India, Mauritius revise tax treaty

News Excerpt: 

India has signed a protocol to amend the Double Taxation Avoidance Agreement (DTAA) with Mauritius, aiming to prevent treaty abuse for tax evasion or avoidance.

Double Taxation Avoidance Agreement (DTAA)

  • The DTAA is a tax treaty signed between India and another country (or any two/multiple countries) so that taxpayers can avoid paying double taxes on their income earned from the source country as well as the residence country.
  • According to available data, as of Feb-2020, India has DTAA with 88 countries out of which 86 are in force.
  • The need for DTAA arises out of the imbalance in tax collection on global income of individuals.

key points related to India and Mauritius revising their tax treaty.

  • The amendment introduces the Principal Purpose Test (PPT), which denies treaty benefits if obtaining such benefits is one of the principal purposes of a transaction or arrangement.
  • The amended treaty includes Article 27B, defining the 'entitlement to benefits' and incorporating the PPT.
    • 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 two nations have revised the treaty preamble to focus on preventing tax avoidance and evasion. 
    • The earlier goal of "mutual trade and investment" has been changed to "eliminating double taxation" without enabling non-taxation or reduced taxation through tax evasion, avoidance, or treaty shopping for the indirect benefit of third-jurisdiction residents.
  • 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 is India's fourth largest source of FPI investments, following the US, Singapore, and Luxembourg. 
      • By the end of March 2024, FPI investment from Mauritius totaled Rs 4.19 lakh crore, representing 6% of India's total FPI investment of Rs 69.54 lakh crore.
  • The amendment may lead to increased litigation as investors from Mauritius will need to demonstrate that obtaining treaty benefits was not the primary objective.
  • There is uncertainty regarding the application of the PPT to grandfathered investments, requiring clarification from the Central Board of Direct Taxes (CBDT).
  • The recent amendment reflects India's intent to align with global efforts against treaty abuse, particularly under the Base Erosion and Profit Shifting (BEPS) framework. 
    • While India is yet to make announcements regarding Pillar Two amendments in its domestic tax laws
      • Developments are anticipated in the budget after the elections in July 2024.

Treaty shopping:

  • Treaty shopping typically involves the attempt by a person to indirectly access the benefits of a tax treaty between two jurisdictions without being a resident of one of those jurisdictions.
  • There are a wide number of arrangements through which a person who is not a resident of a jurisdiction that is a party to a tax agreement may attempt to obtain benefits that a tax agreement grants to a resident of that jurisdiction.
  • Taxpayers engaged in treaty shopping and other treaty abuse strategies undermine tax sovereignty by claiming treaty benefits in situations where these benefits were not intended to be granted, thereby depriving jurisdictions of tax revenues.

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