India will shut the door on investors using Mauritius and Singapore to avoid paying taxes in India, starting in the next financial year, as it moves to curb tax evasion in a move that could also impact capital inflows.

India will get the right to tax capital gains on investments channelled through Mauritius under an amended tax treaty it signed with the island republic on 10 May in Port Louis, the tax department said in a statement on Tuesday.

The amendment to the 1983 India-Mauritius treaty, which will come into force on 1 April 2017, will also apply to the India-Singapore treaty, shutting two lucrative investment routes preferred by foreign investors. The India-Singapore treaty links the capital gains tax regime to that provided in the India-Mauritius treaty.

In addition, the amended India-Mauritius double taxation avoidance treaty has also provided for a limitation of benefit clause that will ensure that only genuine Mauritius-based companies get the benefit of the bilateral tax treaty.

The government said the amendment has been designed to curb treaty abuse, tax evasion and round-tripping of funds—the practice of money stashed away overseas by Indians returning home through tax havens such as Mauritius in the garb of foreign capital.

The changes will have an impact on foreign investors who route their investments from these two countries to avoid paying capital gains tax in India.

Around 50% of foreign direct investment into India comes through Mauritius and Singapore, according to Indian government data. Some 34% of it is channelled through Mauritius and 16% through Singapore.

The changes in the tax treaty will complement the government’s efforts to plug tax evasion and tax avoidance and its fight against black money—untaxed, unaccounted wealth hidden away by Indians.

In a relief to existing investors, shares acquired before 1 April 2017 will not be taxed by Indian authorities.

The amended treaty has also provided a two-year transitionary phase wherein the capital gains will be taxed at 50% of the existing tax rate; the full domestic tax rate will be applicable from 2019-20, provided the limitation of benefit clauses have been adhered to.

Under the earlier bilateral agreement between India and Mauritius, capital gains from sale of securities have been taxable only in Mauritius, where the levy is close to zero.

India has been trying to renegotiate the tax pact with Mauritius for several years to check suspected round-tripping and other treaty abuses.

Under the amended treaty, only those Mauritius-based companies that have a total expenditure of more than 27 lakh in the preceding 12 months will be able to benefit from the tax treaty.

The new treaty “will tackle the long pending issues of treaty abuse and round tripping of funds attributed to the India-Mauritius treaty, curb revenue loss, prevent double non-taxation, streamline the flow of investment and stimulate the flow of exchange of information between India and Mauritius. It will improve transparency in tax matters and will help curb tax evasion and tax avoidance", the tax department said.

The amended treaty brings long awaited closure to treaty talks between India and Mauritius, said Sudhir Kapadia, national tax leader at EY.

“One big positive is that there will be no retroactive impact on any investment made till 1 April 2017. Sometimes, even a prospective amendment has a retroactive effect but the government has done well to avoid that," he said. “With the Singapore treaty co-joined with Mauritius treaty, those funds that are purely Indian-centric will not have any incentive to route their funds through Mauritius and Singapore. This will impact private equity funds who invest in unlisted securities. Portfolio investors investing in Indian stocks will also be impacted if they sell in less than 12 months as it will attract the short term capital gains tax."

The amended treaty also seeks to subject interest arising in India to Mauritian resident banks to a withholding tax of 7.5% in India for debt claims or loans made from 1 April 2017. A so-called grandfathering clause—which provides for an old rule to apply to some existing cases and a new rule to future ones—has been incorporated here too.

The changes in the treaty should be seen in the light of India’s commitment to base erosion and profit shifting and the impending general anti-avoidance rules that will come into effect on 1 April 2017, said Mukesh Butani, managing partner at the law firm BMR Legal.

Base erosion and profit shifting refers to tax planning strategies aimed at artificially shifting profits to tax havens. General anti-avoidance rules target transactions made specifically to avoid paying taxes.

“The grandfathering date of April 2017 and a 50% concessional rate upto April 2019 augers well and lends certainty to investors on the applicability of the treaty as investors have been nervous on the future of the Mauritius treaty," Butani said. “It would push tax costs for investors but there is certainty and clarity for investors. In the medium to long term, it will contribute to attracting investments."

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