30 January 2017 by Ramdass Gooriah
Implications for Mauritius following the revision of the India-Mauritius Double Taxation Avoidance Agreement
In August 1982, a convention was signed between the Government of Mauritius and the Government of India to avoid double taxation and prevent fiscal evasion, with respect to taxes on income and capital gains. It is known as the Double Taxation Avoidance Agreement (DTAA), which sets out how income generated in one country by residents of another country is taxed. The overall aim is to prevent double taxation of income and capital gains, and to encourage mutual trade and investment between India and Mauritius.
Tax incentives in the DTAA were necessary to attract foreign investments in India. The DTAA provided close to $100 billion of foreign direct investment (FDI) equity in India between 2000 and 2015 and accounted for 34% of FDI in India being channelled through Mauritius. Without the DTAA, unemployment in India would have been much higher.
A new financial services sector in Mauritius was created, named the global business sector (also known as the offshore sector) to capitalise on the benefits of the DTAA. It did so by encouraging foreign investors to channel their investments in India through companies set up in Mauritius. This led to greater employment opportunities for professional Mauritians, including accountants, lawyers and chartered secretaries.
It also generated income for the Mauritian authorities and made Mauritius a competitive player in the world offshore sector. Today this sector employs over 17,500 people and contributes around 5% GDP, of which Indian DTAA business represents nearly two thirds.
Contention arose around the loose structure of the DTAA, as investors could get away with paying no capital gains tax on their investments into India. This could happen because a Mauritian entity could avoid capital gains tax made in India – as India is not a resident country – while not paying taxes in Mauritius too, as it does not levy such a tax on its residents.
The misuse of the DTAA for round-tripping money by establishing shell companies in Mauritius was also a major concern. Local funds were being squirreled out of India and returning as foreign capital, thereby avoiding taxes. DTAA critics in India have also suggested that it became a route for bringing in black money and terror funds to India.
Pressure started to build in India as the DTAA had inflicted structural damage on India’s economy and tax structure. It also cast a long shadow on India’s tax reform agenda. With economic growth running high at 7% per annum and FDI at record levels, India was compelled to reassert its tax sovereignty.
The pressures led to the introduction of the General Anti Avoidance Rules (GAAR) in 2012 – set to be effective from April 2017 – which is targeted at arrangements or transactions made specifically to avoid taxes. It is a concept that empowers the authorities in India to deny tax benefits that do not have any commercial substance.
Several parties in the Mauritian global business sector urged the Government of Mauritius to avoid modifying one of the most litigious parts of the DTAA – clause 13. This clause provided that capital gains made by sale of assets be taxed in Mauritius and not in India. Since the capital gains tax rate in Mauritius is zero, altering clause 13 or removing it could drive investors away from Mauritius to other jurisdictions.
As a consequence, management companies that administered global business companies would be severely hit, along with the international banks that channel the funds and their auditors.
Employment in these service provider firms would be at stake and global business companies with local offices in Mauritius might have to close down. A 2016 IMF report pointed out that domestic financial stability, which is dependent on continued funding from the global business sector, could be affected by the DTAA revision. Moody’s forecast a deterioration of 1–2% of GDP annually and this negative ripple effect on the Mauritian economy was greatly feared.
Other analysts believed that there were alternatives to revising clause 13, such as giving up the taxing rights available under it, instead of foregoing the income it generated to the detriment of the Mauritian economy. Others suggested that if the revision was unavoidable, the Mauritius Government should press for a ‘most favoured nation’ (MFN) clause, which would ensure that Mauritius would not be subject to treatment that is less favourable than other countries with which India also had a DTAA.
The Mauritius Government managed to resist the revision of the DTAA until GAAR came into force in 2012, which dictated a change of strategy due to its potentially negative effect on the global business sector. Mauritius thereafter agreed to make two concessions: to adopt a ‘limitation of benefit’ (LOB) clause provided that the capital gains tax exemption was maintained and that the GAAR did not override the DTAA provisions; and to accept a main purpose test for the interest clause.
The Government of Mauritius signed a protocol in July 2015 for revising the DTAA treaty. Resisting its revision had already harmed India/Mauritius relations and had also resulted in Mauritius being perceived as a tax haven. It was therefore imperative to revise the DTAA to build in more transparency in the Mauritius global business sector.
The signature of the amending protocol became effective on 19 July 2016 and provided for a transition period of two years and a grandfather clause for existing business as follows:
Although the DTAA revision has posed significant challenges, the capping of withholding tax rate on interest income to 7.5% (compared to up to 40% previously) has made Mauritius an attractive jurisdiction for debt investments, given that the tax rate is 10% in other offshore jurisdictions such as Cyprus and Singapore.
Operators in the global business sector also saw the DTAA revision as a catalyst for diversification of the sector, with the majority betting on a tax efficient jurisdiction as a major growth factor.
The DTAA has enabled negotiations on the Comprehensive Economic Cooperation and Partnership Agreement (CECPA) between Mauritius and India to restart – discussions started in 2004 and were put on hold in 2007 for nearly 10 years, pending revision of the DTAA treaty. It is expected that in the long term the CEPCA will increase trade between Mauritius and India and develop into a triangular platform of cooperation among India, Mauritius and the African continent.