25 May 2016 20:38 IST

The right amendment

Mauritius Prime Minister Anerood Jugnauth and Prime Minister of India Narendra Modi

The changes in the India-Mauritius tax treaty couldn’t have come at a more opportune time

Last fortnight, something important happened; something that had been in the talks for almost close to seven years, finally materialised. Yes, we’re referring to the amendment to the India – Mauritius Double Tax Avoidance Agreement (DTAA).

While reading a press release by the Indian Government — that the tax treaty has been amended — we could not help but go back to the introduction to tax treaties given to us CA Inter Students by a tax professor. The professor, a well-established and distinguished CA, narrated the story mentioned below, which he personally experienced with one of his clients.

The story

My professor’s client had returned from the US, where the latter was a software engineer. He and his friends had set up a small private limited company and were in the process of developing software. The client would just file his personal tax returns, showing some interest income on the money he had saved up while he was in the US. My professor assisted him with it.

During one tax return season, however, the client came to my professor’s office as usual and handed over the basic documents, bank statements, proofs for investments and the likes. When my professor went through the bank statements, he saw a whopping ₹25-crore credit in the statement.

My Professor (P): Sir, what is this big number I see here? Can you tell me where it came from?

Client (C): Oh! I forgot to tell you. We finally sold the software we had been developing over the last two years.

P: Oh, that’s great! This will be business income for you. You can claim expenses against it. Do you have proofs for business expenses incurred by you?

C: No. I did not sell the software. You know, the software was registered in the name of our company, which was sold.

P: So you sold your company? Then it will be capital gains for you.

C: I did not sell the company. This Indian company was the subsidiary of our Mauritius holding company, which sold this company. And as per some India–Mauritius understanding, this sale is not taxable. This was what someone had advised me to do when I returned from the US to become an entrepreneur.

The professor had no reply.

This, my friends, was possible because under the India-Mauritius DTAA, capital gains arising in India to a resident of Mauritius on sale of shares, is taxable only in Mauritius. And I’m told capital gains are not subjected to tax in Mauritius.

The history

It was in 1983 that India and Mauritius inked the now much-spoken-about tax treaty. Things have definitely changed since then. It is not that we have come to a stage where we no longer need foreign capital; but today, we definitely are a major economic power that can assert its right to ask major multinationals to pay up whatever taxes they are liable to pay.

The way both Indian and Mauritius Governments handled this issue also deserves applause. The amendment is applicable only on a prospective basis, that too for investments made after April 1, 2017.

Investments that have already been made, and that will be made until April 1 2017, will continue to enjoy the treaty exemption. A transition period, where the tax rate would be half that of the normal tax rate, has also been provided. This is, of course, subject to certain conditions. These not only shut the door on uncertainty, but also give everyone adequate time to plan or re-plan their investments.

Other amendments

It’s not just the capital gains Article that has been amended. Income from ‘fees for technical services’, which was hitherto not taxable in India under the India-Mauritius treaty, will now be taxable in India. In addition to some other smaller amendments, there have been changes in the ‘other income’ article of the DTAA as well. Clauses on the exchange of information and assistance in recovery of taxes have also been streamlined.

The amendment to the treaty could not have come at a more opportune time, when the entire world is talking about fixing the global tax system for good. More countries would follow suit and instances of double non-taxation, artificial profit shifting and treaty shopping could soon become things of the past.

With all major economies tightening the screws on aggressive tax planning and tax avoidance, the BEPS project of the OECD and, yes, the Panama Papers too, we feel there is more action in store to watch out for.

(The writers are senior tax professionals at EY India. The views expressed are personal.)