Indian Government Plans Changes To Mauritian Double Tax Treaty

by Lorys Charalambous, Tax-News.com, Cyprus

30 August 2002

There was consternation among some Indian companies last month after the High Court in Delhi struck out a Ministry of Finance circular permitting 'Foreign Investment Investors' to benefit from capital gains tax exemption under the India/Mauritius Double Tax Treaty simply based on a Mauritian residence certificate. The Court believed that Indian companies were abusing the treaty by setting up Mauritian 'post-box' companies which could benefit from tax relief under the Treaty.

The Indian Ministry of Finance and Company Affairs (MoF) then set up a working group to examine the functioning of the Mauritius India Double Taxation Avoidance Agreement (DTAA). The mandate of the group was to suggest ways to improve the administration of the treaty and it has been looking at ways and means of exchange of information and documents to establish the tax residency status of entities operating from Mauritius.

The working group comprising representatives from the MoF and the Securities and Exchange Board of India (SEBI) who visited Mauritius for discussions with the tax authorities in Mauritius and the following modifications are likely to be introduced in the treaty:

• A clause is likely to be introduced in the treaty, which would prevent India entities calling themselves residents of Mauritius;
• There will be a provision for enforcement of the information sharing arrangement between the two countries even at the investigation stage; and
• There will be a requirement that an Overseas Corporate Body (the name given to a company eligible for exemption under the DTAA) should have at least 60% ownership by Non-Resident Investors (NRI).

These changes will impact Indian corporate groups which take the Overseas Corporate Body (OCB) route and set up subsidiaries in Mauritius, merely to avoid taxes in India.

Until now, nothing has prevented an Indian company (or individual) setting up a Mauritian company and using it to make investments in India; under the DTAA, capital gains tax is payable in only one country. If the Mauritian company is not 'effectively managed' from India, then Mauritian taxes apply, and CGT is nil in Mauritius. In 2000, when it became popular to use this structure to escape capital gains tax on stock exchange investments in India, tax inspectors started issuing assessments on Indian companies they said were abusing the Treaty.

In response to complaints from genuine investors, the Central Board of Direct Taxes (CBDT), a part of the Finance Ministry, issued a Circular (circular number 789 dated 13 April 2000) requiring tax inspectors to accept a Mauritian residence document (freely issued in Mauritius, it is said) as evidence that the Treaty should be applied. Circulars issued by the CBDT are enforceable regulations under the Income Tax Act, 1961.

It is this Circular that the High Court 'quashed', saying that the CBDT had acted ultra vires: 'Avoidance of double taxation would mean that a person has to pay tax at least in one country. Avoidance of double taxation would not mean that a person does not have to pay tax in any country whatsoever. In Mauritius, in terms of the statute a foreign company is not entitled to own any property, open any bank account, do any business. Several restrictions have been imposed in that country; as a result thereof no income may be generated in Mauritius and no income tax may be payable therein. Double taxation treaty clearly is not envisaged in such situation.'

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