India-Mauritius tax treaty: FPIs withdraw Rs 8,600 crore from equities in April

In April 2024, foreign portfolio investors (FPIs) made a net outflow of Rs 8,671 crore in Indian equities over concerns over the changed rules in India's tax treaty with Mauritius. Till the March quarter (Q4 FY24), FPIs increased their stake by as much as 15.91 percentage points in 10 stocks in India.

This came following a staggering net investment of Rs 35,098 crore in March and Rs 1,539 crore in February, data with the depositories showed. Overall, the total inflow for 2024 so far stood at Rs 2,222 crore in equities and Rs 44,908 crore in debt market.

Earlier this year, India amended the Double Taxation Avoidance Agreement (DTAA) with Mauritius to prevent misuse for tax evasion or avoidance. The amended pact has included --  the Principal Purpose Test (PPT), which essentially lays out the condition 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 Article 27B of the revised protocol outlines the criteria for 'entitlement to benefits' in the treaty. The PPT can refuse treaty advantages like lower withholding tax on interest, royalties, and dividends if it's determined that seeking these benefits is a primary motive for the transaction party.

The new treaty is expected to result in the denial of tax reliefs for assorted incomes – dividend, royalty, technical free etc. , to investors and traders from Mauritius. Indian HNIs who take the Mauritius route for tax avoidance will also be impacted.

Speaking about FPIs net outflow, Kislay Upadhyay, smallcase manager and founder of Fidelfolio, said this outflow was due to adjustment after heavy inflow in March, a short-term gain prospect in longer duration bond in anticipation of a rate cut and 'wait and watch mode adopted by investors till the announcement of election results.

"While the tweak in India's tax treaty with Mauritius on investments made in India via the island nation continues to bother foreign investors, weak cues from the global markets with uncertain macro and interest rate outlook didn't augur well for emerging market equities," said Himanshu Srivastava, Associate Director Manager Research, Morningstar Investment Research India.

Apart from equities, FPIs withdrew Rs 10,949 crore from the debt market during the month under review. "The trigger for this renewed FPI selling, in both equity and debt, is the sustained rise in US bond yields. The 10-year bond yield now stands at around 4.7 per cent which is hugely attractive for foreign investors," V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services, said.

The DTAA significantly attracted numerous foreign portfolio investors (FPI) and foreign entities to channel their investments into India via Mauritius.

As of March 2024, Mauritius continues to be the fourth largest contributor to Foreign Portfolio Investment (FPI) in India, following the United States, Singapore, and Luxembourg. The FPI inflow from Mauritius was recorded at Rs 4.19 lakh crore by the end of March 2024, representing 6% of India's total FPI accumulation of Rs 69.54 lakh crore.

Last month, the Income Tax department said the concerns are premature at the moment since the Protocol is yet to be ratified and notified.

The I-T department said: "Some concerns have been raised on the India Mauritius DTAA amended recently. In this context, it is clarified that the concerns /queries are premature at the moment since the Protocol is yet to be ratified and notified u/s 90 of the Income-tax Act, 1961. As and when the Protocol comes into force, queries, if any, will be addressed, wherever necessary."

Tax experts say tax authorities in India are likely to look beyond TRC and will have the ability to deny the benefit of India-Mauritius tax treaty.

"Introduction of PPT is a measure implemented to align the tax treaty with BEPS Action Plan 6, which was developed to combat tax evasion.  This would mean that taxpayer’s resident in Mauritius can no longer simply rely on a Tax Residency Certificate issued by Mauritius Revenue authority to claim treaty benefits.  With PPT test now introduced in the India-Mauritius tax treaty, tax authorities in India are likely to look beyond TRC and will have the ability to deny the benefit of India-Mauritius tax treaty if it is reasonable to conclude. The tax authorities will have the ability to take a closer look at the structure, and assess the intent and commercial rationale, before granting treaty benefits. Existing structures / investments from Mauritius will now need to pass through the PPT test," said Lokesh Shah, Partner, INDUSLAW.

"The text of a protocol signed between India and Mauritius on 7 March has just been released. The protocol incorporates a Principal Purpose Test (PPT) as was expected and also amends the objects clause of the Treaty. This is on expected lines and it will now enable Mauritius to also notify the treaty as a CTA. India has already done so. The protocol come into effect based on the dates it is notified to enter into force by the respective Governments. Logically this will mean the changes will come into effect for period beginning from 1 April 2025 for India," said Rohinton Sidhwa, Partner, Deloitte India.