How India got Mauritius to agree to changes in tax law

Mauritius wanted extension of the benefits limitation clause in India’s treaty with Singapore, which we were quite willing to extend, for our price

In negotiations with the government of Mauritius, Indian tax officials found a bargaining chip in the tax treatment for money invested from Singapore in India.

It simply says if an investor from Singapore can claim to have spent a fixed sum of money as his investment in the island, the Indian government will not lift the ‘corporate veil’ to demand to know the antecedents of the money.

This will apply even when India rings in its General Anti-Avoidance Rules on tax from next year. The latter would arm officials with the authority to demand difficult answers from foreign investors about the tax paid by them abroad.

The clause is known as limitation of benefits (LOB), typically one of several in the tax world’s penchants for naming rules opposite to what they are supposed to mean. The India-Singapore tax treaty includes the  clause but the Mauritius treaty, being of an earlier vintage, did not. This although both have the same attraction for investors into the Indian stock market.

Port Louis has, however, begun to recognise the killer impact of the clause for swinging business away to Singapore as far as investments into India are concerned. In its recent negotiations for renewal of the double tax avoidance treaty with India, it had asked for being provided a similar benefit.

For India, this was the opportunity. As the government press release issued on Tuesday says, this has now been introduced in the protocol. As it reads, there will be a ‘benefit of 50 per cent reduction in tax rate during the transition period from April 2017 to March 31, 2019...whereby a resident of Mauritius (including a shell/conduit company) will be entitled to benefits of 50 per cent reduction in tax rate (only) if its total expenditure on operations in Mauritius is (more) than Rs 2,700,000 in the immediately preceding 12 months.’

In other words a shell company will continue to get the benefits till August 2019 of the capital gains only if it makes the investments.

This clause protects the interests of investors transiting through Mauritius, though only as a temporary measure. The cost that the former paid is in having to give up the advantage of differential taxation of capital gains forever.

Even with the LOB inclusion, Mauritius has not gained much. After making the investments as mandated by LOB, for an investor the option of using Singapore or Mauritius are now equal. Rather, with the sophisticated financial sector Singapore offers, there is more probability of the investors preferring it to the Indian Ocean island.

For India, it really does not matter how the two countries arrange to ensure that investors make bona fide investments in either. For, in either case, they’d be subject to the capital gains tax regime that operates for domestic investors here, partially from April 2017 and fully from April 2019.

If, as expected, the capital flows do not abate, it will prove the experts right who have been asking for this for long. It is possibly the most salutary anti-black money measure the Indian government has taken in a long while.

In 2005, when former Prime Minister Manmohan Singh had visited Mauritius, he had offered a deal. He asked them to remove the advantage of zero capital gains taxation for business located in the island and investing in Indian stock markets. Since Mauritius was afraid this would drain out the capital being invested in its country, he had offered them a corresponding financial support to make it good.

The sum involved was less than Rs 500 crore (Rs 5 billlion), not even a blip in the Indian budget. That government had passed up the opportunity. Indian tax officials said there is likely to be renewed discussion on this support, very soon.

Photograph: Jason Lee/Reuters