DTAA – a peep

By Vijay Kumar

These agreements were to fulfill the following objectives

• Facilitate investment and trade flow
• Prevent discrimination between taxpayers
• Provide fiscal certainty to cross border transactions and
• Contribute to attainment of national development goals.

India has comprehensive DTAAs with more than 65 countries and limited DTAAs covering income from airlines and merchant shipping business with more than 10 countries.

In pursuance of Section 90 of the Income Tax Act, the Government of India has entered into DTAAs with various countries for

• granting relief in respect of income on which tax has been paid under the Income Tax Act of both the countries; or

• the avoidance of double taxation of income under the Act, and under the corresponding law in force in that country; or

• exchange of information for the prevention of evasion or avoidance of income tax chargeable under this Act or under the corresponding law in force in that country,

• or investigation of cases of such evasion or avoidance; or

• recovery of income tax under the Act, and under the corresponding law in the other country in respect of the income, profits or gains; or

• promoting mutual economic relations, trade and investment

This had a strange result. Do you know which Country had topped in Foreign Direct Investment in India in the last four years? It is not USA, it is not Japan, It is not UK, it is not Korea, but it is little Mauritius.

The Mauritius factor :

A body corporate registered under the laws in Mauritius would be a resident in Mauritius and thus "subject to taxation" as a resident. Income Tax Act of Mauritius provided that offshore companies were liable to pay 'zero percent' tax. Thus, by bringing an offshore company within the definition of resident, not only was the benefit of offshore company extended to it but also the benefits of residency allowable under DTAA bestowed on it. This led to establishment of conduit companies in Mauritius. In effect, the whole exercise of avoidance of double taxation turned out to be avoidance of taxation altogether.

Foreign institutional investors (FIIs), realizing the opportunity, also channelised their investment into India through the Mauritius route. A few stockbrokers were considered to have exploited the same and contributed to huge inflow of monies to create undue fluctuations in the stock markets, which was identified as one of the causes of the securities scam, which was investigated by the "Joint Parliamentary Committee" (JPC). The JPC in its observation on the Indo-Mauritius DTAA had noted that RBI did not have information on FII inflows country wise. The External Affairs Ministry deposing before the JPC had brought out that there were similar problems pertaining to taxation of long-term capital gains with 17 other countries, to which the Ministry of Finance also agreed. Based on the deposition by various Ministries, the Committee had observed, “there could be substantial revenue loss due to the ‘residency clause’ in the Indo-Mauritius DTAA”. It, therefore, recommended that Companies investing in India through Mauritius should be required to file a declaration of ownership with RBI, to the effect that all the Directors and effective management was in Mauritius.

Landmark Judgement of Supreme Court

Income Tax authorities, recognizing the need to curtail the 'abuse' of the Indo-Mauritius treaty denied the benefit of the treaty to some offshore business companies (OBC) registered in Mauritius that had claimed exemption from tax by rejecting the certificate of residence furnished by them. Such OBCs were claiming exemption of capital gains from stock market operations, which gave the right of taxation of such capital gains to Mauritius.

Around the same time, there were fluctuations in the stock markets and general perception that the action of the department denying the benefit of Mauritius residency to some Mauritius based FIIs was the root cause for such fluctuations. It was projected that this would have or had resulted in huge outflows of foreign investment from India. To clear the doubts, and to clarify the intent of the Indo-Mauritius DTAA, the Board issued Circular 789 dated 13 April 2000, requiring the assessing officer to accept the certificate of residence granted under the local legislation of Mauritius to OBCs operating from third countries including India.

Considering a 'public interest litigation' (PIL), Delhi High Court quashed the above circular as bad in law on the grounds that the income tax officer was entitled to lift the corporate veil in order to ascertain whether a company was actually resident of Mauritius or not in exercise of his quasi-judicial powers and any attempt by the Board to interfere with this would be contrary to the Act.

However, the Honourable Supreme Court in the case of Azadi Bachao Andolan in 2003, upholding the issue of circular by the Board and the Indo-Mauritius DTAA, held that

• Indo-Mauritius DTAC? (1983) is not 'ultra vires' of the powers of the Central Government under section 90, on account of its susceptibility to “treaty shopping*”.

• Circular 789 of April 2000 issued by the Board falls within the parameters of the powers exercisable by the Board under section 119.

• The circular does not in any way crib, cabin or confine the powers of the assessing officer with regard to any assessment. It merely formulates guidelines to be applied in the matters of assessment of assessees covered by the provisions of Indo-Mauritius DTAA.

• Merely because, at a given time there may be an exemption from income tax in respect of particular head of income, it is not correct to say that the taxable entity is not liable to taxation.

The CAG in its report to Parliament in 2005 had on this subject observed that

• A well-directed and clear strategy was not in place to remove inconsistencies and shortcomings in DTAAs especially those relating to definition of permanent establishment, limitation of treaty benefits, disallowing or consciously allowing ‘treaty shopping’, amendment of DTAAs and enforcing exchange of information clauses effectively.

• Cost benefit analysis of DTAAs had not been conducted.

CAG recommended that

• DTAAs may be examined critically through a phased and well monitored programme so that interests of revenue are safeguarded and one sided concessions are avoided.

• the Board may assess the costs and benefits from each DTAA transparently and objectively, especially as DTAAs are not placed before Parliament.

• MAP, EOI and recovery of tax be suitably codified and implementation monitored so that there is consistency and clarity in action being taken by assessing officers.{MAP- mutual agreement procedure; EOI- exchange of information}

• database of FIIs and sub accounts relating to all entities operating in India is prepared and their liability to tax examined critically so that benefits of DTAA are availed only by assessees actually and rightfully entitled to the same.

• the Board may issue necessary clarification to ensure correct and proper taxation of income arising to FIIs/sub accounts

• the Board strengthen the mechanism of coordination with regulatory bodies so that vital information relating to the income of FIIs/sub accounts is obtained regularly and acted upon promptly by assessing officers with a view to bringing the same to tax, if necessary by bringing in a suitable amendment to the Act

• clear procedures be introduced and implementation monitored so that regular assessments of income from maritime business are seriously made and assessing officers do not treat issue of NOCs as an end in itself.

• the Board unambiguously clarify issues such as incidence of surcharge and the option of availing concession under DTAA and the Act simultaneously, for the same assessment year for different sources of income, so as to ensure consistency in assessments and prevent loss of revenue

• Board may issue guidelines for regulating credit to taxes paid abroad and specifying the manner of treatment of tax credit, so that assessments are consistently made and interests of revenue are safeguarded

Without doing all these adding one more country to the DTAA does not really help the country. Is the Board listening?