The Indo-Mauritius tax treaty, signed in 1983, spares investors based in Mauritius from paying capital gains tax on the sale of shares of Indian companies. The treaty made it clear that capital gains from sale of shares by residents in Mauritius does not tax capital gains, the tax rate is zero.

The official reason is that India wants to curb treaty shopping, a practise in which residents of a third country take advantage of a beneficial tax treaty between two countries to lower their tax liability. However, the fact that Mauritius has no domestic companies or financial investors capable of investing larger sums in India is well known to the government. The real reason is that India is confident that investors will come directly even if they have to pay tax.

It wants to tax foreign investors at the same rate as domestic ones. Currently, the long-term-defined as more than one year - capital gains tax for equity is zero while it is 10% for shares held for less than a year.

Mauritius has resisted re-working the treaty with India. But the global regulatory environment towards so-called tax havens has hardened. As a result, Mauritius has agreed to resume a dialogue with India through a joint working group, comprising officials from both countries. The JWG had broken down in 2008 after six rounds of talks. The treaty can be reworked only if Mauritius agrees to do so and that will be long haul.

It may agree to re-work the pact on information exchange to end banking secrecy and provide information to India's tax authorities and to agencies like CBI or ED even if such information is not of domestic interest to Mauritius. However, Mauritius would resist forgoing the beneficail tax treatment on capital gains. India wants to ensure that shell companies in Mauritius don't enjoy tax benefits.But most companies registered in the Island nation have done so only to invest in India. Thus, Mauritius may never agree.

India will introduce a new direct taxes code in April 2012 that will give authorities the power to lift the corporate veil and look at the substance of a deal. But if an entity being probed is located in Mauritius, then the authorities there have to agree.

Surely not in 2011. First, Mauritius has to agree to re-work the treaty and this can happen only after rounds of JWG talks. Secondly, after Mauritius agrees, it would take at least a year to re-work the treaty.

No. With China's strategic 'string of pearls' approach, India needs Mauritius to counter the threat of losing its foothold in the blue waters.