May 03, 2012

good impact of india's new tax avoidance rule

A little over a month back I was asked to write an editorial (in the newspaper I work for) on Indian direct tax system's new General Anti-Avoidance Rule. With the help of the very useful insights provided by my much-senior colleague, I came up with the following:

GAAR & the Mauritius route

No tears will be shed if the Mauritius route is closed for those investors who not being genuine residents of that country are using it only for tax mitigation purposes just because it is legally possible for them to do so. True, the general anti-avoidance rule (GAAR) for direct taxes, which can make this happen, is being sought to be implemented earlier than the entire Direct Tax Code of which it has been an important part for the past few years. But any progressive measure is welcome, even if it comes a tad earlier than some others.

India has double taxation avoidance (DTA) treaties with over 70 countries, including Mauritius. The foreign portfolio investments and foreign direct investments coming into the country from Mauritius is certainly not small. The intention of any DTA treaty between two countries, whose businesses trade with each other, is that no income should be taxed twice and not that it is tax-free or taxed at unrealistic low rates. But some countries inevitably get tempted to structure their laws such that they become tax havens for companies operating elsewhere.

But India is not a tax haven to encourage such practices by any such country. Tax havens do not attract investments in their own economies, otherwise the Mauritian stock exchange would be much larger than the Indian stock market. The benefits of a DTA treaty should accrue to genuine domestic businesses. If non-domestic businesses operating in a country counterparty in a DTA treaty which India has signed up it is a violation of the core principles and ethics behind a DTA treaty.

It is not that foreign investors or global businesses want to evade the payment of tax on their income but in planning for their taxes (a legitimate act any tax payer in the world has the right to perform) they scan the globe for structures which enable them to pay the lowest taxes. Their search ends at countries which serve as tax havens.

Mauritius, for instance, offers very attractive term for global businesses and investors to seek a domestic corporate registration even if little or no activity of that business or investor would take place in the domestic economy. The maximum income tax on declared income is just 3 per cent. The DTA treaty between Mauritius and India is the first reason why global companies wanting to invest in Indian assets would want to consider routing their investments through Mauritius.

India also has DTA treaties with those very countries which are the real home countries of the Mauritius-based global companies. If Mauritius did not offer them a way to obtain residency permits and avail of the India-Mauritius DTA treaty benefits then they would stay in their home countries, invest in India and avail of whatever benefits DTA treaties between their home countries and India offered.

Mauritius has not been amenable to repeated Indian government efforts, in the past decade, to stop the misuse of residency permits given to businesses that are not truly domestic. If the GAAR provisions are able to plug the loopholes that tax havens such as Mauritius offer then it will serve a great purpose which India has been struggling to achieve for the past one decade.

The India-Mauritius DTA treaty took place in mid-1980s when there were geo-strategic reasons for the Indian establishment to overlook the possibility of Mauritius becoming a tax haven. Today, India is in a position to be unafraid to face any geo-political consequences. Using the GAAR fearlessly, therefore, will be a welcome step in that direction.

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