India has been trying for many years to persuade the country to renegotiate the Double Taxation Avoidance Convention (DTAC) between the two nations, but has been unable to lean too hard because of strategic reasons. Nearly 40% of India's foreign direct investment comes from Mauritius, much of which is third-country investment routed this way to take advantage of the tax treaty.
The IMF staff report flagged a slowdown in the global economy, particularly in Europe, a big risk to the country's economy forecast to grow 3.75% in 2013, and mentioned the end of its treaty with India as another high risk.
"Other risks to the outlook with a potentially high impact on the Mauritian economy include a protracted period of slower European growth and the end of double taxation agreement with India," the report said.
However, it assigned 'low probability' to such an event.
The report was issued as part of the IMF's Article IV consultation with Mauritius.
India has been trying to renegotiate its DTAC with Mauritius to curb its alleged misuse, but has had limited success so far because of the reluctance from the other side.
The India - Mauritius DTAC provides that tax on capital gains arising out of sale of shares can be levied only in the resident country of the investor. Mauritius does not levy any capital gains tax which means that an investor routing his investments through Mauritius into India escapes capital gains tax in India or in Mauritius. This has encouraged third country residents to route investment through Mauritius, a treaty abuse that India has been unable to stop.
There is also fear that a large part of investment routed through Mauritius is actually Indian money brought that way to avoid taxes, popularly called round tripping.
The two countries had set up a Joint Working Group in 2006 to put in place safeguards to prevent misuse of the, but eight rounds of discussions have not yielded much. Separately, India has proposed GAAR to prescribe that any business arrangement entered solely with the purpose of avoiding tax will be denied treaty benefit, which could also have implications for the India-Mauritius treaty. These rules will kick-in from April 1, 2016. The pressure has yielded some results with Mauritius agreeing to build in safety clause to ensure that the treaty is not abused.