India’s recent protocol amendment to its tax treaty with Mauritius has stirred significant concerns among investors and market analysts. The amendment aims to tighten the terms under which investments from Mauritius are taxed, introducing measures that increase scrutiny over these investments. This move is part of an ongoing effort to prevent tax evasion and abuse of the treaty, but it has led to apprehension about increased regulatory burdens and potential retrospective taxation.
Market reactions
These concerns were immediately reflected in the stock market, with a noticeable sell-off by Foreign Portfolio Investors (FPIs) on Friday and Monday.
What is the DTAA all about?
The Double Taxation Avoidance Agreement (DTAA) between India and Mauritius was originally established to prevent the double taxation of income earned in one country by residents of the other. This treaty allowed capital gains from investments routed through Mauritius to be taxed at the lower of the two countries’ rates. Since Mauritius did not tax such gains, the arrangement provided significant tax advantages to investors, making Mauritius one of the most favored routes for foreign investments into India.
Plugging the gaps
Over the years, the treaty has been criticised for facilitating tax avoidance through the creation of shell companies—entities with no real business operations in Mauritius but established solely to benefit from the favorable tax treatment. In response, India sought to plug these loopholes to ensure that the treaty serves its original purpose without enabling tax evasion.
The 2016 and 2024 amendments
The 2016 amendment marked a pivotal shift by introducing source-based taxation for capital gains, meaning that gains from the sale of shares acquired in an Indian company through a Mauritius entity, from April 1, 2017, onwards, would be taxed in India. This change was complemented by grandfathering provisions, protecting investments made prior to this date from the new rules.
The latest 2024 amendment goes further by implementing the Principal Purpose Test (PPT). This test requires Mauritius-based investment entities to demonstrate that they have a substantial economic presence and are not merely shell operations. The inclusion of the PPT in the treaty not only aims to enforce greater compliance but also casts a shadow over the grandfathering provisions by allowing scrutiny of all investments, regardless of when they were made.
Impact on the stock market
The fear of more stringent tax norms and the potential for investigations into previously untaxed gains has caused unease among investors, contributing to volatility and declines in the Indian stock markets.
Although the fear of retrospective effects of the new rules have spooked investors, the impact is expected to be short-lived. V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services, said, “This is a healthy and desirable development which will impact only investments from those conduits formed with the sole purpose of tax avoidance. The impact will be short-lived.”
Whether the markets bounce back on Monday remains to be seen.
With inputs from agencies
Link to article –
Here’s why Indian stock market felt the heat from revised India-Mauritius tax agreement
