mauritius, has created a stir in the market resulting in Indian stocks facing downwards fluctuation on Monday..The Finance Minister Pranab Mukherjee yesterday confirmed that India and Mauritius have resumed talks for re-negotiation of the 30-year old DTAA..The Government has been concerned on the investments from Mauritius as investment route from Mauritius is misused. India now seeks that company(s) investing from Mauritius pay tax on the capital gains made in India..Central Board of Direct Taxes (CBDT) chairman Mr. Prakash Chandra told the reporters, “We want that the capital gains tax should be source-based. As gains are made by these companies here, they should pay tax”..These statements by CBDT Chairman had an impact on the share market. The Sensex was down by 2 percent on Monday over concerns that a review of the Indo-Mauritius pact may impact the existing tax regime on capital gains on investments from Mauritius..The Government, however, on Monday stepped forward to calm the nervous stock market assuring that New Delhi cannot arbitrarily impose capital gains tax on investments from Mauritius and that any revisions to the DTAA would be based on agreement of the two nations. The Finance Minister speaking to reporters said, “As far as the Mauritius double taxation avoidance agreement is concerned, this is nothing new. It’s an old one. For some time talks were suspended, now it has resumed”..In the early eighties, Indian government had signed the tax treaty with the island nation which stipulated that capital gains on Indian securities held by a Mauritian company would be exempted from tax in India. Since Mauritius has no tax or negligible tax on such income, it virtually led to all FIIs getting registered in Mauritius. Government now intends to revisit the earlier decision and wants capital gains tax at source to be applicable..Though negotiations have been underway for a while, there has been no discussion since 2008 when talks broke down on the issue. Recently, India and Mauritius agreed to review the operations of the Joint Working Group (JWG), which was set up in 2006 to strengthen the mechanism for exchange of information under the India-Mauritius tax treaty, besides putting in place adequate safeguards to prevent misuse of the DTAA between them..The DTAA has come under criticism several times for misuse resulting in loss to the Indian exchequer. According to experts, it is estimated that India loses over $600 million a year in revenues on account of the double tax avoidance treaty with Mauritius. In a bid to avoid tax liability, companies routes their investments in Indian securities through Mauritius to gain exemption from capital gains tax. Some experts have suggested introducing source-based taxation of income earned by companies based in Mauritius to bring about some equity in taxation, prevent loss of revenue and curb treaty shopping..The DTAA was examined by the Supreme Court of Indian in the matter of Azadi Bachao Andolan v Union of India. The Supreme Court stated that, “if it was intended that a national of a third state should be precluded from the benefits of the DTAA, then a suitable term of limitation to that effect should have been incorporated therein”. Supreme Court was clear that it was for the Parliament to take appropriate action in the matter and in the absence of a prohibition one could not deny the benefits of a treaty on the basis of the belief that treaty shopping was not permissible..An anti treaty shopping provision is normally inserted in a Double Taxation Avoidance Agreement by a limitation on benefits clause. Such a clause exists in the Indo-US Double Taxation Avoidance Agreement as Article 24 which permits a non-individual person to avail of treaty benefits only if more than 50 percent beneficial interest therein is owned by individual residents of a contracting state..According to experts, the Indian government’s position is that they do not want to touch the capital gains provision. All they are insisting is a limitation of benefit clause. The limitation of benefits clause, which is not present in the current treaty, prevents India from levying capital gains tax because all capital gains tax under the India-Mauritius treaty is to be levied by Mauritius and Mauritius presently does not levy capital gains tax..The current legal position is that benefits of the treaty are available as of now. The decision of the two nations to sit and renegotiate the terms of the treaty depends on the two governments. Whatever the outcome, the new provision will be applicable only prospectively..According to financial express, Mauritius has accounted for about 42 percent or $54.22 billion of the total $130 billion worth of foreign direct investment in the country since April 2000..According to media, some tax officials say there is reluctance on both sides to revise the tax treaty. More than 40 percent of foreign direct investment to India comes through the Mauritius route and the island nation..Fund flow from tax havens has been under close scrutiny in recent times for money laundering. The Indian government is facing intense pressure from the civil society activists, Opposition parties and also from the Supreme Court over the issue of black money stashed away by some Indians in tax havens like Switzerland and Mauritius..Critics state that Indian authorities should insist on reviewing the treaty with Mauritius and plug the loopholes soon. Tax authorities said the department has informed the foreign ministry that they would like to hold talks with their counterparts in Mauritius on the issue but it was up to them to respond, according to TOI..However, presently as stated by one of the tax officials to TOI, “Nothing is final. It could take 3 year to 30 years for any discussion on the issue”.