Mauritius Treaty

What you need to know and how it will impact Indian markets?

During the week, the long standing Mauritius Treaty was amended to permit India to tax capital gains realized by Mauritius based companies. Since 1983, there has been a double taxation avoidance agreement (DTAA) between India and Mauritius. While the amendment to the DTAA is unlikely to deeply impact markets, it could have a few key implications from a medium to long term perspective.

FIIs will be at par with residents…

 Today, because of the DTAA between India and Mauritius, most FIIs manage to avoid paying any capital gains tax. This is because capital gains are tax-free in Mauritius and India does not tax them due to the DTAA. All that will change effective April 2017 as FIIs will be brought at par with resident Indians and will have to pay 15% tax on short term capital gains. Of course, long term capital gains will continue to be tax-free.  This will compel the foreign investors to look at India more as a genuine investment destination rather than as a source of tax arbitrage.

Clarity on the FII tax regime…

The most important take-away for FIIs is the greater stability in the tax regime. The amendment has made it explicit that there will be no retrospective taxation prior to April 2017. This will be a major positive for FIIs. In addition, there will also be a 2 year grand-fathering clause between April 2017 and March 2019. During this period, the FIIs will be charged capital gains at half the rate only. The biggest clarity comes for FIIs on the capital gains versus business income conflict. The amendment to the Mauritius Treaty almost makes it clear that the profits made by FIIs in India will be treated as capital gains and not as business income. This does away with uncertainty in the tax regime.

Challenge for VC / PE funds…

The big challenge from the amendment to the Mauritius Treaty will be for VC / PE funds who have invested in India through the Mauritius route. Since the VC / PE funds predominantly deal with unlisted companies, they are subjected to tax at the rate of 40% on short term capital gains and 10% on long term capital gains. This would be a huge hit on the profits of these funds and it may impel many of these funds to route their investments through other geographies.

In a way, the amendment to the Mauritius Treaty is a step in the right direction. With GDP growth at 7.5% and a stable rupee, Indian markets are in a sweet spot. The sharp rise in FDI inflow has reduced the importance of portfolio flows as a means of bridging the fiscal deficit. The impact on the markets is likely to be positive in the medium to long term. The amendment may be a step in the right direction for the maturing of the Indian markets. ©

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