Frequently asked questions (FAQ) on implication of protocol to the India-Mauritius double taxation avoidance (DTAA) agreement on FPIs:India-Mauritius have signed a protocol which amends the existing India-Mauritius double taxation avoidance agreement (‘India-Mauritius DTAA’). The text of the protocol has been released by the Mauritius Government (Government of India is yet to release the text). Key amendment in capital gains provision by the protocol includes source based taxation of capital gains arising out of alienation of shares in a company resident in India acquired on or after 01 April 2017 with effect from financial year 2017-18. The protocol further provides for protection to investments in shares acquired before 01 April 2017. For capital gains arising during the transition period from 01 April 2017 to 31 March 2019, it is proposed to limit the rate of taxation to 50% of the ‘domestic tax rate of India’ , subject to the fulfilment of the conditions in the Limitation of Benefits (‘LOB clause’) Article as prescribed in Article 8 to the protocol.

FAQs Responses

1 What is the essence of the amendment in the protocol relevant to FPIs?

Following are the essence of the amendment in the protocol relevant to FPIs:

• Introduction of source based taxation of capital gain on sale of shares acquired on or after 01 April 2017;

• Limitation of benefit clause for claiming exemption during the transition period between 01 April 2017 to 31 March 2019;

• Tax rate of 7.5% on interest income introduced; and

• Exchange of information.

2 How will capital gains be taxable in India after the Protocol is effective?

Investment made Capital Gain taxation under India-Mauritius DTAA

On or before 31 March 2017 Exempt

01 April 2017 to 31 March 2019 50% of the ‘domestic tax rate of India’ (subject to satisfaction of LOB clause)

On or after 01 April 2019 Taxable at ‘domestic tax rates of India’

3 What is the effective date of protocol?

The protocol will enter into force once notification to this effect is issued by both India and Mauritius. Once the protocol is notified, the provisions relating to capital gains will be applicable for financial year 2017-18 (assessment year 2018-19.

4 What is the LOB clause? Article 4 to the Protocol prescribes source based taxation in case of alienation of shares acquired on or after 01 April 2017. However, for cases of gains on alienation of such shares arising in India during the transition period (period beginning on 1st April, 2017 and ending on 31st March, 2019) the tax rate applicable on such gains shall not exceed 50% of the ‘domestic tax rate of India’.

In this regard, Article 8 of the protocol which prescribes ‘LOB clause’ mentions that the benefit of 50% reduced rate of taxation shall not be available in following cases-

1. The affairs are arranged with the primary purpose to take benefit of provision granting reduced rate of tax; or

2. The company claiming the aforesaid benefit is a ‘shell or a conduit company’1;

3. A resident is deemed to not be a shell/conduit company, if its expenditure on operations in its home country is equal to or exceeds INR 2.7 mn (1.5 mn Mauritius Rupees/ approx. US$ 0.04 mn) in the immediately preceding 12 month period from the date the capital gains arise or if it is listed in a recognised stock exchange of the contracting state.

5 What would be the impact of protocol on existing investments from Mauritius?

The protocol provides grandfathering of investments made up to 31 March 2017. Accordingly, gains arising on alienation of shares from the investments made up to 31 March 2017 will continue to enjoy existing capital gains tax exemption under the India-Mauritius DTAA.

6 Whether LOB will have an impact to claim DTAA benefits for income other than capital gains on sale of shares?

The LOB clause is applicable only in situations where a 50% capital gains tax rate in case of alienation of shares is claimed during the period 01 April 2017 to 31 March 2019 under amended Article 13 of the India-Mauritius DTAA.

7 What is the impact on instruments other than shares like derivatives, debt and other instruments not characterised as shares?

The protocols amends taxation rights in case of capital gains arising from alienation of shares. In case of any other instruments, the capital gains on alienation would continue to be governed by residence based taxation under the exiting India-Mauritius DTAA sans protocol.

1. a ‘shell or a conduit company’ is defined to mean any legal entity with negligible/nil business operations or carrying on no real and continuous business activities

FAQs Responses

8 What is the impact on interest from debt securities?

Interest income arising to Mauritian resident were subject to taxation in India as per domestic tax rate of India. The protocol prescribes tax rate of 7.5%. Further, interest income arising to a Mauritian bank was exempt under the treaty. This exemption has now been restricted to interest income in respect of any such debt-claims existing on or before 31st March, 2017.

