Under the amendments, gains arising from the sale of listed securities within one year of purchase will be subject to tax at 10%; long-term capital gains arising from sale of capital assets other than listed securities are subject to tax at 20%; and short-term capital gains arising from the sale of shares other than listed securities will be taxed at 30% for individuals and 40% for companies.

Fund managers expect that the changes will have little effect on the flow of investments to India from individuals because banks are already deducting 10% capital gains tax at source before funds are credited into clients' accounts, and also UAE-based investors are currently getting good rates of return on their Indian investments. However, managers say that the new tax treaty structure could negatively affect institutional investors, leading to a substantial amount of these funds to be routed through Mauritius which has a more favourable tax treaty in place with India, under a practice known as 'treaty shopping.'

"In terms of individual investors who put in a small amount of money through portfolio management accounts, there is no issue for them because they have been (paying tax) for decades. But it does negatively impact the institutional funds," Jay Jeganathan, managing director of Dubai-headquartered alternative investment company Evolvence Capital's $250 million Evolvence India Fund, was quoted as observing by Gulf News.

Jeganathan told Gulf News that he may now use Mauritius to route his investments into India, but added that this was "a tried and tested route."

However, other managers say that the UAE government will not wish to be seen as facilitating international tax avoidance through the establishment of shell companies for the specific purpose of avoiding capital gains tax.

"The last thing that Dubai or the UAE really wants is to be seen as facilitating these kind of loopholes," Jason Blick, CEO of Financial Partners International in Dubai, said in the report.

The Indo-Mauritius DTAA has been a long-time source of friction between the two governments. The Indian tax authorities have believed for years that Indian investors 'round-trip' through Mauritius in order to escape capital gains tax on stock market investments. But their attempts to re-interpret the treaty through the courts have largely failed.

Indian tax officials, with perhaps only lukewarm support from their government, hope that Mauritius will stiffen the requirements for tax exemptions under the DTAA. They point to a new protocol Mauritius has added to its treaty with China under which capital gains arising in Mauritius on the sale of Chinese assets will be subject to a 10% tax in China in some circumstances. The protocol came into force on 1st January 2007.

The Mauritian authorities did move to placate the Indians last year, tightening up on the issuance of Category 1 Global Business Licence applications for Collective Investment Schemes, Private Equity Funds, Venture Capital Funds, Investment Companies, CIS Manager, and Investment Adviser/Managers; but India wants further action before it will implement parts of a trade agreement which will be highly favourable for Mauritian exports to India.

In response to Indian pressure to change the treaty, the Mauritian government has expressed a willingness to cooperate with New Delhi, but only if an amended tax treaty does not erode the jurisdiction's competitiveness.

"Let me state very clearly that we will collaborate to prevent any alleged misuse of the treaty," said that country's Minister of Finance, Rama Sithanen, on a trip to New Delhi last year. "But keeping in view historical, cultural, political and diplomatic ties between the two countries we need a global solution that will not penalise Mauritius," he added.