In a move that could potentially pull the Indian equity markets lower, apart from the higher core inflation in the US, the government has ended tax relief for foreign portfolio investors (FPIs) from Mauritius. Although the agreement between India and Mauritius was signed on March 7, the amendment was made public for the first time on Wednesday.

Mauritius-faced FPIs may face higher scrutiny after the amendment in the India-Mauritius tax treaty introduced a principle purpose test (PPT) to prevent treaty abuse by taxpayers. Under this standard, a foreign investor has to show tax departments that they did not choose a particular jurisdiction to avail beneficial tax rates. It is a common practice amongst global funds, including the US and European-based ones, to route their India investment through Mauritius, Singapore, Netherlands, or Luxembourg since these countries have favorable tax agreements with India.

Experts told the Economic Times that this could also open exits of past investments to questioning, with no grandfathering provisions likely to insulate them from the amended rules.

Foreign funds can pass the PPT by showing substantial presence, which usually involves a permanent office, a workforce, and revenue generation. The fund should be compliant with PPT conditions at the time when the fund was started.

In February, the Mauritius cabinet agreed to amend the Double Taxation Avoidance Agreement (DTAA) with India to comply with standards prescribed by the Economic Co-operation and Development (OECD), an intergovernmental organization. Although the agreement between India and Mauritius was signed on March 7, the amendment was made public for the first time on Wednesday. During the three-day state visit of President Draupadi Murmu to Mauritius in March this year for delegation-level talks with Prime Minister Pravind Jugnauth of Mauritius, the two leaders witnessed the exchange of four agreements including the protocol to amend the India-Mauritius Double Tax Avoidance Agreement (DTAA) to make it compliant with Base Erosion and Profit Shifting (BEPS) Minimum Standards.

According to depository data, Mauritius-based FPIs owned shares worth Rs 5.2 lakh crore in April 2017, contributing to 20 percent of the total FPI assets in India. According to the Reserve Bank of India, Mauritius was also the top source of FDI inflows into India between FY14 and FY18. In those five years, Mauritius accounted for $43 billion worth of FDI inflows, contributing about 30 percent to overall FDI investment into India during the period.

Mauritius is currently the fourth largest source of FPI flows with funds from the island nation owning shares worth Rs 4 lakh crore, or 6 percent of total FPI assets in India. In FY23, Mauritius was the second largest source of FDI with inflows to a tune of $6.1 billion, data showed.