India and Mauritius have signed a protocol amending the double taxation avoidance agreement (DTAA). The amendment incorporates a principal purpose test to determine the eligibility of foreign investors to claim treaty benefits.

Tax experts have noted the addition of a new article, "Article 27B Entitlement to Benefits," to the protocol. The amended protocol was signed on March 7 and has now been made public.

The introduction of the PPT aims to reduce tax avoidance by ensuring that treaty benefits are only granted for transactions with a genuine purpose.

Rakesh Nangia, Chairman of Nangia Andersen India, stated that the amendment signifies India's effort to align with global initiatives against treaty abuse, especially under the BEPS Action 6 framework. However, there is ambiguity regarding the application of the Principal Purpose Test (PPT) to grandfathered investments, underscoring the necessity for explicit guidance from the CBDT.

Nangia further noted that the omission of the phrase "for the encouragement of mutual trade and investment" in the treaty's preamble indicates a shift in focus towards preventing tax evasion rather than promoting bilateral investment flows.

He added that this development highlights India's commitment to international tax cooperation standards while presenting crucial considerations for investors utilising the India-Mauritius corridor.

Head of Tax Market at AKM Global, Yeeshu Sehgal, stated that the Principal Purpose Test (PPT) will result in denying treaty benefits, such as the reduction of withholding tax on interest, royalties, and dividends, if it is reasonable to conclude, based on all relevant facts and circumstances, that obtaining that treaty benefit is one of the principal purposes of the party seeking to rely on the said treaty.

Mauritius has historically been a preferred jurisdiction for making investments in India due to the exemption of capital gains tax from the sale of shares in Indian companies until 2016.

In 2016, India and Mauritius entered into a revised tax agreement, granting India the authority to tax capital gains in India from transactions in shares routed through the island nation starting from April 1, 2017.

However, investments made before April 2017 were grandfathered. Sehgal stated that this amendment applies to all types of income, including capital gains, dividends, and fees for technical services.

"Following this change, any Indian inbound or outbound cross-border investment structuring routed through Mauritius should consider the impact of Base Erosion and Profit Shifting (BEPS) and Member Lending Institutions (MLI), particularly if the structuring involves seeking tax treaty benefits," Sehgal added.

It is expected that there may be an increase in litigation as investors from Mauritius will now be required to justify the commercial rationale behind their transactions, demonstrating that the primary objective was not to obtain treaty benefits, Sehgal said.

Image source: PTI News