The government of India issued a press release on 10 May 2016 to notify that it had signed a protocol with Mauritius, under which India gets the taxing rights in respect of capital gains on shares of Indian companies which, as per the Tax Treaty, rested with Mauritius. India had signed a Tax Treaty with Mauritius in 1983, inter alia as a preferred jurisdiction for India's outbound investment to Africa. What then, seemed to be a benign clause on taxation of capital gains, based on principle of residence-based tax system, turned out to be the biggest irritant for tax administrators. All these years, the concurrence of Mauritian authorities was not forthcoming to amend the treaty, frustrating India. Apart from the loss of taxes, India kept the stance that the Mauritius route was being used for 'round-tripping', a claim hotly contested by Mauritius. While the validity of the pro-vision in the treaty was being debated, India's credibility took a heavy beating on the world stage, making it lose precious foreign direct investment too. This well thought out and progressive proto-col provides that India gets taxation rights on capital gains arising from alienation of shares acquired on or after 1 April 2017 in a company resident in India with effect from financial year 2017-18, where simultaneously, protection to investments in shares acquired before 1 April, 2017 has also been provided. Further, in respect of such capital gains arising during the transition period from 1 April 2017 to 31 March 2019, the tax rate will be limited to 50 per cent of the domestic tax rate of India, subject to the fulfilment of the conditions in the Limitation of Benefits Article that requires an annual expenditure spend of T27 lakh. Taxation in India at full domestic tax rate will take place from 2019-20 onwards. In the coming days, as the ink dries, clarity should emerge in respect of taxation of instruments such as derivatives, convertible debentures, debt instruments, etc. With this wish fulfilment, India has been able to achieve several goals at one go. Achieving fiscal objective, providing clarity on taxation to potential investor, improving the investment climate, de-clogging tax judicial system from litigation and importantly, appeasing the domes-tic taxpayer, who felt short-changed that foreign investors, earning gains in India, were not being taxed.
So, what made Mauritius bite the bullet? Part of the credit goes to the initiative of the G20 nations, which is driving actions that would limit Base Erosion and Profit Shifting (BEDS). The finance ministry will now follow pursuit in amending the India-Singapore (although a formality) and India-Cyprus treaties on simi-lar lines. It will now be interesting to observe the fate of GAAR provisions, which are set for introduction from 1 April 2017. With this amendment, the most affected lot are the foreign investors who have flocked to India through the Mauritius route. While, many feel that this clarity of tax law was much needed, there are others who are of the opinion that the new tax rules would only make it more expen-sive to invest in India and would impact invest-ment as the return to be offered to overseas investors would diminish, making investment in India less attractive. Coupled with con-tinuing currency depreciation and the capital gains tax will make PE fund managers' task that much tougher.
The new agreement provides for an updated system for exchange of information, which will ensure that the names of entities invest-ing funds through the island nation are easily available to tax authorities. This brings to light the challenges that would be faced by participa-tory notes ('P Notes') holders who may not be inclined to disclose all the details. The general refrain is that India is asking for details which no other country does. At a time when 'down round' in billion-dol-lar start-ups have become common, the amend-ments in India-Mauritius double taxation avoidance treaty might impact PE investors. PE firms invest through preferential shares to pro-tect themselves from such down rounds, where their investee companies raise funds at lower val-uation than what they invested at. Usually, these preference shares are converted before their exit, which could be through a public issue that offers ordinary shares. This welcome policy move is a formidable step in providing the non-adversarial tax regime that this government has been promising even before they came to power two years ago. Clearly, this amendment is the most important legislative change in the tax domain in the past three decades.