What are double tax avoidance treaties? Why are tax authorities not happy with these?

From the name itself, it is cleared that Double Tax Avoidance Agreement (DTAA) aims to ensure that a foreign investor need not pay tax twice i.e., in the country of origin and the country where it is investing.

Also, it prescribes payment of tax in any of two countries where tax rate is low. Such a treaty is signed to encourage investors.

However, such a treaty has another consequence. This encourages investors to route their money through a country where tax rate is very low or even zero. Such a country, called a tax haven, provides tax residency to foreign investors. Because of such a certificate, tax authorities in India cannot collect tax. This also leads to litigations.

When was the Indo-Mauritius DTAA first signed and what benefits did it give to those investing into India from Mauritius?

The treaty was first signed on August 24, 1982. Mauritius was initially the preferred channel for foreign portfolio and foreign direct investors due to the tax advantage that accrued due to the DTAA between two countries.

The agreement laid down that capital gains tax had to be paid in the country where the foreign investor was based. Since the rate of capital gains tax in Mauritius was zero, investors from this country paid no capital gains tax.

How was this treaty watered down after 2017?

It was decided that in the case of shares purchased after April 1, 2017, capital gains arising from an investment in an Indian company will be taxed in India. With the double tax avoidance treaty with Singapore being linked to the agreement with Mauritius, investments from Singapore have also been brought into the Indian tax net.

What is the change to the Indo-Mauritius tax treaty made this year?

India and Mauritius signed a protocol dated March 7, 2024, to amend the tax treaty. It prescribes a change in the preamble where the expression ‘encouragement of mutual trade and investment’ has been removed.

It has been said that both countries are intending to eliminate double taxation with respect to taxes covered by this convention without, however, ‘creating opportunities’ for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this convention for the indirect benefit of third jurisdiction).

A specific provision for PPT (Principal Purpose Test) has been added and to apply this, a new article has been added to the treaty which says ‘a benefit under this convention shall not be granted in respect of an item of income if it is reasonable to conclude that obtaining that benefit was one of the principal purposes.’

How will this impact FPI or FDI investments into India?

Post 2016, investment inflows from Mauritius have already come down. Cumulative FDI worth $161 billion came from Mauritius to India in the two decades from 2000-2022 (26 per cent of total FDI inflows into India), thanks largely to the DTAA.

Since the signing of the DTAC (Double Taxation Avoidance Convention) amendment in 2016, FDI inflows from Mauritius have dropped from $15.72 billion in 2016-17 to $6.13 billion in 2022-23, with Mauritius becoming India’s third largest source of FDI.

Now, there is apprehension that not only future inflows but even investment made could be affected. Experts say the application of the PPT to grandfathered investments remains ambiguous. Meanwhile, to curb all such application, the Finance Ministry has said that concerns/queries are premature since the Protocol is yet to be ratified and notified under Section 90 of the Income-tax Act, 1961. As and when the Protocol comes into force, queries, if any, will be addressed, wherever necessary.