Change to India–Mauritius Tax Treaty Impacts Investor Decisions

The governments of India and Mauritius have signed a protocol that carries immense potential significance for the India-Mauritius double taxation avoidance agreement, or DTAA. This protocol introduces the principal purpose test, or PPT—a crucial development for taxpayers intending to claim benefits under the DTAA.

This change has the potential to significantly alter the tax benefits previously enjoyed by taxpayers.

The protocol was signed March 7 but the amendment will only come into effect once both governments of India and Mauritius notify each other according to their domestic laws.

The introduction of the PPT may entail a marked shift from established practices regarding grandfathering provisions and the treatment of tax residency certificates, or TRCs, in India.

Questions for Investors

The introduction of the PPT will have a profound impact on investor decisions on opting for tax jurisdictions based on the benefits available under the DTAA. While the existing DTAA already provides for various anti-abuse measures, such as beneficial ownership tests and defined periods for the availability of benefits, the PPT introduces a relatively discretionary measure for the tax authorities.

Principal purpose test. The PPT sets out a two-pronged examination to curb multinational enterprises’ base erosion and profit shifting tactics under the DTAA. The protocol comprises a subjective and an objective test. The subjective test examines whether one of the “principal purposes” of an arrangement is to obtain the benefit of the DTAA. The objective test examines the alignment of such an arrangement with the object and purpose of the relevant DTAA provisions.

If an arrangement doesn’t qualify for benefits under the subjective test, it may be saved by the objective test if it aligns with the object and purpose of the relevant provision. The benefits will be disallowed if an arrangement fails both tests.

The introduction of the PPT brings specific practical and legal challenges, creating uncertainty that businesses and investors will need to navigate. The potential impact on taxpayers and investors highlights the importance of clear and comprehensive guidance from the government.

Broad scope of the subjective test. An arrangement can fail the subjective test even if it is intended to reap specific business/operational or other benefits, not merely DTAA benefits. The arrangement fails if one of the principal purposes is to obtain benefits under the DTAA.

The threshold exceeds the domestic general anti-avoidance rule, the GAAR, incorporated under the Indian income tax law. The GAAR provides anti-abuse safeguards if the principal purpose—not one of the principal purposes—is to obtain treaty benefits.

Accordingly, tax authorities possess greater power to deny benefits under the DTAA and may go beyond the defined limits of the GAAR.

The Indian government’s clarification in Circular No. 7 of 2017 settles that the GAAR and specific anti-avoidance rules can coexist and may be applied based on the facts and circumstances of each case.

However, exercising such extended powers may also be thwarted by Section 90 of the Indian Income Tax Act, 1961, which provides that domestic income tax law provisions may prevail over tax treaties if the former are more beneficial for a taxpayer.

“Object and purpose” of the objective test. An arrangement won’t be disallowed under the PPT if it conforms to the object and purpose of the relevant DTAA provisions. However, determining such object and purpose could lead to disputes and uncertainty on applying the PPT to past transactions. This could lead to a broader interpretation and application of the objective test.

The tax authorities may rely on the DTAA’s preamble to determine the object and purpose of the relevant provision. In this case, the overarching principles of the DTAA—such as the elimination of double taxation, no taxation or reduced taxation, including through treaty shopping arrangements—may be relevant to the authorities.

This could lead to a broader interpretation of the DTAA’s “object and purpose,” potentially creating conflicts with other tax treaties and affecting the application of the PPT and the availability of treaty benefits.

Retrospective application of the PPT. The protocol doesn’t provide any benefit for transactions for the period before the PPT’s introduction. This means that transactions previously considered protected under the DTAA may now be subject to the PPT, potentially leading to the denial of treaty benefits for past years.

The protocol specifies that it will be effective from its entry into force, without specifying the date the taxes are levied or the relevant tax years to which the protocol will apply. This lack of clarity could lead to disputes and uncertainty on applying the PPT to past transactions.

Tax residency certificates. According to Indian income tax law a nonresident taxpayer can claim the benefits of a tax treaty if it provides a valid TRC obtained from its resident jurisdiction. Incorporating the PPT in the DTAA may dilute the position of the taxpayer’s TRC if the relevant arrangement fails the PPT. This could lead to a taxpayer holding a valid TRC but being denied the DTAA benefits.

Treaty shopping conflict. Treaty shopping—the practice of choosing a jurisdiction solely based on the benefits available under its tax treaties—may sometimes be characterized as abusive, even though some jurisdictions provide these tax incentives to attract businesses and investment.

The proposed amendment in the preamble of the DTAA considers treaty shopping in all instances as abusive, potentially leading to the denial of treaty benefits. This complex issue underscores the need for a comprehensive understanding of the PPT and its implications.

Going forward. Given these potential implications and the complexity of the PPT, the government must provide clear and comprehensive clarifications to help businesses understand the new rules and assist them in strategizing their tax structures.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Aditya Singh Chandel is partner and Akshat Jain is an associate at AZB & Partners, New Delhi. The views expressed in this article are those of the authors and do not necessarily reflect the views of the organization with which the authors are affiliated.

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