Indian Government About To Challenge High Court Mauritius Ruling

by Lorys Charalambous, Tax-News.com, Cyprus

19 September 2002

Reports in India suggest that the central government will soon appeal in the Supreme Court against the Delhi High Court's decision to quash the April 2000 CBDT circular that barred income-tax inspectors from querying the Mauritius residence asserted by foreign institutional investors (FIIs) seeking tax benefits under the India/Mauritius Double Avoidance Agreement (DTAA).

There has been consternation among foreign institutional investors and brokers since the High Court decision, but it is said that the government has assured foreign institutional investors that the issue will be resolved. The Government is thought to be about to challenge not just the particular issue dealt with by the ruling, but to seek clarification about the powers vested with the Central Board of Direct Taxes (CBDT) to issue circulars interpreting the Income Tax Act.

Foreign investors are said to have been removing funds from India during the last few weeks. “Global fund managers are increasingly indifferent about India. After disinvestment setbacks, investors do not want problems with regard to tax matters. At the same time, emerging markets are performing better over the past couple of weeks. India has underperformed during this period. Fresh inflows are unlikely till the government sorts out the matter related to Mauritius-based entities,” a fund manager at a US-based mutual fund told the Economic Times.

After the High Court's decision, the Indian Ministry of Finance and Company Affairs set up a working group to examine the functioning of the Mauritius India Double Taxation Avoidance Agreement (DTAA). The mandate of the group was to suggest ways to improve the administration of the treaty and it has been looking at ways and means of exchange of information and documents to establish the tax residency status of entities operating from Mauritius.

After visiting Mauritius, the working group suggested various modifications to the DTAA, including the introduction of a clause which would prevent India entities calling themselves residents of Mauritius, and a requirement that an Overseas Corporate Body (the name given to a company eligible for exemption under the DTAA) should have at least 60% ownership by Non-Resident Investors (NRI).

These changes will impact Indian corporate groups which take the Overseas Corporate Body (OCB) route and set up subsidiaries in Mauritius, merely to avoid taxes in India.

Until now, nothing has prevented an Indian company (or individual) setting up a Mauritian company and using it to make 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. 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.

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