A recently published protocol to the longstanding Double Taxation Avoidance Agreement (DTAA) between India and Mauritius is poised to significantly alter the landscape for foreign investments, particularly those previously considered "grandfathered." The key change introduces the Principal Purpose Test (PPT), a measure designed to prevent treaty abuse.
Understanding the New Protocol and the Principal Purpose Test
The amendment, made public in April 2024, integrates the Principal Purpose Test (PPT) into the India-Mauritius DTAA. Originating from the Multilateral Instrument (MLI) developed under the OECD's Base Erosion and Profit Shifting (BEPS) initiative, the PPT allows tax authorities to deny treaty benefits if it is reasonable to conclude that obtaining those benefits was one of the principal purposes of an arrangement or transaction.
Historically, the India-Mauritius DTAA was a popular route for foreign portfolio investors (FPIs) and foreign direct investments (FDIs) into India due to its favorable tax treatment, especially the exemption on capital gains tax for investments made from Mauritius.
Impact on Grandfathered Investments and Capital Gains
A crucial aspect of the original DTAA was the "grandfathering" clause, which protected investments made before April 1, 2017, from changes in capital gains taxation. These older investments continued to enjoy exemption from capital gains tax in India upon their sale.
However, the new protocol's introduction of the PPT raises questions about the continued applicability of this grandfathering clause. Experts now widely interpret that the PPT will apply to all provisions of the DTAA, including those related to capital gains, irrespective of when the investment was made. This means even grandfathered investments could be subject to Indian capital gains tax if their primary purpose is deemed to be tax avoidance rather than genuine commercial activity.
The onus will likely be on investors to demonstrate that their arrangements were not primarily driven by the intent to secure tax benefits under the treaty. This could necessitate a re-evaluation of investment structures and a greater emphasis on substance over form.
Implications for Investors and the Road Ahead
The application of the PPT marks a significant shift, aiming to curb "treaty shopping" – the practice of routing investments through jurisdictions primarily to avail of treaty benefits. For investors with existing portfolios routed through Mauritius, especially those relying on the grandfathering clause, a thorough review of their structures and tax positions is imperative.
While the full extent of the protocol's implementation and its interpretation by tax authorities will unfold over time, the message is clear: the era of automatic tax exemptions for capital gains via Mauritius, even for long-standing investments, is evolving. Investors should seek expert advice to ensure compliance and understand potential liabilities under the revised treaty.