Has the law with regard to taxation of foreign institutional investors (FII) changed as a consequence of the Vodafone verdict? Objection to the present unsatisfactory situation arose only in the context of investments being routed through Mauritius. The Supreme Court considered this issue and pointed out in Para 105 of the judgment. India is considered to be the most attractive investment destination.

India has received $37.763 billion in foreign direct investment (FDI) and $29.048 billion in FII investment up to March 31, 2010. Between April 2010 and January 2011, FDI inflows were $22.958 billion and FII investment $31.031 billion. Millions of rupees go out of the country only to be returned as FDI or FII investment. Round-tripping can take many formats like under-invoicing and over-invoicing of exports and imports. Round-tripping involves getting the money out of India to, say, Mauritius, and then bringing it back to India as FDI or FII investment. An Indian company with the idea of tax evasion can also incorporate a company offshore, say in a tax haven, and then create a wholly-owned subsidiary in Mauritius. It can then obtain a tax residency certificate (TRC) from Mauritius and invest in India. Large amounts, therefore, can be routed back to India using TRC as a defence (Article 4 of the Indo-Mauritian Double Taxation Avoidance Agreement defines a ‘resident' to mean a person liable to taxation by reason of his domicile in the contracting state).

The Supreme Court observed: “Once it is established that such an investment is black money or capital i.e. hidden it is nothing but circular movement of capital known as Round Tripping; then TRC can be ignored, since the transaction is fraudulent and against national interest.”

However the Court concluded that the facts may offer food for thought to the legislature and suggested adequate legislative measures to be taken to plug the loop hole.

But a genuine corporate structure set up purely for commercial purpose will have to be recognised. In case of fraud, the Court can pierce the corporate structure since fraud unravels even a statutory provision. Legislature never intends to guard fraud. TRC may be accepted as a conclusive evidence for accepting status of residents as well as beneficial ownership for applying the tax treaty but it can be ignored if the treaty is abused for the fraudulent purpose of tax evasion.

Limitation of benefit

The Supreme Court noted that our treaty with Mauritius does not contain any limitation of benefit (LOB) clause similar to the Indo-US treaty, wherein Article 24 stipulates that benefits will be available if 50 per cent of the shares of a company are owned directly or indirectly by one or more individual residents of a contracting state.

The Supreme Court said: “No presumption can be drawn that the Union of India or the tax department is unaware that the quantum of both FDI and FII do not originate from Mauritius but from other global investors situated outside Mauritius. Mauritius, it is well known, is incapable of bringing FDI worth millions of dollars into India.

If the Union of India and the tax department insist that the investment would directly come from Mauritius and Mauritius alone, then the Indo-Mauritius treaty would be dead letter.” The Court concluded: “We are therefore of the view that in the absence of LOB clause and the presence of Circular No.789 of 2000 (considered in Azadee Bachao ' s case) and the TRC Certificate, tax department cannot at the time of sale/disinvestment/exit from such FDI, deny benefits to such Mauritius companies by stating that FDI was only routed through a Mauritius company by a principal resident in a third country.” The Court also stated that TRC does not prevent enquiry into a tax fraud. Nothing prevented the Revenue from looking into special agreements, contracts or arrangements made by the Indian resident or the role of the OCB in the entire transaction.

Future of TRC

The TRC issued by the Mauritius tax office is proof that the investor is a resident of Mauritius and can take advantage of tax exemption on capital gains made in the Indian stock market. The withdrawal of the TRC benefits has been before the Government for well over 10 years. Even in the Azadee case, the Supreme Court pointed out that fiscal policy constraints may have prevailed in the overlooking of treaty abuses when it came to interpretation of the Mauritian tax treaty.

TRC is not the requirement of the treaty. It can safely be withdrawn as it is only one form of documentary evidence to prove tax residency. The Supreme Court has not barred investigation when the transaction appears to be sham. The Court only pointed out the way forward for the legislature in matters concerning FDI and the FII.

The ruling does not alter the existing view about tax planning and tax evasion. Both McDowell and Azadee Bachao continue to be good law. Introduction of general anti-avoidance rule will of course strengthen the case of Revenue in fighting tax evasion.

(The author is a former Chief Commissioner of Income-Tax.)

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