The signing of the protocol between India and Mauritius to amend the double taxation avoidance agreement is a step in the right direction. It signals India’s continued commitment to checking tax evasion or avoidance. Countries have lost billions of dollars over the years due to treaty shopping and tax evading arrangements in low-tax jurisdictions. As one of the active participants in framing OECD’s BEPS (Base Erosion and Profit Shifting) guidelines to combat these practices, India needs to make these changes to the treaty to adhere to the minimum standards laid down by the guidelines.

Indian authorities have already been gradually withdrawing the benefits derived from the Indo-Mauritian treaty. Between 1982 and 2016, foreign portfolio and direct investments routed through Mauritius did not face any capital gains tax since the treaty allowed taxation at the point of origin; and rate of capital gains tax in Mauritius is zero. But the amendment made in 2016 laid down that investments in shares made after April 1, 2017, will be taxed in India, thus removing the benefit for prospective investors.

Two changes are being proposed to the treaty now. One, the preamble of the agreement is being amended to state that both governments intend to eliminate double taxation and check tax evasion. Two, a Principal Purpose Test (PPT) has been included in the agreement. Under this, the benefit of the treaty can be denied if it is established that the main objective of the arrangement or the transaction is to benefit from the treaty. Thus far, tax residency certificate (TRC) issued by the Mauritian government was sufficient to enable an entity to prove its residency status. But the amended treaty will give powers to the income tax authorities to look past the TRC. While foreign portfolio investors appear concerned about these changes, which can lead to higher scrutiny from tax authorities, this is probably a good time to tighten these laws. The stock market is at elevated levels and domestic demand is robust enough to absorb selling by foreign investors. Also, the changes to the DTAA in 2016 have already reduced flows from Mauritius into Indian stock markets, and through foreign direct investment.

The amendments will come into force only after they are notified by authorities in both countries. Indian tax authorities should clarify on some of the issues flagged by stakeholders, before the changes are notified. The proposed article 27B appears to be anomalous. It says that if an entity enters into a transaction in line with the original object of the convention, which is to promote investment, the benefit can still be availed. This could negate the objective of inserting the PPT, which is to check tax evasion and treaty shopping. Tax authorities should also clear the air over applicability of the amended agreement on transactions initiated prior to its date of enforcement. Retrospective taxation will erode India’s credibility as an investment destination.