India and Mauritius modifies the DTAA; Capital gains tax becomes source based

In a major agreement that may redirect capital flows into India, the government has modified Double Taxation Avoidance Agreement (DTAA) with Mauritius. Both countries have made the amendment thirty-three years into the running of the DTAA which was signed in 1983.

As per the modification, capital gains made by a Mauritius registered company on share selling in India will be taxed in India. The tax becomes source based (tax should be paid at the source of tax (e.g. India) rather than residence based (e.g. Mauritius) of the entity that makes the income).

This change will help India to reduce the DTAA misuses of round tripping and treaty shopping. Majority of the FDI coming from Mauritius are investment made by Indian origin entities or persons. The White Paper on Black Money has pointed out round tripping as a major opportunity for black income generators.

The source basing of capital gains tax implies that if a Mauritius company makes profit while selling shares, it will be taxed in accordance with the tax rate in India. Now, the major implication is that both FPIs and FDIs who exit India that comes from Mauritius should pay tax in India for the profit of selling shares at a higher price.

An interesting development of the treaty is that Mauritius will become less attractive comparted to Singapore. Already, FDI from Singapore is rising and that from Mauritius is slowing down ever since India has modified the DTAA with Singapore and supported it with other bilateral agreements.

As per the Singapore-India tax treaty, the sale of shares in an Indian company by a Singapore entity should generally be taxed in Singapore. The limitation of benefit clause stipulates that if some conditions (easy) are met, the Singapore company who is making capital gains in India should pay tax in Singapore. There is no capital gains tax in Singapore. At the same time, the tax regime in Singapore is robust and superior compared to Mauritius.