Recent Developments in India-Mauritius Tax Treaty

The recent ruling on the India-Mauritius tax treaty has highlighted significant issues in cross-border taxation. It emphasizes that Indian tax authorities can now look beyond the tax-residency certificate (TRC) to deny treaty benefits, causing concern among global investors. This situation underscores India's shifting stance on capital taxation and its implications for the rule of law.

Foundations of Cross-Border Taxation

• Tax policy has profound impacts on economic growth.
• The value-added tax (VAT) system in international trade ensures neutrality by applying the destination principle.
• In finance, residence-based taxation is critical, where capital income is taxed in the recipient's country, not where the investment is made.
• For example, if a US pension fund invests in India, returns should be taxed in the US.

Impact on Investment

• India is a capital-scarce economy needing foreign capital for growth.
• Source-based taxation reduces post-tax returns for foreign investors, increasing the cost of capital in India.
• This acts as a tariff on capital, discouraging investment and slowing GDP growth.

Tax Treaties and Legal Certainty

India historically used tax treaties to implement de facto residence-based taxation. The Azadi Bachao Andolan case provided legal certainty, where a valid TRC from Mauritius was enough to prevent further scrutiny by Indian tax authorities.

Changes in 2016

• The 2016 amendment to the tax treaty introduced a Limitation of Benefits (LOB) clause, altering the framework by allowing tax authorities to scrutinize beyond the TRC.
• This amendment aimed to curb abuse but fundamentally changed the rules of engagement, leading to uncertainty.

Investment Trends

• The shift in the tax treaty coincided with challenges in private investment.
• Foreign ownership in Indian companies rose from 8.38% in 2000-01 to 19.19% in 2015-16, but then stagnated and declined to 16.04% by 2024-25.
• In emerging markets, foreign ownership should rise as the economy integrates globally, but this hasn't been the case for India.

The Role of Judiciary and Policy Recommendations

• The judiciary should act as a check on executive overreach to uphold the rule of law.
• Predictability is crucial for foreign investors to assess risks adequately.
• Four policy projects are vital for India's economic growth:
   
  1. Remove customs tariffs.
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  1. Address blockages in input credit under GST.
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  1. Implement a carbon tax.
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  1. Adopt residence-based taxation.
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These strategies must be propagated within the bureaucracy, revenue departments, and the judiciary to facilitate economic efficiency and growth.