India seeks to close tax treaty loopholes
2-May-2008India is looking to include limitation on benefits clauses and switch to taxation based on where the profits arise rather than on the residency of the taxpayer in its renegotiations of income tax treaties with Cyprus, the United Arab Emirates and Mauritius.
Previously capital gains taxes were levied based on the residency of the taxpayer rather than on the jurisdiction in which the gains arose. The Indian Department of Revenue has estimated that treaty shopping has cost the government INR 50 billion (about $1.3 billion) from 1991 to 2006.
The Indian government has announced that it will soon issue a notification that the terms of the Cyprus-India treaty have been renegotiated to institute a 10% capital gains tax on both Cypriot individuals and companies doing business in India when those capital gains arise in India. Dividend income will retain its exemption from withholding tax
Previously, CGT was levied based on the residency of the taxpayer rather than on the jurisdiction in which the gains arose. Because Cyprus does not impose a CGT on its residents, taxpayers resident in Cyprus but doing business in India were able to avoid paying any CGT.
The changes to the Cyprus-India agreement are similar to changes made to the India-UAE treaty. This treaty was first entered into in April 1992, and the new provisions took effect from 1 April 2008.
The new limitation on benefits (LOB) clause, inserted as article 29 of the treaty, will particularly affect investment companies that have been using the UAE as a conduit into the Indian market. Article 29 states that treaty benefits will be denied, "if the main purpose or one of the main purposes of the creation of such an entity was to obtain the benefits of the [double taxation avoidance] agreement."
Residency has also been addressed in the protocol, with a UAE resident now defined as an individual who resides in the UAE for at least 183 days in a calendar year. For a company to be a UAE resident, it must be incorporated, managed, and controlled wholly in the UAE.
India is also trying to renegotiate its treaty with Mauritius, particularly seeking to add an LOB clause to the text of the treaty in order to stop abuse. It is hoped that amendments to the Cyprus-India and India-UAE treaties may create pressure for Mauritius to agree to changes.
Mauritius has resisted amending the treaty. With nearly 70% of Mauritians being of Indian origin, the country is heavily dependent on revenue generated through investments passing though Mauritius because of its privileged treaty position. About 40% of the $45 billion to $50 billion of foreign direct investment flowing into India between 1991 and 2006 was routed through Mauritius. A similar percentage of foreign institutional investor inflows are also coming from Mauritius.
Mauritius has no capital gains tax and has a corporate tax rate of only 3% to 4%, making it an advantageous jurisdiction from which to enter the Indian market.
The Indian Ministry of Finance has suggested giving aid of INR 5 billion to INR 6 billion (about $126 million to $151 million) to offset any losses suffered by Mauritius due to changes in the treaty, according to a Times of India report.
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