“Deciphering the Mauritius-India Tax Protocol: Unravelling the amendments”

The recent amendments, signed on 7 March 2024, influenced by the global Base Erosion and Profit Shifting (BEPS) initiatives, were indeed inevitable. However, given the uncertainties that the protocol has ushered in, one cannot help but ponder whether a better outcome could not have been possible.

This article delves into the nuances of these amendments and their implications for Mauritius, offering insights that resonate both locally and internationally.

Revisiting the Treaty’s Preamble

The removal of the trade and investment objective from the treaty’s preamble is a significant alteration. In the landmark 2003 case of Union of India v. Azadi Bachao Andolan, the Supreme Court of India addressed the objectives of the Double Taxation Avoidance Agreement (DTAA) between India and Mauritius. The judge stated that the purpose of the DTAA, as specified in the preamble, is the “avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains, and for the encouragement of mutual trade and investment”. This statement underscores the DTAA’s role in fostering economic cooperation between the two countries by facilitating investment and preventing tax evasion. The object of “encouragement of mutual trade and investment” was a definite attribute in the old DTAA which weighed in considerably to uphold the DTAA at that time.

Having said this, it is noteworthy that the refocusing of the Mauritius-India DTAA with a taxation object now aligns with the treaties that India has consistently signed with other nations like France, the Netherlands, and Singapore, which have traditionally focused solely on tax matters without explicitly promoting trade and investment. This fact highlights the privileged relationship which Mauritius had with India at that time!

The new preamble to the DTAA now includes the standard wording of Article 6 of the BEPS Multilateral Instrument (MLI), which Mauritius has also signed, about the purpose of a covered tax agreement which are, in essence, to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance including through treaty-shopping arrangements for the indirect benefit of residents of third jurisdictions.

The retention of the wording “mutual economic relations” in the India-UAE treaty, which is also covered by the MLI, is however intriguing, especially against the backdrop that Dubai has the ambition to be a strategic hub for India’s investments in Africa, facilitated by robust financial infrastructure and business-friendly policies. If Dubai can have “mutual economic relations” in the preamble of its treaty with India, could Mauritius not have retained its original object or be at par with Dubai, given the excellent relationship Mauritius boasts of having with India? A crucial element of perception is at play here!

The Comprehensive Economic Co-operation and Partnership Agreement (CECPA)

The CECPA signed by India with Mauritius in 2021 was a strategic move by India. While our DTAA’s preamble no longer includes a trade and investment objective, it may perhaps be argued that economic cooperation and investment flows are better served by the CECPA, thus compensating for the DTAA’s narrowed focus on taxation.

The Principal Purpose Test (PPT)

It is interesting to note that both governments had opted to keep the DTAA out of the MLI mainly because of the grandfathering provisions in the revised DTAA in 2016.

The Protocol has now introduced the standard Article 7 of the MLI to the DTAA relating to the Principal Purpose Test (PPT). The PPT consists of denying treaty benefits if obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit. There is an exception to the PPT though.

The inclusion of the PPT is a direct response to the global crackdown on treaty abuse, especially under the BEPS Action 6 framework. The PPT in the Protocol specifically applies to income and not to capital, while capital is included in the DTAA covered by the MLI that India has with France, as an example. The 2016 amended Mauritius-India treaty already addressed capital gains taxation under Article 13 of the DTAA.

To avoid falling foul of the PPT, investors must structure their transactions with a genuine economic purpose beyond tax optimization. This means that there is a need to have more substance-based investments. The exception within the PPT—stating that granting a benefit may be acceptable if it aligns with the object and purpose of the relevant treaty provisions—holds significant implications. If an investor can establish that the arrangement serves the intended purpose of the treaty & their transaction has a genuine economic purpose, beyond mere tax benefits, the PPT may not apply. Example may be in a case of say a business expansion objective where an Indian company investing in a GBC in Mauritius for legitimate business expansion into Africa could argue that its purpose aligns with the treaty’s intent.

Mauritius aligned its tax laws with BEPS via Income Tax Regulations 2018 by introducing the concept of Core Income Generating Activities along with more substance requirements in the Income Tax Act. Substance was always a requirement in Mauritius even before BEPS, but the requirement evolved with time and international developments. The PPT means that the need for investors to document the economic rationale behind their arrangements is now crucial, more than ever before. Furthermore, practical considerations should no longer trump the demonstration of substance in Mauritius. This means that physical board meetings (physical or by video/audio is ok) held /chaired in Mauritius should resolve on key / strategic decisions instead of by circular resolutions. Other factors, including operational presence, employment, and genuine commercial activity, also strengthen the case.

PPT vs. Indian GAAR

The PPT is notably more stringent than India’s General Anti-Avoidance Rules (GAAR), which include safeguards and an approving panel for enforcement. The absence of such mechanisms in the PPT underscores the need for comprehensive guidelines to aid taxpayers in understanding the assessing officers’ criteria, thereby mitigating uncertainty and subjective interpretation.

While our DTAA’s preamble no longer includes a trade and investment objective, it may perhaps be argued that economic cooperation and investment flows are better served by the CECPA, thus compensating for the DTAA’s narrowed focus on taxation.

The Grandfathering Clause and Clarity

The grandfathering clause in the prevailing DTAA, which protects investments made before 2017, is now under scrutiny. The lack of clarity on whether these investments will continue to enjoy the treaty’s benefits post-amendment is troubling. It was crucial to secure explicit assurances that would prevent any possibility of retroactive taxation, thereby safeguarding investor interests. The negative impact on the Mauritius IFC cannot be underestimated.

The current wording of the Protocol in general introduces a layer of unpredictability that could deter future investment into India through Mauritius. It could easily have been anticipated that the language adopted in the Protocol would clearly cause confusion and concern, especially if the intention was not to introduce retroactive taxation, and should have been avoided.

The Azadi Bachao Andolan Case and Circular No. 789

The 2003 landmark Azadi Bachao Andolan case, which upheld the validity of Circular No. 789, is now cast in a new light. The circular’s relevance is now questioned, given the treaty amendments, suggesting a shift in how the treaty will be applied moving forward.

Immediate Impact of the Protocol

On 12^th April 2024, Indian online media platforms reported that foreign portfolio investors withdrew nearly $1 billion from Dalal Street (location of Bombay Stock Exchange) due to the new Protocol!

Reacting to the Protocol, the Indian I-T department said: “Some concerns have been raised on the India Mauritius DTAA amended recently. In this context, it is clarified that the concerns / queries are premature at the moment since the Protocol is yet to be ratified and notified u/s 90 of the Income-tax Act, 1961. As and when the Protocol comes into force, queries, if any, will be addressed, wherever necessary.”

A legitimate question may be asked about whether the avoidance of such volatility should not have been a prime objective!

Conclusion

In conclusion, while the changes to the DTAA were unavoidable in light of the global BEPS movement, the approach taken by the two governments ought to have been more thoughtful. 

The Indian side would no doubt have attempted, understandably, to get the maximum benefit possible from the negotiation, thereby favouring GIFT City, its own IFC in Gujarat. 

For the Mauritius side, it was essential to balance the need for compliance with international tax norms against the imperative to maintain Mauritius’ position as a favourable investment hub. Foresight, consultation with our local private sector, and a stronger advocacy for Mauritius’ economic interests ought to be our guiding principles, moving forward.

Disclaimer: This article offers general information and not tax advice. Readers should consult a tax professional for specific guidance.