Indian Government Reaffirms 'Management' Test For Mauritian Residence

by Lorys Charalambous, Tax-News.com, Cyprus

21 February 2003

In a continuation of the long-running saga over the Indian tax treatment of Mauritius-resident companies, the Indian Central Board of Direct Taxes (CBDT) has issued a new circular (see below) saying that companies incorporated in Mauritius will be taxed if, for all practical purposes, they are effectively managed from India.

CBDT issued the circular on February 10, saying that companies resident in Mauritius can be taxed in India if the department finds that the company is also a resident in India and is effectively managed from India. The circular states: "Where it is found as a fact that the company has its place of effective management in India then, notwithstanding its being incorporated in Mauritius, it would be taxed under DTAC in India."

This new development comes while the the Supreme Court is hearing a government appeal against a High Court order quashing a previous CBDT circular which effectively prevented tax inspectors from asserting India's taxation rights against Mauritius-based companies.

At issue is the extent to which the Indo-Mauritius Double Taxation Avoidance Convention (DTAA) allows Indian shareholders in Mauritian companies to take advantage of low-tax concessions in Mauritius in respect of their investments in India.

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 a Circular (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 the High Court famously 'quashed' last May, saying that the CBDT had acted ultra vires: 'Avoidance of double taxation would mean that a person has to pay tax at least in one country. Avoidance of double taxation would not mean that a person does not have to pay tax in any country whatsoever. In Mauritius, in terms of the statute a foreign company is not entitled to own any property, open any bank account, do any business. Several restrictions have been imposed in that country; as a result thereof no income may be generated in Mauritius and no income tax may be payable therein. Double taxation treaty clearly is not envisaged in such situation.'

The Delhi High Court judgement has created extreme unease amongst the international community investing in India through Mauritius, which the Government fears could have a major effect on the flow of foreign investments into India, hampering the overall globalisation of the Indian economy. Thus the Government has appealed against it.

The new Circular amounts to a gesture in the direction of the tax inspectors by reaffirming the exclusion from the DTAA of companies effectively managed from India, which had been put in doubt by the original Circular.

In the past, the Government has normally defended the DTAA when it has come under fire, and this latest move by the CBDT probably represents a tactical withdrawal by the Government to a line which it thinks it can hold.

Here is the text of the new Circular:

Direct Tax Circular No.1 - 2003 dated 10th February, 2003

Topic
DTAA - India and Mauritius

Sub Topic
Residential status

Summary
The CBDT has clarified that where an assessee is a resident of both the contracting States, then for the purpose of taxation it shall be deemed to be a resident of that contracting State in which the place of effective management is situated and not the State where it was incorporated, if the two are not the same

To
All the Chief Commissioners/
Director Generals of Income-tax
Clarification regarding residential status under Indo-Mauritius Double Taxation Avoidance Convention (DTAC) - Reg.
Reference is invited to the Circular No.789 dated 13.4.2000 issued by the Board where it was clarified that "wherever the certificate of residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence for accepting the status of residence, as well as beneficial ownership for applying DTAC accordingly.' The said circular specified the mode of proof of residence of an entity in Mauritius.

Certain doubts have been raised regarding the effect of the aforesaid circular, particularly whether the said circular would also apply to entities which are resident of both India and Mauritius. In order to remove all doubts on the subject, it is hereby clarified that where an assessee is a resident of both the contracting States, in accordance with para 1 of Article 4 of Indo-Mauritius DTAC, then, his residence is to be determined in accordance with para 3 of the said article, which reads as under:-

"3. Where, by reason of the provisions of paragraph 1, a person other than an individual is resident of both the Contracting States, then it shall be deemed to be a resident of the Contracting State in which the place of effective management is situated.'

In view of the above, where an Assessing Officer finds and is satisfied that a company or an entity is resident of both India and Mauritius, he would be free to proceed to determine the residential status under para 3 of Article 4 of DTAC. Where it is found as a fact that the company has its place of effective management in India, then notwithstanding its being incorporated in Mauritius, it would be taxed under the DTAC in India.

The contents of the circular may be brought to the notice of all Commissioners of Income-tax and Assessing Officers in your Region.

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