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India And Mauritius May Have To Change DTAA

by Lorys Charalambous, for, Cyprus

18 August 2006

The spat rolls on between India and Mauritius over the use by Indian investors of the countries' Double Tax Agreement to 'round-trip' through Mauritius in order to minimize Indian taxes.

The long-term affair has seen the Indian tax authorities making multiple attempts to lessen use of the DTAA by Indian investors, but these have been denied by the courts, while the Government itself has seemed relaxed about the situation.

Recent reports however suggest that the Indian government may ask Mauritius to introduce a capital gains tax to counter abuse of the DTAA, although the Mauritian government has pointed out that the tax treaty cannot be changed unilaterally. An alternative would be source-based taxation of the income earned by Mauritius-registered companies investing in India; but this equally flies in the face of the terms of the treaty.

Two factors have perhaps changed the situation: one is the signing of a DTAA and a Closer Economic Co-operation Agreement (CECA) between India and Singapore which has noticeably less favourable conditions for investors into India; and the other may be a recent case in which the Indian Securities and Exchange Board (SEBI) fined Citibank in Mauritius Rupees 1m for infringements of its rules.

Citibank had issued offshore derivative instruments in Mauritius and according to SEBI had incorrectly declared that none of them had been bought by Indian residents; an Indian investor is of course not entitled to the benefits of the DTAA unless he can genuinely assert Mauritian residence - the crux of the complaints of the Indian tax authorities.

Citibank claimed that SEBI had misconstrued the terms of the regulations, and that it was not aware of the identity of underlying investors; but SEBI's adjudicator said: "A professionally managed Citigroup, having its presence in the financial/capital sectors world wide, is expected to have compliances of highest level, and which is found lacking in the instant matter. It seems that the noticee has failed to give any significance to the information to be given to the Regulator, on the ODI’s (Offshore Derivative Instruments) issued to OCBs (Offshore Corporate Bodies). It is a common knowledge and fact that OCBs had mis-utilised ODI route to park their illegal money and to manipulate Indian securities market without the fear of their identity getting detected. So the issues . . . are decided to the effect that the noticee has violated the declaration furnished in the fortnightly statement on issue of ODIs submitted to SEBI (As on August 15, 2003).

The adjudicator applied the maximum permitted penalty. It is not known whether Citigroup will appeal the ruling, which was issued on 11th August, but that affair can only increase the pressure on the Indian government to take some sort of action to change the current situation.

The Adjudicator said: "In the Committee's view, there is a need to have a fresh look at OCBs' operations after an in-depth study of inflows and outflows on a holistic basis covering their PIS and non-PIS transactions. The exercise should also include identification and plugging of loop holes and possible establishment of a proper regulatory set up with stringent penal provisions for violations. The regulatory provisions should inter-alia enable detection of cases where same set of individuals have formed more than one OCB and have their investment spread across the OCBs to escape provisions of SEBI. The Committee feel that the suggestions made by RBI for stipulation of a minimum paid up capital for OCBs and adoption of same registration procedure as applicable to FIIs (Foreign Institutional Investors) deserve careful consideration by the Government. The Committee would like the Government to review the ban imposed on OCBs in the light of the above and clearly lay down the responsibility to a particular agency to oversee the OCB operations."

"SEBI has expressed suspicion that some of the Indian promoters have purchased shares of their own companies through Participatory Notes issued by sub-accounts of FIIs. This mechanism enables the holders to hide their identities and enables them to transact in Indian Capital Market. The Committee note that SEBI has since directed FIIs to report about details of the Participatory Notes as and when issued by them. The Committee suggest that failure on the part of FIIs to report about issue of PNs should be viewed seriously and should entail stringent punitive action. It should also be ensured that this instrument is not misused in any way to manipulate the Indian Securities Market."

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