Earlier this month, the International Consortium of International Journalists published over 200,000 confidential documents from the offices of Conyers Dill & Pearman, a Bermuda-based law firm that allegedly aids large Western businesses to set up letterbox companies in Mauritius aimed at making tax-motivated investments in Africa and Asia.
Not surprisingly, the leak has reignited the debate on multinational tax avoidance and how businesses use tax-friendly jurisdictions to channel funds from one country to another in order to minimise their overall corporate tax liability.
The ‘Mauritius Leaks’ comprise names of some of the most popular brands in India and globally. Pertinently, the leaks cannot and do not conclusively establish any wrongdoing on the part of these businesses, and the tax arrangements in question need to be examined in view of the provisions of the Income Tax Act and the relevant double taxation avoidance agreements.
The India-Mauritius tax treaty has been a subject matter of controversy and debate ever since it was signed over 30 years ago. Before 2017, Article 13(4) of the tax treaty exempted capital gains arising from sale of shares in an Indian company at the hands of Mauritian residents.
And the effective capital gains tax rate in Mauritius was zero per cent, which is why a majority of the largest foreign incorporated corporations that invested in India over the last decade did so through Mauritius.
The capital gains exemption in the treaty was plugged in 2017, paving the way for India to levy capital gains tax involving sale of shares in an Indian company. However, till date, the tax treaty does not contain a general anti-abuse clause to tackle round tripping of funds or treaty-shopping arrangements.
While India’s tax treaty with Mauritius contains provisions for exchange of tax information, any information requested has to be “foreseeably relevant” for giving effect to the tax treaty or the Income Tax Act.
A blind or fishing expedition is thus not permitted. In the absence of extensive, worldwide information-sharing network, wealth is usually not repatriated to India where it belongs, but shifted to new, non-collaborating secrecy jurisdictions.
As part of the base erosion and profit shifting (BEPS) project, the OECD recommended that countries adopt a principal purpose test in their tax treaties to deny inappropriate treaty benefits.
Both India and Mauritius have signed the OECD’s Multilateral Instrument (MLI) designed to implement some of the BEPS recommendations. However, Mauritius has conveniently kept India outside the network of tax treaties that are covered under the MLI.
It is, therefore, vital for India to put pressure on Mauritius and renegotiate its tax treaty to include a principal purpose test to deny tax arrangements that do not have any genuine commercial substance and are primarily meant to obtain a treaty benefit. In the absence of such a provision, Indian courts, who are bound by the principle of pacta sunt servanda (agreements must be kept), would be hesitant to endorse claims of treaty abuse.
It is true that some of these arrangements would get captured under the newly incorporated general anti-avoidance rule (GAAR) in the Income Tax Act. However, India’s domestic GAAR is narrower that the OECD-recommended “principal purpose test” as GAAR uses the “main purpose” test.
Under the principal purpose test, the tax authority may deny tax benefits if obtaining a tax benefit was “one of the principal purposes” of a tax arrangement.
Besides, the safeguards available under the Income Tax Act before invoking GAAR are not available in case of the principal purpose test.
By and large, it is the global industry of tax advisers such as accounting firms, law firms, banks who assist businesses in aggressive international tax avoidance. The existence of a wide tax treaty network comes handy to achieve the desired tax outcome.
One effective way to strengthen India’s tax administration in this regard is to supplement India’s domestic GAAR regime with a mandatory tax disclosure regime for tax advisers. Countries such as the United Kingdom, South Africa, Canada, among others, already have in place detailed tax disclosure rules for tax advisers.
It is necessary for India to mull over a range of policy options to target corporate tax avoidance and allocate separate funds for addressing challenges faced by tax officers in enforcing anti-abuse rules.
We have some serious catching up to do on the long-awaited corporate tax reform in the coming years.
The author is a lawyer