With the amended India - Mauritius Double Tax Avoidance Agreement removing the advantage that allowed investors to avoid paying capital gain taxes in India, Moody's Investors Service India on Monday termed the changes as credit negative for Mauritius.
"The amended treaty removes a longstanding advantage that allowed investors to avoid paying capital gain taxes in India by channelling their investment through Mauritius, " the American rating agency said in a credit outlook report 'Mauritius' Tax Treaty Amendments with India Are Credit Negative'.
"The taxation agreement is credit negative for Mauritius because its financial centre will be a less attractive platform for investing in India than it used to be, " it said.
"We estimate that a curtailment of new investment flows through Mauritius would cause a deterioration in the balance of payments equal to 1 percent - 2 percent of GDP annually, and consequently put pressure on Mauritian foreign exchange reserves, " it added.
However, a sharper shift in investor sentiment would have more dire consequences, Moody's said.
The report said Mauritius' financial industry is a key economic pillar and primary source of net financial inflows from abroad.
The tax changes will especially weaken Mauritius' balance of payments, thereby increasing its external susceptibility.
Last week, India announced signing a protocol agreement with Mauritius to prevent evasion of taxes on income and capital gains by entities of either side.
An Indian finance ministry statement said this protocol will tackle long - pending issues of treaty abuse - - where ill - gotten money is first sent to Mauritius through havala transactions, and then comes back as a legitimate investment.
This is called round - tripping.
Moody's said companies using the DTAA operate in Mauritius under a Global Business Company 1 (GBC1) license are subject to Mauritian tax jurisdiction, and benefit from an advantageous tax regime, including low corporate taxes and a zero percent capital gain tax.
The report cited the Financial Sector Commission of Mauritius to say that at the end of 2014, Mauritian companies with GBC1 licences held $200 billion in Indian assets, constituting 38 percent of their $520 billion total assets held worldwide, including in Mauritius.
"In an unlikely scenario in which investors no longer leverage Mauritius for new investment in India, a sudden stop in investment flows would cause a stronger deterioration in the Mauritian balance of payments, " it added.
In this connection, in a case involving Indian income tax authorities and sale of shares by Mauritius - based Copal Research to a Moody's group company based in Cyprus, the Delhi High Court has ruled on the non - taxability in India of gains from the sale of these shares.
India's revenue department has filed an appeal against the decision in the Supreme Court.
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