Companies moving in through the Mauritius/Cyprus route to take advantage of concessional tax rates (under the double taxation avoidance agreement or DTAA) may soon run into a wall. The direct tax code, which is being drafted, plans to prevent the misuse of tax treaties by introducing anti-abuse provisions.
Several companies from Europe and the US prefer to route investments through Mauritius to avail of tax breaks. There are also concerns over round-tripping, when domestic funds go out of the country and come back from Mauritius to avail of capital gains tax exemption available under the agreement.
The reason for what tax authorities describe as rampant misuse of the treaty is because it provides that capital gains arising in India from the sale of securities can only be taxed in Mauritius and in Mauritius, capital gains accruing to a resident are exempt from tax.
Renegotiating a treaty is an uphill task. India has been trying to rework its treaty with Mauritius for quite some time now, but has not been successful. Having general anti-abuse provisions, which allow only genuine investors to take advantage of the DTAA, are thus being planned to tide over this difficulty.
The new code could have provisions to ensure benefits of the treaty flow only to a genuine investor, a government source said. The code is expected to be introduced in Parliament in the winter session.
The source said all treaties are entered into for the benefit of genuine investors and not to facilitate avoidance of tax. Though a proposal in this regard was considered before Budget 2007-08, the ministry abandoned the idea in favour of the new law instead of tinkering with existing Act.
There are two schools of thought on such provisions in the domestic law. One view is that such a provision may not be able to prevent treaty shopping as the beneficial clause in any treaty would prevail in any such situation. Any clause to prevent treaty abuse has to be inserted within the treaty itself.
However, the other school of thought feels including such a provision in law, a practice followed in some countries, may be able to address Indias concerns.
A general avoidance rule in domestic law to prevent any breach of good faith on which the treaty is based is present in many countries, the source said, adding all treaties are aimed at benefitting genuine investors and such a law would be able to prevent abuse. The ministry has decided to go by the second school of thought, the source said.
Technically speaking, transfer pricing regulations are also anti-abuse legislation and the Indian Income-Tax Act already has some anti-abuse provisions, including transfer pricing in Chapter X of the Act. I presume the government is looking at bringing more transactions within its purview and framing laws to regulate them. A provision such as this will help in situations where India does not have a DTAA. Even if there is a DTAA, the department will be able to rely upon these provisions, Ernst & Young partner Amitabh Singh said.
Earlier, an internal committee in the tax department examined the issue of treaty abuse and ways to prevent it. The committees view favouring provisions in domestic law are likely to find place in the direct tax code.