India recently amended its Double Taxation Avoidance Agreement (DTAA) with Mauritius to plug certain loopholes. Now, a Mauritian entity will have to pay capital gains tax here while selling shares in a company in India from April 2017. Earlier, the company could avoid tax as it was not a ‘resident’ in India. It could get away from the taxman in Mauritius too, due to non-taxation of capital gains for its residents. As a result, many shell entities sprang up in Mauritius to profit from investments in India and get away without paying taxes anywhere.

What is it?

A DTAA is a tax treaty signed between two or more countries. Its key objective is that tax-payers in these countries can avoid being taxed twice for the same income. A DTAA applies in cases where a tax-payer resides in one country and earns income in another.

DTAAs can either be comprehensive to cover all sources of income or be limited to certain areas such as taxing of income from shipping, air transport, inheritance, etc. India has DTAAs with more than eighty countries, of which comprehensive agreements include those with Australia, Canada, Germany, Mauritius, Singapore, UAE, the UK and US.

Why is it important?

DTAAs are intended to make a country an attractive investment destination by providing relief on dual taxation. Such relief is provided by exempting income earned abroad from tax in the resident country or providing credit to the extent taxes have already been paid abroad. DTAAs also provide for concessional rates of tax in some cases.

For instance, interest on NRI bank deposits attract 30 per cent TDS (tax deduction at source) here. But under the DTAAs that India has signed with several countries, tax is deducted at only 10 to 15 per cent. Many of India’s DTAAs also have lower tax rates for royalty, fee for technical services, etc.

Favourable tax treatment for capital gains under certain DTAAs such the one with Mauritius have encouraged a lot of foreign investment into India. Mauritius accounted for $93.65 billion or one-third of the total FDI flows into India between April 2000 and December 2015. It has also remained a favoured route for foreign portfolio investors. But the problem is DTAAs can become an incentive for even legitimate investors to route investments through low-tax regimes to sidestep taxation. This leads to loss of tax revenue for the country.

Why should I care?

For us to prosper, the economy has to grow. And for growth in today’s globalised world, foreign investments are inevitable. DTAAs basically provide clarity on how certain cross-border transactions will be taxed and this encourages foreign investors to take the plunge.

If you are sent on deputation abroad and you receive emoluments during your stint away from home, your income may sometimes be subject to tax in both the countries. You can claim relief when filing your tax return for that financial year, if there is an applicable DTAA. Similarly, if you are an NRI having investments in India, DTAA provisions may also be applicable to your income from these investments or from their sale.

However, given India’s narrow tax base, it can ill-afford a tax regime that allows big fish to completely evade the tax net, citing a DTAA. Hence the ongoing drive to plug loopholes in these agreements.

The bottomline

There can be double income and double taxation; but don’t hope for double avoidance.

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