July 26, 2012

abuse of double taxation avoidance treaties

Here is an editorial on the issue of double taxation avoidance agreement signed by India with over 70:

Obfuscating role of DTAAs 
India-Mauritius DTAA is being used for everything but what the concept stands for

Three weeks before an important meeting of Indian and Mauritian on the revision of the double taxation avoidance agreement (DTAA) between the two countries, the minister of 
foreign affairs, international trade and cooperation of Mauritius was camping last week in India and holding press conferences with the Indian media in what appeared to be an attempt to soften the hardline thinking on DTAAs among Indian tax and government officials. 

This was notwithstanding the fact our Prime Minister currently holding the additional position of a finance minster is not seen as someone being anywhere close to the hardline thinking group of which the previous finance minister, Pranab Mukherjee, was considered as a crucial member. Mukherjee played a key role in getting a draft of the General Anti Avoidance Rules (GAAR) on direct taxation ready and seeking its implementation as soon as possible regardless of whether the larger proposed Direct Taxes Code was approved or not. 

With influential members of the political establishment being on either side of revise-and-curb-allowances-under-DTAAs, with the one holding the status quo view being more influential right now, it is time to take a hard look at the original purpose and objective of a DTAA whether or not any of the DTAAs signed by India with over 70 countries meet them or not. In a world, and in an era encompassing a few centuries, where global trade has inevitably flourished, companies and individuals earn income and make profits from their business operations and transactions in multiple countries. It becomes not just unfair, but also unviable, for a taxpayer if the income or profit made from operations in a foreign country is taxed by that foreign country as well as his home country. 

It was precisely to remove this element of double taxation, treaties such as the DTAAs were conceived and implemented by countries across the globe. The idea was always to eliminate unfair double taxation in order for countries to encourage trade between themselves and attract foreign investments. It was never the purpose to do this by making the rate of taxation very low or almost zero. But this is not considered by the status quo proponents of India's DTAAs with all countries including with countries such as Mauritius which are un-deniably nothing else but tax havens since they charge zero or close to zero rates for income or capital gains taxation. 

Foreign investments into India, whether direct or indirect, are pouring in through such tax havens. About 37 per cent of foreign direct invesments in the country come from Mauritius-registered companies. Clearly, this is nothing but treaty shopping by companies from other countries and there is also the element of round-tripping by Indian companies which route their domestic investments through shell companies set up in Mauritius to evade domestic rates of taxation. 

Such misuse of DTAAs should not be allowed to continue regardless of the threat of foreign investments drying up if they are stopped. India-Mauritius DTAA use is perfectly legitimate if a global investment firm, with its home base in US, or a European country, sets up shop in Mauritius, garners funds from domestic Mauritians and then invests it in India. But if the source of funds are not Mauritian, as they pre-dominantly, then the DTAA ought to be immediately revised to prevent it from happening. 

Even the draft GAAR clauses are lenient in the sense that they only cover residency which only requires board meetings to be held in the other country and adequate manpower and capital to be deployed in the business. Capital requirement is minimal for investment companies seeking registration in Mauritius and even GAAR can not effectively be a party pooper. But a real revision of the India-Mauritius DTAA can provide the much-needed cleansing.

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