9 How will GAAR (General Anti Avoidance Rule) impact the tax on capital gain on sale of shares?

GAAR is proposed to be effective in India from 01 April 2017. GAAR provisions can be invoked only if the main purpose is to obtain tax benefits on satisfaction of certain conditions . If the conditions mentioned therein are satisfied, a transaction can be termed as ‘Impermissible arrangement’.

Investment made Impact of GAAR in relation to capital gains on sale of shares

On or before 31 March 2017

Considering that exemption under DTAA will be available, GAAR implication needs to be analysed.

01 April 2017 to 31 March 2019

Since, benefit of lower tax rate i.e. 50% of the ‘domestic tax rate of India’ can be availed on satisfaction of LOB clause. The GAAR provisions should ideally not be triggered in view of the special anti-avoidance rule.

On or after 01 April 2019

As the income would be taxable in India as per domestic tax rates of India, GAAR provisions may not be relevant.

10 Does this amendment revoke all the benefits of India- Mauritius DTAA?

Only specific articles referred in the protocol are amended under India-Mauritius DTAA like:

• Introduction of Service PE clause as per the UN Model

• Source based taxation of capital gains

• Taxation of interest at 7.5%

• Introduction of fees for technical services

• Granting taxing rights to source country (India) under the other income article; from the effective date as ratified by the countries

11 What is the tax implication on Participatory-Notes (P-Notes) holders?

P-Notes issued by an FPI in Mauritius that are backed / collaterally issued by the investments made in India after 1 April 2017 would not have any direct implication. However, one will have to examine the practical aspect to deal with:

• Passing on the tax cost to P-Note holders incurred after capital gains become taxable in India

• Mechanism to claim tax cost passed on account of Indian taxes paid by the P-Note holders

12 Does this amendment impact the India-Singapore DTAA?

The protocol to the India-Singapore DTAA grants capital gains tax exemption to Singapore residents under the India-Singapore DTAA “so long as” the capital gains tax benefit is available under India-Mauritius DTAA to the Mauritius resident.

In this regard, we understand that the Indian Government is in deliberation with the Singapore counterpart to amend the DTAA between India and Singapore.

13 Which are the other jurisdiction which provides for capital gain tax exemption from investment made in India?

Based on the DTAA executed by India with other countries, some of the jurisdictions which provide for capital gains tax exemption from investment made in India are Netherlands, Sweden, France, Belgium, Spain, Korea, etc. subject to conditions as mentioned in the respective DTAA.

However, it is essential to analyse the domestic tax laws of these countries vis-à-vis DTAA in detail before availing of the tax benefits under the DTAA.

2. Some of the conditions are (i) creates rights and obligations not normally created in arm’s length transactions; (ii) results in direct or indirect misuse or abuse of the provisions; (iii) lacks or is deemed to lack commercial substance in whole or part; (iv) is not bonafide; etc.

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Scope Limitation:

The comments expressed above are generic in nature. Our comments are based on our understanding of the protocol and perception of the prevailing law and regulations. Further, our comments expressed above cannot be considered as an opinion. Based on the facts of the case, a written opinion from tax consultant needs to be obtained for taking a position impacting investments in India. There can be no assurance that the a position contrary to that expressed herein will not be asserted by a tax or regulatory authority and ultimately sustained by an appellate authority or a Court of law.

* In case of listed shares and securities held for more than 12 months - Long term; else short term

In case of unlisted shares and securities held for more than 24 months - Long term; else short term

In case of other assets held for more than 36 months – Long term; else short term

# Interest received from rupee denominated corporate bonds or Government Securities earned by FII / FPI for interest payable between 1 June 2013 to 30 June 2017, would be taxable @5% u/s 194LD, subject to certain conditions

i domestic tax rate of India

Nature of Income Non-Corporates / Corporates – Income

upto 10 mn

Non - Corporates Income above 10mn

Corporates - Income from 10mn to 100mn

Corporates - Income more than 100 mn

Short-term capital gains* (STT paid)

15.45% 17.768% 15.759% 16.22%

Long-term capital gains* (STT paid)

Exempt Exempt Exempt Exempt

Short-term capital gains* (no STT)

30.90% 35.535% 31.518% 32.445%

Long-term capital gains* (no STT )

10.30% 11.845% 10.506% 10.815%

Corporate Dividend Exempt Exempt Exempt Exempt

Interest (gross)# 5.15% / 20.60% 5.923% / 23.69% 5.253% / 21.012% 5.408% / 21.63%