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Countries enter into tax treaties to avoid or mitigate double taxation. Today, India has comprehensive Double Taxation Avoidance Agreements (DTAA) with nearly 100 countries.
A tax treaty between India and Mauritius was signed in 1982 keeping in view India’s strategic interests in the Indian Ocean and close cultural relations with that country. The treaty provided for a capital gains tax exemption (i.e., zero tax) to a Mauritius resident on transfer of Indian shares and securities. After India opened its economy to foreign investment in 1991, Mauritius became one of the top destinations for funnelling investments into India. In 2005, the tax treaty between India and Singapore was amended, and a similar exemption was extended to Singapore. However, the protocol provided that the capital gains benefits would be co-terminus with those available under the Mauritius Treaty.
With large investments flowing from both countries, Indian tax authorities became apprehensive of misuse and abuse of these treaties. To curb revenue losses, prevent double non-taxation and tackle treaty abuse and round-tripping of funds, they made several attempts to tax capital gains; however, the treaties stood in the way.
Meanwhile, questions were raised globally on multinational corporations (MNCs) exploiting tax rules to shift profits to low or no-tax locations. There was a view in India as well that MNCs were not paying their fair share of taxes.
In order to curb mala fide practices, the Organisation for Economic Cooperation and Development (OECD) along with G20 countries formulated the Base Erosion and Profit Shifting (BEPS) Action Project. This project aims at providing a mechanism to plug loopholes/gaps/mismatches in international tax laws, giving every country an opportunity to earn its fair share of tax revenues. India played a key role in the project.
The globally coordinated action plan on BEPS supported Indian tax authorities in the renegotiation with Mauritius and Singapore. Ultimately, 2016 proved to be a “historic" year for Indian tax authorities, with revisions to both tax treaties.
The revised treaty provides that capital gains on shares in an Indian company acquired up to 31 March 2017, will be exempt, subject to fulfilment of conditions in the Limitation of Benefits (LOB) clause, if any. For a period of two years, starting from 1 April 2017, capital gains will be shared between India and Mauritius/Singapore, subject to the LOB clause, if any. And, capital gains will be fully taxable in India (being a source state) from 1 April 2019 onwards.
Indian tax authorities deserve to be commended for giving sufficient advance information to investors before the change took effect, protecting existing investments, and for the transition period. This provided certainty to investors and helped in a smooth transition to the new regime.
With a view to protect its tax base and increase transparency, India made a slew of other changes in its (i) domestic tax law such as, introduction of General Anti Avoidance Rules; and (ii) bilateral tax treaties such as, exchange of information, proposed signing of Multilateral Instruments to incorporate Principal Purpose Test (PPT) and LOB clause in its tax treaties with various countries.
Taxmen worldwide have come together to create an inclusive framework where MNCs pay their fair share of taxes in respective geographies. India is very much ahead of the curve. The new framework requires a fundamental shift in the way MNCs plan their business.
Neeru Ahuja is a partner with Deloitte India, and Gaurav Jain is a senior manager with Deloitte Haskins and Sells Llp.