The recent revision in the tax treaty agreement between India and Mauritius has been finally carried out after years of trying to close its loopholes but there are still ambiguities that remain.
The current version of the tax treaty does not specify howthe convertible instruments in Indian companies held by offshore institutional investors as well as private equity firms would be taxed when they are converted into shares. Tax could be calculated either considering the acquisition date to be the time of the conversion or the original date of purchase of the instrument.
According to the revisions in the tax treaty, capital gains made on investments by Mauritius entities in Indian companies will now be taxed in India but only for shares. Other financial instruments like debentures, derivatives and convertibles mutual funds are exempt. The new tax regime will have a phased roll out starting April 1, 2017. To begin with, 50 percent of the tax rate will be imposed on shares sold between April 2017 and March 2019. From April 2019 onwards, 100 percent of the tax rate will be imposed.
This means that April 1, 2017 is the crucial cut-off date for calculation of tax liability. Quasi-equity instruments have been the most favored route for investments by overseas institutions who use interest paid as an expense to reduce tax.
However industry experts say there still are a number of clauses that require clarifications in order to avoid legal issues. In a statement, Bijal Ajinkya, partner at law firm Khaitan & Co said
Unless a clarification is provided, this could lead to potential litigation. Though the point of conversion is never generally dealt with in tax treaties, the grandfathering provision being unique to the India-Mauritius tax treaty, a clarification on treatment on conversion is a must.
Amendments to the 34-years old tax treaty were necessary since its terms have often been abused by investors. Mauritius companies investing in India did not have to pay tax in India, and since Mauritius does not charge tax on offshore companies, there were no capital gains to be paid at all.
Round tripping was therefore a common occurrence when Indian money went to Mauritius and was then re-routed to India for investments. The recent revision closes this loophole. Indian Finance Minister Arun Jaitley said that the Indian economy was now strong enough to attract investments on its own strength and did not need a tax-incentivized route any more.