May 03, 2024

Introduction of Principal Purpose Test in India – Mauritius Tax Treaty

Investors have since long made investments in India through the Mauritian route, given the permissible tax advantages within the Mauritian tax laws read with the Double Taxation Avoidance Agreement (‘DTAA’) between India and Mauritius. In fact, the Central Board of Direct Taxes (‘CBDT’) clarified its stand as early as in the year 1994[1], which was reiterated in 2000[2], that capital gains derived by a Mauritian resident, on sale of Indian company shares, would not be taxable in India subject to production of a valid tax residency certificate (‘TRC’) issued by Mauritian authorities[3]. As such, while doing so, the CBDT specifically relied upon the unambiguous language contained in Article 13(4) of the DTAA.

Despite this clear understanding of law, disputes arose between investors and the income tax department (‘Department’) over the motive with which investments were being made in India by way of the Mauritian route. While neither the Indian domestic law nor the DTAA created an exception for disregarding the benefit available under Article 13(4) of the DTAA to a Mauritian resident, the Department invoked judicially evolved substance over form principles to allege treaty shopping and tax avoidance. However, as is evident from the prevailing jurisprudence, the Indian Courts have resisted such an approach of the Department and have repeatedly upheld the claim of investors, who held valid TRC issued by Mauritian authorities.

Meanwhile, the DTAA was also amended with effect from April 01, 2017. Post the amendment, gains derived by a Mauritian resident from sale of Indian company shares acquired on or after April 01, 2017, became taxable in India. Thus, by virtue of Article 13B, capital gains realised after April 01, 2017 and before March 31, 2019 were to be taxed at 50% of the domestic tax rate in India while there was no change to the benefit under Article 13(4) of the DTAA. On the other hand, gains derived from sale of Indian company shares acquired before April 01, 2017, were grandfathered, and thus, continued to enjoy the benefit of Article 13(4) of the DTAA. However, since no anti-avoidance measure in respect of grandfathered shares was introduced in the DTAA, the Department’s allegation of tax avoidance did not find any support from Indian Courts.

Very recently, India and Mauritius have signed a Protocol dated March 07, 2024 (yet to be notified), seeking to further amend the DTAA with the intent of eliminating double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion/ tax avoidance/ treaty-shopping. This Protocol now seeks to insert a principal purpose test[4] (‘PPT’) that would allow the denial of benefit under the DTAA in respect of any item of income, if it can be reasonably concluded that obtaining such benefit was one of the principal purposes of the transaction in dispute[5].

Therefore, post the notification of the Protocol, the Department may seek to take shelter of PPT to go behind the TRC. The Protocol has already done enough to spook Mauritian investors who have pulled out substantial stakes from the Indian market[6]. Although the CBDT has assured that there is no cause for concern,[7] clarity on many aspects of the Protocol is much required. Needless to add, this Protocol by way of introducing the subjective standard of reasonableness is likely to unsettle the law that is fairly settled in the context of the DTAA, thus paving the way towards further litigation.

[1] Central Board of Direct Taxes, Circular No. 682 of 1994 dated March 30, 1994.

[2] Central Board of Direct Taxes Circular No. 789 of 2000 dated April 13, 2000.

[3] In the case of Union of India v. Azadi Bachao Andolan, (2004) 10 SCC 1 (SC), the constitutionality of the CBDT Circular No. 789 of 2000 dated April 13, 2000 was upheld.

[4] PPT was introduced as a concept under the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (‘BEPS MLI’).

[5] The bare text of the relevant provision is as follows:

Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention

[6] .





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