Foreign direct investment and offshore funding has been an integral part of the Indian economic landscape over the last decade. With the requirement of technological expertise in native projects being at an all-time high, India has entered into various tax treaties with other countries, with a prominent one being the India-Mauritius Tax Treaty.
The Key Issue Regarding The India-Mauritius Tax Treaty
Formally put into place to facilitate ease of investment in India and powered by the ambitious investment into the Indian economy, the treaty came in handy in ensuring that the quantum of tax imposed on the investment is relatively less or in some cases, nil. This prompted an investment backing from Mauritius to an extent that Mauritius has consistently been ranked as India’s top foreign investor over the last few years until 2016 when an amendment for taxing capital gains on shares was brought into the India-Mauritius Tax treaty. The amendment though was prospective and forward looking in a way as it sought to grandfather the gains on the investments made up to March 31st, 2017.
Subsequently, or rather very recently, a change has been proposed by the Mauritian government to its local regulations which is projected to impact the investments made even prior to March 31st, 2017.
How? Allow us to elucidate
The Mauritian Government has proposed to amend the rules for determining the tax residency of the companies in Mauritius so that the companies which are centrally managed and controlled outside Mauritius will not be considered to be the tax residents of Mauritius. It has been proposed that certain criteria shall be laid out to determine the tax residency for companies incorporated in Mauritius. Furnishing of a Tax Residency Certificate (‘TRC’), being a pre-condition for claiming the treaty benefits in India which is also backed by the judicial precedents (Azadi Bachao Andolan, being the most prominent ones), only time will tell the impact of this proposed amendment to Mauritian tax residency rules, at least on the investments made in India prior to March 31st, 2017.
Analysis Of The Proposed Move
The move is a double-edged sword, which will although attract criticism for its perceived strictness yet will also bring in transparency in exposing shell companies and illicit beneficiaries of the sale of shares made. It will also bring in more structure and control to the Mauritian offshore funds investing in India, with the Mauritian Government denying them tax residency benefit if they fail to show substantial on-ground management and control.
Secondly, the process of offshore funding will be thoroughly put under the scanner as well, with routing of funds standing to be exposed and thereby ensuring that legitimate investments from legitimate benefactors are being made into India. This will undoubtedly streamline and ease the ensuing tax processes as well.
On a critical level, the move does have the propensity to cause a snowball effect where other Governments can also pick up a similar strategy, which might be deemed as tax-aggressive on certain grounds (example, Singapore).
The Way Forward
The primary solution to this, from an investor point of view would be to obviously ensure that the structure of funding is relatively simple and unilateral, and there is no illicit routing which is in the underbelly of the investments made. The requirement of a single-channel funding mechanism and similar structuring would be paramount to ensure no legal action is taken for any perceived wrongdoing. The role of Mauritian tax consultants / lawyers will be handy to assess the local law and the impact that this proposed investment could have on the tax residency status of the companies.
This will also prompt investors to ensure that the offshore funds in Mauritius have an appropriate level of structuring and have on-ground control and management to prove their legitimacy, thereby avoiding the ensuing legal implications for the same.
Another open ended point which needs to be carefully monitored / understood upon coming into force of this amendment is, whether the company which satisfies the tax residency test and qualifies to be a tax resident of Mauritius would automatically be treated to be not a shell / conduit company as envisaged by the LOB clause in Article 27A of the India-Mauritius tax treaty.
While this will arguably affect the investments made in India, and more significantly those made up to March 31st, 2017, it should be noted that a transparent structure for tracking investments is also imperative to ensure smooth bilateral relations.
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Source: The Asian Age