India has decided to adopt a carrot-and-stick approach towards Mauritius while renegotiating the Double Taxation Avoidance Agreement and bring it in line with the model treaty finalised by the finance ministry.

The carrot comes in the form of a $100-million line of credit through the Exim Bank of India to help Indian companies set up shop in Mauritius. "The amount is significant by their standards and will help their economy," said an official.

The carrot was necessary because the India-Mauritius DTAA provided for periodic reviews of the agreement, but did not allow the reopening of the treaty unless both countries agreed to it, senior government officials said.

In case this does not help in convincing Mauritius, the government has indicated it will wield the stick by giving tax benefits similar to those available under the Mauritius DTAA to countries like Singapore and other Asean members with which it is negotiating comprehensive economic co-operation agreements.

This will take away Mauritius's advantage as an investment destination.

India wants three key changes in the Mauritius DTAA to improve tax collections from companies coming through the Mauritius route, but its request has not been met so far.

In line with the model DTAA, the key change is a shift from residence-based taxation to source-based taxation.

Under the current DTAA, companies incorporated in Mauritius are considered "residents" of Mauritius for taxation purposes. However, the provision has been misused by some, which have formed conduit companies to avoid paying tax in India.

A certificate of residence issued by the Mauritius government allows a company to claim exemption from the capital gains tax. The model treaty has sought to plug this loophole.

It also wants to review the "limitation of benefit" clause to check treaty shopping, under which companies from high-tax countries use tax havens like Mauritius to set up residency. Thirdly, it is also proposed that the rates of the withholding tax be reworked.

A joint study group on the CECA with Mauritius has favoured reworking the DTAA. India is also negotiating DTAAs with Chile and Bosnia, based on the model worked out by the finance ministry after the United Progressive Alliance came to power in May this year.

Finance Minister P Chidambaram on Friday told Parliament the government wanted to revisit the provisions of the DTAA with Mauritius, which has been in place since 1983. India's DTAAs with Malta, Zambia, Qatar, and Cyprus are also proposed to be reopened.

Mauritius has also taken some steps like barring the registration of companies with parent in India to check misuse of the DTAA. But this has not been found to be enough by India.

Advantage India

• Carrot: $100 million line of credit through the Exim Bank of India. The move will encourage investments by Indian companies in Mauritius
• Stick: India will give similar tax benefits as part of bilateral trade deals with countries like Singapore and Asean members, which may affect the benefit that Mauritius enjoys under the double taxation pact