India and Mauritius have recently reinforced their Double Taxation Avoidance Agreement (DTAA) with the introduction of a Principal Purpose Test (PPT). This amendment aims to curb tax avoidance by scrutinizing the eligibility of foreign investors for treaty benefits. The PPT will require Mauritius-based investment vehicles to demonstrate genuine operational substance, ensuring they are not merely shell companies set up to exploit tax benefits. This move signifies India’s commitment to fostering transparency and preventing misuse of the DTAA, particularly concerning investments routed through Mauritius to capitalize on tax advantages.
The introduction of the PPT in the DTAA could have significant implications for foreign portfolio investments (FPIs) flowing into India via Mauritius. While the 2016 amendment to the DTAA had already mandated source-based taxation of capital gains and introduced grandfathering provisions to protect existing investments, the 2024 amendment could potentially subject even pre-2017 investments to fresh scrutiny. This development may raise concerns among market players, particularly regarding foreign direct investments (FDI) routed through Mauritius-based structures. The reduced withholding tax rates on incomes such as interest, dividends, and royalties received from Indian companies, which previously incentivized corporations to route FDI through Mauritius, may no longer be applicable under the revised treaty.
Despite the apprehensions surrounding the latest DTAA amendment, market experts believe that the impact on FPI inflows may be minimal, as the 2016 revision had already prompted significant changes and eliminated many structures solely aimed at tax avoidance. However, there is growing speculation that FDI inflows through Mauritius-based vehicles could be adversely affected. Investors and corporations are advised to reassess their investment strategies and consider alternative routes for FDI to India, given the evolving regulatory landscape. As the market continues to adapt to these changes, proactive measures and compliance with the revised DTAA provisions will be crucial for foreign investors navigating the Indian investment landscape.