Why text of amended tax treaty with Mauritius triggered stock sell-offs

Subject: Economy

Section: External Sector

Context:

The text of the amended tax treaty with Mauritius has raised concerns of greater scrutiny on investments, and led to a sell-off in stock markets by Foreign Portfolio Investors (FPIs) on Friday.

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India has signed a protocol amending its tax treaty with Mauritius with an aim to plug treaty abuse for tax evasion and avoidance.
India and Mauritius,signed a protocol at Port Louis, amending the Double Taxation Avoidance Agreement (DTAA) between the two nations.
The amended treaty introduces the Principal Purpose Test , essentially implying that the tax benefits under the treaty will not be applicable if it is established that obtaining that duty benefit was the principal purpose of any transaction or arrangement.

Introduction of the Principal Purpose Test

The amended pact includes the Principal Purpose Test (PPT), which is in line with the global efforts against treaty abuse, particularly under the BEPS (Base Erosion and Profit Shifting) framework.
The PPT essentially implies that the tax benefits under the treaty will not be applicable if it is established that obtaining that duty benefit was the principal purpose of any transaction or arrangement.
The two nations have also amended the preamble of the treaty to incorporate the thrust on tax avoidance and evasion.
The earlier objective of “mutual trade and investment” has now been replaced with an intent to “eliminate double taxation” without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance including through “treaty shopping arrangements” aimed at obtaining relief provided under this treaty for the indirect benefit of residents of third jurisdictions.
The recent amendment reflects India’s intent to align with global efforts against treaty abuse, under the BEPS framework.

Impact of the amended treaty

The text of the protocol amending the treaty states that the provisions of the protocol shall have effect from the date of entry into force of the protocol, without regard to the date on which the taxes are levied or the taxable years to which the taxes relate.
This suggests that the PPT will apply to all transactions after the treaty gets notified, irrespective of the date of the investment itself.
Investors are apprehensive that this will result in greater scrutiny of the capital gains tax levy and exemption, as the PPT will be applicable to past investments where investors have not made an exit yet.
The DTAA was a major reason for a large number of FPIs and foreign entities to route their investments in India through Mauritius, as there was no capital gains tax on sale/transfer of shares.

India and Mauritius:

Mauritius remains India’s fourth largest source of FPI investments, after the US, Singapore, and Luxembourg.
FPI investment from Mauritius stood at Rs 4.19 lakh crore at the end of March 2024, which is 6 per cent of the total FPI investment of Rs 69.54 lakh crore in India.
FPI investment from Mauritius had stood at Rs 3.25 lakh crore, out of total FPI investment of Rs 48.71 lakh crore at the end of March 2023.