India, Mauritius sign protocol to amend tax treaty; principal purpose test introduced

India and Mauritius have signed a protocol to amend the double taxation avoidance agreement (DTAA), which included a principal purpose test (PPT) to decide whether a foreign investor is eligible to claim treaty benefits.

Tax experts said a new article has been added to the protocol "Article 27B Entitlement to Benefits". The amended protocol was signed on March 7 and made public now.

The introduction of the PPT aims to curtail tax avoidance by ensuring that treaty benefits are only granted for transactions with a bona fide purpose.

Nangia Andersen India Chairman Rakesh Nangia said the amendment represents a move by India to align with global efforts against treaty abuse, particularly under the BEPS Action 6 framework.

"However, 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", Nangia said.

This development underscores India's commitment to international tax cooperation standards while raising critical considerations for investors leveraging the India-Mauritius corridor, he added.

AKM Global Head of Tax Market Yeeshu Sehgal said the PPT will have the effect of denying treaty benefits, such as the reduction of withholding tax on interest royalties and dividends, where it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that treaty benefit is one of the principal purposes of the party seeking to rely on the said treaty.

Historically, Mauritius has been a preferred jurisdiction for engaging in investments in India due to the non-taxability of capital gains from the sale of shares in Indian companies until 2016.

In 2016, India and Mauritius signed a revised tax agreement, which gave India the right to tax capital gains in India on transactions in shares routed through the island nation beginning April 1, 2017.

However, investments made before April 2017 were grandfathered.

Sehgal said this amendment applies to all incomes like capital gains, dividends, and fees for technical services.

"After this change now, any Indian inbound or outbound cross-border structuring of investment routed through Mauritius should factor in the BEPS and MLI impact, especially if the structuring involves availing of tax treaty benefits (in India or Mauritius)," Sehgal added.

It can be anticipated that 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, Sehgal said.