The PPT will deny treaty benefits, such as the reduction of withholding tax on interest royalties and dividends, where it is established that obtaining that treaty benefit is one of the principal purposes for the party engaged in the transaction.
India has signed a protocol amending the Double Taxation Avoidance Agreement (DTAA) with Mauritius to plug treaty abuse for tax evasion or avoidance. The amended pact has included what is called the Principal Purpose Test (PPT), which essentially lays out the condition that the tax benefits under the treaty will not be applicable if it is established that obtaining that duty benefit was the principal purpose of any transaction or arrangement.
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In the amended protocol, Article 27B has been introduced in the treaty defining the ‘entitlement to benefits’. The PPT will deny treaty benefits, such as the reduction of withholding tax on interest royalties and dividends, where it is established that obtaining that treaty benefit is one of the principal purposes for the party engaged in the transaction.
The amendment to the India-Mauritius treaty was signed on March 7 at Port Louis and was made public Wednesday. Mauritius has been a preferred jurisdiction for investments in India due to the non-taxability of capital gains from the sale of shares in Indian companies until 2016. The treaty was last amended in May 2016 allowing the right to tax capital gains arising from sale or transfer of shares of an Indian company acquired by a Mauritian tax resident and exempting investments made until March 31, 2017 from such taxation.
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This recent amendment, however, does not clarify if the past investments will be grandfathered. The Ministry of Finance is yet to issue a clarification on the same.
The DTAA was a major reason for a large number of foreign portfolio investors (FPI) and foreign entities to route their investments in India through Mauritius. Mauritius remains India’s fourth largest source of FPI investments, after the US, Singapore, and Luxembourg. FPI investment from Mauritius stood at Rs 4.19 lakh crore at the end of March 2024, which is 6 per cent of the total FPI investment of Rs 69.54 lakh crore in India. FPI investment from Mauritius had stood at Rs 3.25 lakh crore, out of total FPI investment of Rs 48.71 lakh crore at the end of March 2023.
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The two nations have now also amended the preamble of the treaty to incorporate the thrust on tax avoidance and evasion. The earlier objective of ‘mutual trade and investment’ has now been replaced with an intent to “eliminate double taxation” without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance including through “treaty shopping arrangements” aimed at obtaining relief provided under this treaty for the indirect benefit of residents of third jurisdictions.
“After this change now, any Indian inbound or outbound cross-border structuring of investment routed through Mauritius should factor in the BEPS MLI (Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting) impact, especially if the structuring involves availing of tax treaty benefits (in India or Mauritius). Also, this amendment applies to all incomes such as capital gains, dividends, fee for technical services, etc,” Yeeshu Sehgal, Head of Tax Market, AKM Global said.
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While this amendment aims to curb tax treaty abuse and minimise avenues for tax avoidance or mitigation by integrating PPT into the said treaty, it may result in a rise in litigation. “…there may be a surge in litigation as investors from Mauritius will be required to substantiate the commercial rationale behind their transactions now, demonstrating that the primary objective was not to take treaty benefits. It remains to be seen whether this amendment will extend to grandfathered investments. It is noteworthy that ongoing litigation pertaining to beneficial ownership and substance concerning Indian investments is already prevalent,” Sehgal said.
Tax experts also said that any guidance issued by the Indian government will be required to understand the full impact of these changes on investments and tax planning strategies. “…the application of the PPT to grandfathered investments remains ambiguous, highlighting the need for explicit guidance from the CBDT. Furthermore, the omission of the phrase “for the encouragement of mutual trade and investment” in the treaty’s preamble suggests a shift in focus towards preventing tax evasion over promoting bilateral investment flows,” Rakesh Nangia, Chairman, Nangia Andersen India said.
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The recent amendment reflects India’s intent to align with global efforts against treaty abuse, particularly under the BEPS framework. Though India is yet to make any announcements regarding Pillar Two amendments in its domestic tax laws, tax experts said it is anticipated that developments may be announced in the budget in July 2024 after elections, experts said.
In October 2021, over 135 jurisdictions agreed to implement a minimum tax regime for multinationals under ‘Pillar Two’. Following this, in December 2021, Organisation for Economic Co-operation and Development (OECD) released the Pillar Two model rules — Global Anti-Base Erosion (GloBE) rules — which will introduce a global minimum corporate tax rate set at 15 per cent. The minimum tax is proposed to apply to MNEs with revenue above €750 million and is estimated to generate around $150 billion in additional global tax revenues annually. The Pillar Two also provides for a co-ordinated system of taxation of a top-up tax on profits arising in a jurisdiction whenever the effective tax rate, on a jurisdictional basis, is below the minimum rate of 15 per cent.
