Foreign Investor Group Joins Indian Government Appeal Against Tax Ruling

by Lorys Charalambous, Tax-News.com, Cyprus

25 October 2002

A group of international investors has joined the Indian Government in its appeal to the Supreme Court against the Delhi High Court judgement that leaves the tax authorities able to challenge the benefits available to foreign institutional investors under the Indo-Mauritius Double Tax Avoidance Agreement (DTAA).

Uncertainty about the tax treatment of investments chanelled through Mauritius as a result of the judgement has caused consternation among existing investors, and has severely reduced the flow of inward investment to India, 40% of which flows through Mauritius, at a time when the Government is desperate to maximise FDI.

The judgement had quashed a circular issued by the Central Board of Direct Taxes (CBDT) clarifying that certificates of residence issued by the Mauritian authorities are enough to qualify investors for benefits under the DTAA.

Global Business Institute (GBI), a company incorporated under the laws of Mauritius, comprising asset managers, management companies, banks, custodians and international investors, recently filed a Special Leave Petition before the Supreme Court, appealing against the final judgement of the Division Bench of the Delhi High Court dated May 31, 2002.

GBI says it is worried about the uncertainty of foreign investors regarding their tax liability on their investments in India: "We are finding it difficult to market India to our investors. FIIs have open-ended schemes wherein investors enter and exit daily. Investors are also worried about exit prices because of any change in tax liabilities. It’s important to remember that these investors put in their money on the basis of existing tax laws and implications,” said a spokesman for the company.

The SLP filed by GBI, inter alia, challenges the power of the Indian income tax authorities to question residency of a Mauritius entity, arguing that determination of such residency is the sovereign right of the Mauritius government.

Until 2000, nothing prevented an Indian company (or individual) setting up a Mauritian company and using it to make tax-exempt investments in India; under the DTAA, capital gains tax is payable in only one country. If the Mauritian company is not 'effectively managed' from India, then Mauritian taxes apply, and CGT is nil in Mauritius. But in 2000, when it became popular to use this structure to escape capital gains tax on stock exchange investments in India, tax inspectors started issuing assessments on Indian companies they said were abusing the Treaty.

In response to complaints from genuine investors, the CBDT, a part of the Finance Ministry, issued the Circular (number 789 dated 13 April 2000) requiring tax inspectors to accept a Mauritian residence document (freely issued in Mauritius, it is said) as evidence that the Treaty should be applied. Circulars issued by the CBDT are enforceable regulations under the Income Tax Act, 1961. It is this Circular that was quashed by the Delhi judgement.

During its 20 or more years of operation, this is by no means the first time that the DTAA has come under fire, and it is noticeable that every time, the Indian government has leapt to its defence. For instance, in 1994 the Ministry of Finance issued a circular clarifying that capital gains derived by a resident of Mauritius by alienating shares of Indian companies shall be taxable only in Mauritius according to Mauritius tax law. There have also been a number of Indian court rulings over the years which have tended to support the DTAA against attempts to weaken the benefits it offers foreign investors.

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