Of late, with the civil society movements upping the ante against black money and Vodafone tax litigation, FDI routes like ‘Mauritius Route’ have been in the thick of controversy. This legal snapshot explores the policy options in this context
In its July 6th, 2012 edition, Times of India asked a very pertinent question in the wake of latest tax controversies and ‘Mauritius Route’ being under the cloud: “How far will a country go to secure a favourable deal for itself? Pretty far, it seems. Mauritius has offered a couple of sundrenched islands to India as part of a trade and investment deal. While the offer has been talked about for a while, Mauritius has revived it – at a time when it’s very keen on persevering with the 1983 double taxation avoidance treaty with India.”
Since double taxation is inequitable, many nations make bilateral double taxation avoidance agreements with each other. Such agreements generally avoid and reduce the burden of juridical double taxation. Their primary objective is to limit the taxes that can believe by the contracting states under their domestic tax law. The contracting states allocate the taxing rights under a contractual agreement and the residence state grants double tax relief if it arises.
Further, it could amount to breach of the rule of “pactasuntservanda” as contained in Article 26 of the Vienna Convention on the Law of Treaties, 1969, but the same is subject to the discretion of the executive as it is a directive principle of the Constitution of India to honour international treaties. Nonetheless, if the limitations of benefit clause come in, it would be a good defence for genuine investors using the Mauritius route to be able to defend their inbound structures to India. The idea is to tax flyby-night companies, which did not have their management and control in Mauritius but only using it as a conduit.
The Indian Government has explicitly suggested that it wants certainty and predictability in the treaty which has been in existence since three decades now. In fact lately the press reports suggest that with the proposed amendment in the Income Tax Act on the GAAR provisions, even Mauritius has stepped up lobbying with such intentions and purposes.
To preserve its importance as a tax haven, the island nation is nudging India to include a ‘grandfathering provision’ while finalising the General Anti-Avoidance Rules (‘GAAR’) that have put off many foreign investors. Such a grandfathering clause will spare existing investments from capital gains tax and make GAAR applicable only on new inflows on and after the date the rules come into force. Even in recent rulings pronounced by the Authority of Advance Rulings, it has been held that the tax authorities in India cannot arbitrarily tax the investments routed from Mauritius.
It has also been proposed to introduce a ‘limitation of benefits’ (‘LoB’) clause in the treaty. Such a clause is quite popular globally and also exists in the India-Singapore tax treaty. Investors coming into India through Singapore have to meet certain conditions such as minimum expenditure of $200,000 in Singapore and a track record of two years to avail the DTAA benefit. AnLoB clause will spell out the conditions that foreign investors will have to fulfill to avoid tax while setting up investment vehicles in Mauritius. Such a clause will enable the Indian government to define the parameters that will differentiate a conduit company with the one with substance.
A joint working group of the two countries has been involved in the process of thrashing out details of the clause at its meeting which was schedule to held during August 22-24.
In addition to the above, it has also been proposed that treaty obligations should generally not be overridden by domestic law provisions and the scope of override (if any) should be both narrow and clear.
However, it is apposite to note that the process of renegotiation is both political and bureaucratic, and this makes predictions on expected timelines harder to formulate.
In September 2006, Indian government endeavoured to include clauses to check round-tripping of investments in the said tax treaty. It was proposed by India that only companies listed on a recognised stock exchange and have a total expenditure of $200.00 or more on operations in Mauritius for at least two years prior to the date on which a capital gain arises, be eligible for capital gains tax exemption under the treaty. In response, in October 2006, the Mauritian government only announced that it would tighten up rules on the issuance of Tax Residence Certificates, and the same would be issue for only one year at a time. However, Mauritius said it had not received any official report of round-trippingoffence from the Indian authorities.
It is clear that round tripping can lead to tax revenue leakage and inflow through this method is not really FDI and, hence, it must be checked. Although an arrangement involving round trip financing has been deemed to be an arrangement lacking commercial substance under the General Anti Avoidance Rules (‘GAAR’) under Direct Tax Code, thus, prone to be declared as impermissible, measures like aggressive investigations by the International Tax Division of the Tax Department in case of suspicious transactions and strengthening of the DTAA by streamlining provisions relating to exchange of information to facilitate routine automatic flow of information can help address the problem. Making KYC norms more stringent to ascertain beneficial owner of funds, putting appropriate regulatory checks and imposing penal consequences could work. The major incentive for round tripping is the capital gains benefit that the present DTAA provides. Though the Supreme Court in Vodafone’s case has expressed its reservation on availability of Mauritius tax treaty benefit in case of round tripping, a renegotiation of the DTAA to curb misuse of the treaty in cases like round tripping could have a discouraging effect on this practice.
No matter how strongly some sections of the society or the government feel about treaty shopping by the investors, yet the treaty cannot be simply junked, as it has served a far greater purpose. However, it cannot be forgotten that Mauritius has geopolitical importance;it serves as a base for gateway to Africa and a route for outbound investments by corporate India. And in our reformatory zeal, it must also not be forgotten that the Hon’ble Supreme Court of India, in Azadi Bachao Andolan case, further upheld the Mauritius route in unequivocal terms holding that, “there are many principles in fiscal economy, which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long term development. Deficit financing, for example, is one; treaty shopping, in our view, is another”.
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