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CBDT task force to advise on preventing tax treaty misuse
April, 06th 2009

With global and political will turned against tax havens, New Delhi is looking to turn the heat on Mauritius and Cyprus to amend tax treaties with these countries or bring in anti-abuse provisions in their local laws.

The Central Board of Direct Taxes (CBDT) has set up a special task force to suggest ways to prevent abuse of double taxation avoidance agreements (DTAAs), said a government official, who did not wish to be identified. The task force would look at the prevalent global best practices adopted by the US and others to see how they can be replicated here and ensure Indias tax treaties are transparent and promote information-sharing.

Indias attempts to amend the treaty with Mauritius, from where the country receives 43% of its foreign investments, have so far met with tremendous diplomatic resistance from the island nation.

The just-concluded G-20 summit on global financial crisis in London had raised the pitch on scrapping DTAAs. DTAAs are pacts between two countries that seek to eliminate double taxation of income or gains arising in one country and paid to residents or companies of the other country. The idea is to ensure that the same income is not taxed twice.

However, in some cases, these treaties are misused to avoid taxes, leading to a loss of revenue to a countrys exchequer. This is called treaty shopping, where residents of a third country take advantage of a tax treaty between two countries, by routing their investments from there to avoid taxation. As per some available estimates, India loses more than $600 million every year in revenues on account of the DTAA with Mauritius.

New Delhi had also considered a limitation of benefit clause in the treaty, to prevent ineligible entities from taking advantage, the official said. Through this clause, the government can put in conditions such as listing on the local stock exchange in any of the countries, ceiling on turnover and cap on expenditure for carrying out operations in one of the contracting states.

Both India-Mauritius and India-Cyprus tax treaties provide that capital gains arising in India from the sale of securities can only be taxed in Mauritius and Cyprus. This leads to zero taxation as there is no capital gains tax in these countries.

After failing in its attempt to amend the tax treaty, the UPA government tried to introduce treaty anti-abuse provisions in Budget 2007, but dropped the idea subsequently as work on the new comprehensive direct tax code had begun by then.

Indian tax authorities have upped their ante after the Vodafone-Hutch deal in which the transaction was carried out through subsidiaries domiciled in Mauritius and Cayman Islands, in the case that involves a tax demand of about $1.7 billion.

However, now, since direct tax code may not come into effect anytime soon, effort may be made to bring some such provisions in the tax laws in the forthcoming Budget itself, since all leading political parties have expressed desire to contain such tax havens. We should endorse sharing information and bringing tax havens and non-cooperating jurisdictions under closer scrutiny, prime minister Manmohan Singh had said at the G-20 dinner. Senior BJP leader LK Advani has also raised his pitch against black money stashed away in such tax havens.

Some countries such as Singapore and Canada have opted for a general anti-avoidance rule (GAAR) that allows examination of the real nature of a transaction and a limitation of benefits clause to ensure that treaty benefits accrue only to genuine investors. Singapore also allows examination of the real nature of a transaction.

The US government has empowered itself through a legislation that allows it to declare a country as a tax haven and impose additional tax on investments coming in from there.

It may be noted that India has already amended its tax treaty with the United Arab Emirates.

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