THE ECONOMIC TIMES

EDITORIAL

Double impact
BY INVITATION / SANDEEP PAREKH

[ SUNDAY, OCT 12, 2003 ]

The Supreme Court of India pronounced a landmark judgement a few days back on the Indo-Mauritius double tax treaty which will have international repercussions on the financial markets.

The judgement would introduce India as an even more attractive fund destination not only because of the tax benefits which would be available but even more so because of the certainty of taxation which is of great value to people who invest other people’s money in India e.g. pension fund managers or mutual funds.

The past decade has seen substantial investments into India via Mauritius because of a favourable tax treaty with the country. In early 2000, some tax officers started questioning some FII to prove their residence of Mauritius. This preliminary investigation resulted in a huge uncertainty for foreign investors and funds which approached the finance ministry. The government therefore, to quell uncertainty and a cataclysmic outflow of funds, issued a circular  on 13th April 2000 clarifying that a certificate of residence issued by the Mauritius authorities should be taken as sufficient evidence of residence of Mauritius. This circular was issued pursuant to the Double Tax Avoidance Convention between India and Mauritius which states that the determination of residence of a ‘person’ of Mauritius shall be made according to the laws of Mauritius where such person is liable to tax.

People’s Union for Civil Liberties and a retired income tax officer, Mr Jha, filed a writ petition before the Delhi High Court challenging the validity of the circular issued by the Central Board of Direct Taxes (CBDT). By an order dated 31st May 2002, the Delhi High Court quashed circular 789 of 2000 and held that the circular was ultra vires Section 90 of the IT Act which allowed treaties only for the purpose of avoiding double tax not for encouraging trade and investments (as was provided in the Preamble of the Treaty). It was further held that since Mauritius charged no capital gains tax, there was no question of ‘double’ taxation. It was also held that the circular took away the discretion of the income tax officer in determining the residence of a person and that right granted by statute could not be taken away by a mere circular. The HC even decided what was not part of the arguments and stated that “treaty shopping, which amounts to abuse of the Indo Mauritius Bilateral treaty, may amount to fraudulent practice and cannot be encouraged.” The HC order, thus, raised uncertainty amongst foreign investors regarding their tax liability in relation to their investments in India.

The HC order was challenged by a consortium of Mauritius-based companies called the Global Business Institute (represented by P.H. Parekh & Co and Mr Salve before the SC) and also by the government of India (represented by the Attorney General of India). After extensive arguments, the SC passed a judgement upholding the circular and reversing the findings of the Delhi HC on all counts. The court found that the treaty prevails over the taxing statute. Unless the treaty gives away something which the IT Act charged, the treaty would be meaningless. The court found that the argument that the treaty itself is beyond Section 90  of the Act “deserves short shrift” merely “on account of its susceptibility to treaty shopping on behalf of the residents of the third countries”.

Noting that there were benefits and problems of such treaties, the court found that the issue is one of policy and it would not like to interfere in the matter since the government is better placed to decide the pros and cons of the issue. “The loss of tax revenues could be insignificant compared to the other non-tax benefits to their economy.” Such practices might appear to be evil but “are tolerated in a developing economy, in the interest of long term development.”

The judgement very clearly puts across the view that there were policy reasons for the treaty to exist even if some people think that it would be morally unfair. With the court putting its imprimatur, the burden of removing the benefits now clearly available to foreign investors falls on the government alone. The Indian Prime Minister on his visit to Mauritius last year clearly promised the Mauritius government that the treaty will not be revoked. Besides, the Mauritius government has overhauled the transparency of its systems and with an agreement between their financial regulator and our Sebi, the possibility of Indian persons misusing the treaty to conduct clandestine or manipulative acts a la Ketan Parekh (no relation of mine) on the Indian stock market would be properly regulated. An Indian person/ company which is also a resident of Mauritius may or may not be liable to tax in India based on the facts of the case – the issue is covered by the tie breaker clause of the treaty.

The use of Mauritius route, which was always under a cloud for uncertainty and more so after the HC order, is now very clearly opened up for foreign investors to use. We should, therefore, expect funds far in excess of historical records to come via Mauritius. A foreign investor looks at the risk and returns of a country before investing. Given a relatively constant risk, the improved returns would make India a far more attractive destination. With the tax advantage, the Indian economy would be substantially more desirable to foreign investors and India should position itself well so that money badly needed by infrastructure projects etc are the beneficiaries of the increased competitiveness of India by virtue of the treaty. The loss of tax revenue would more than adequately be compensated by increased employment, more production and an increase in the standard of living of Indians.

The author is an advocate with P.H. Parekh & Co and a visiting faculty at IIM, Ahmedabad