Plugging the Mauritius Route

The Stock Markets are not exactly with this googly. In fact the free fall on the BSE despite a reduction in the securities transactions tax soon after the budget, was mainly on this count, regardless of what your television analysts are telling you.
Finance Minister Pranab Mukherjee has finally done what everybody has been demanding should be done for a long time but never had the guts to do – plug the Mauritius route for round tripping.
Mukherjee managed to slip it through, by a simple amendment to section 90 and Section 90A  of  the income tax law, a clause which says that an entity cannot claim benefits of a tax avoidance treaty signed with a tax haven, just by “submission of a tax Residency Certificate containing prescribed particulars”. The firm or individual has to prove that it does really do most of its business there.
India for long, was trying to plug a loophole in its tax laws by which firms used to round trip through Mauritius to buy and sell shares here while avoiding paying capital gains. By declaring they were Mauritan residents they could avoid payiong any tax all as India has Direct Tax Avoidance Agreement with the zero tax island nation.
Mauritius consequently has been a funnel for pouring investments into India, some of which were perhaps shady. India had started talks with the island country on renegotiating the treaty but Mauritius officials were not exactly happy about anyamendment to the tax treaty which could affect investments into the island country, and were for long dragging their feet over it. 
Mukherjee simply circumvented these long drawn out negotiations and attacked the opportunist money which was often being routed through these islands, avoiding Indian taxes. The legal tweak is expected to address concerns that investments into Indian stock market are often routed through Mauritius to avoid short term capital gains tax of 10 per cent. About 40 per cent of all foreign institutional investments coming to Indian bourse are routed through this tiny Indian Ocean island.
Finance ministry officials point out that foreign institutional investors who have kept shares with them for more than a year will not be affected by the changes in rules as there is zero tax on any share sold on bourses after being kept for a year. Short term capital gains stand at 15 per cent, while off-market deals which is the preferred route when one company acquires another such as the Hutch-Vodafone deal, attracts 10 per cent tax.
Pranab babu's move to plug the tax haven loophole also addresses concerns that Indian firms are often bought or sold outside the country, simply to avoid paying taxes here. Remember the Vodafone tax case which the government lost? Hutch sold its mobile phone operations through a complex overseas tax free deal to Vodafone and both sides refused to pay income tax to the government.
Even in Cairn India’s case, initial reports suggested the deal to sell the Rajasthan oil and gas fields could be offshored, where again the Indian government would lose out on taxes.  Other transactions over which the finance ministry is anxious to get its `pound of flesh’ include the Idea Cellular-AT&T deal worth $150 million, SABMiller's purchase of  100 per cent shares in Foster's India and General Electric (GE) sale of its majority stake in Genpact in a $500 million deal.
What tax authorities want is that firms who want to benefit from Mauritius’ and other tax havens’ zero tax status should show two things – that they are genuine residents of these tax havens and do not do earn most of their revenues in India, which means they are not shell firms registered in tax free isles.
The Mauritius route for investment is an important one for India too and it too does not want to kill the golden goose altogether, though it is to be seen how the move will impact this. Foreign direct investment flows into India from the island nation totalled $55.2 billion, about 42 percent of the total $133 billion during that period.
A General anti-avoidance rule, which allows tax authorities to declare any business deal to be an ‘impermissible avoidance arrangement’ if part or whole of the deal has been crafted with the intention of obtaining ‘tax benefits’, too has been brought in along with these amendment. In essence it becomes an adjunct to amendment to Section 90 and 90A to plug tax leaks by routing investment through tax havens.
It speaks of four tests by which taxmen would determine whether any business deal through tax havens has been done just to avoid paying tax or whether they were bonafide ones.
The four tests are: the arrangement creates rights and obligations which are not normally created between parties; it results in ab use or misuse of tax laws, it lacks commercial substance and is done in a manner which is not normally employed for bonafide purposes. These tests make it virtually impossible for firms to use tax havens to buy or sell Indian assets.
Politically, it was important for the Congress-led government to go forward with this move to scotch opposition accusations that its soft on black money generation. Last year, not only did activists like Ramdev and Anna Hazare target the government over black money, the BJP started a nationwide campaign on the same issue.