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Tuesday, Oct 14, 2003

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FIIs breathe easy

FOREIGN INSTITUTIONAL INVESTORS must have heaved a sigh of relief after the recent Supreme Court ruling on their tax status. Though they have invested close to $20 billion in the decade since the market was opened up to them, the FIIs are widely perceived to have not had a successful time in India. Antiquated trading practices in the initial days, market manipulation, irrational exuberance and, of course, the steady decline in rupee's external parity all combined to erode steeply their portfolio values. And such of those which managed to last out the rough weather and generate a surplus, need no longer fear the taxman taking away a portion of their earnings.

The question before the Supreme Court was essentially two-fold: Whether these entities are at all resident in Mauritius in the sense of some active management control residing in that country to be eligible for the beneficial treatment under the tax treaty between the two countries and, second, even if the FIIs are to be regarded as notionally operating out of Mauritius, should they get a tax concession inasmuch as their incomes are anyway exempt by virtue of a specific provision under the local laws? The spirit of a double-taxation avoidance treaty is that no entity ought to pay tax twice on a single source of income merely because the local laws demand it. But insofar as these FIIs have been saved the Mauritian taxation by virtue of a special exemption, there can be no argument of inequity if they were taxed under the Indian laws. The apex court, rightly choosing to confine its inquiry to the letter of the law, ruled that the agreement clearly stipulated tests of residency of an entity though there may be a suspicion that some of these outfits are mere nameplates in Mauritius, their real seat of control being elsewhere. Similarly, the court held that the agreement speaks only of a `liability to tax' as opposed to actual payment, thus rendering the second argument irrelevant for this purpose. If Parliament chooses to confer unfettered powers on the Executive or that the latter, on geo-political considerations or otherwise, enters into an agreement with Mauritius that does not secure its fiscal interests completely, it is for the Legislature to intervene. To expect the courts to step in, on what after all is in the realm of the Legislature, would amount to taking judicial activism to new high, which is clearly unwarranted.

The agreement with Mauritius was entered into at a time when the concept of portfolio investments by overseas entities was not part of the policy framework in India. Minus the portfolio investments, the scope for double taxation from traditional economic ties between the two nations is negligible. It is entirely conceivable that the agreement suffered from a certain amount of loose drafting or deliberate vagueness as a concession to bilateral sentiment. It is for civil society to create the environment for the political establishment to institute policy changes.

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