India Makes Another Attempt at the India-Mauritius Tax Treaty


In yet another attack on the India-Mauritius Tax Treaty (a time-honored route for inbound investment into India), several provisions in the new draft Indian Direct Tax Code (Draft Code), announced on August 12, 2009 and scheduled to come into force on April 1, 2011, could have a significant effect on the continued use of income tax treaties, including the India-Mauritius Income Tax Treaty (Treaty), for direct investments into India. In a significant departure from current tax rules, the Draft Code provides that neither a tax treaty nor the Code would have preferential status by reason of it being a treaty or a law and that, in the case of a conflict between the provisions of a treaty and the provisions of the Code, the one that is effective later in time prevails. Since the Treaty dates back to 1983, the Draft Code would (absent a later renegotiation of the Treaty) be later in time and its provisions would prevail.
 
Of particular concern to a potential Treaty claimant, Section 5(1)(d) of the Draft Code provides that any income from the transfer, directly or indirectly, of a capital asset situated in India would be deemed to accrue in India and thus would be taxable in India to a nonresident taxpayer. The practical effect of these provisions in the Draft Code would be to eliminate the use of the Treaty and subject the capital gain on the sale of stock of an Indian company to capital gains tax in India.
 
In addition, the Draft Code provides for the introduction into Indian tax law of a general anti-avoidance provision (GAAR). The GAAR would allow a commissioner of income tax to declare any transaction as an "impermissible avoidance arrangement" and disregard, combine or recharacterize any step in a transaction or the whole transaction. The discussion note to the Draft Code specifically states that the GAAR provisions will override the provisions of a treaty. Thus, the use of the Treaty to protect against the imposition of Indian capital gains tax would, depending on the specific facts and circumstances, be subject to being disregarded by a tax commissioner as an impermissible avoidance arrangement. The taxpayer, however, would be able to demonstrate the commercial substance of the transaction.
 
But if past precedence is anything to go by, one can safely bet that the concern about the negative effect on foreign investments coming to India if the lucrative routes through Mauritius did not exist will cause India to take some mitigating steps that will eventually uphold the Treaty.
 
The material in this publication is based on laws, court decisions, administrative rulings, and congressional materials, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship. Internal Revenue Service rules require that we advise you that the tax advice, if any, contained in this publication was not intended or written to be used by you, and cannot be used by you, for the purposes of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
 
This article is republished with permission of Pepper Hamilton, LLP. Further duplication without the permission of Pepper Hamilton, LLP is prohibited. All rights reserved.