Treaty shopping by investors to be over if island nation budges on capital gains tax.

Even as the chorus of demands against tax havens is gathering momentum at home, Mauritius, after years of dilly-dallying, has softened its stand on taxing capital gains on investments routed through the island nation to India by third-country investors.

In taxation jargon, such routing of investments is called treaty shopping and is used as a tool for abusing the Double Taxation Avoidance Agreement between India and Mauritius.

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As such, India and Mauritius will shortly start renegotiation of their tax treaty with regard to treatment of capital gains, which is supposed to be a major stumbling block in revising DTAA.

India has been pushing Mauritius for a long time to revise the treaty, since a provision of not taxing profits made out of share sale in India by a resident of Mauritius is being misused by investors from third countries.

While a joint working group was constituted in 2006 to renegotiate DTAA with Mauritius, its last meeting was held in 2008.

The negotiations were stalled for several years as Mauritius was not ready to revise DTAA with India because it would have affected interests of its investors.

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An amendment in the treaty would change the way foreign investors structure their investments in India.

The review is aimed at preventing evasion of taxes as over 40 per cent of the total foreign direct investment in India is made through Mauritius, which is a low-tax jurisdiction.

"Treaty renegotiation with Mauritius will start in a few days. . . It will include all important areas," a finance ministry official told Business Standard.

He said Mauritius has agreed for this after India and global forums put pressure on it.

The Mauritius government has already started providing banking information and assistance in collection of taxes, the official added.

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India retains the right to tax capital gains arising to non-residents under most of its tax treaties, except Mauritius.

Under the treaty, only Mauritius has the right to tax such gains, but it does not levy any tax in line with its domestic laws.

As a result, a Mauritius-based investor does not pay capital gains tax either in India or in Mauritius.

This has resulted in foreign investors of third countries routing their investments through Mauritius.

While India wants to revise the tax treaty to provide for taxation of such income at home, it may not seek to completely eliminate the capital gains exemption, as that might hurt genuine investors.

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The two countries may discuss introducing some anti-treaty shopping provisions.

Another finance ministry official said as Mauritius is a friendly country with a huge Indian population, the tax exemption on capital gains was given to benefit investors there, but this was misused and many companies started routing their investments through the island to get tax benefit.

He said the idea was to tax fly-by-night companies which did not have their management and control in Mauritius.

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India has already started raising tax demands against the companies and many of these cases are being disputed in various courts.

India has also set up an overseas Income Tax unit in Mauritius.

Besides, the Direct Taxes Code, proposed to be implemented in April 2012, the government will introduce general anti-avoidance rules to override provisions of tax treaties under specific situation.

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"On the other side, there is Global Forum on Transparency and Exchange of Information for Tax Purposes.

"We are vice-chair in the peer review process in the group, which has been able to make considerable headway in aligning Mauritius with the requirements for transparency and exchange of information.

"So off late we have been getting some positive inputs from Mauritius," the official said. Civil society movement against black money has gathered momentum in India. One of its demands is to disable operations of any bank which belongs to a country that is a tax haven.