The interpretation of the tax treaty with Mauritius has for long been a subject of serious controversy in India. The provision of the tax treaty that a resident of Mauritius would not be taxed in India on capital gains arising out of sale of securities in India has given rise to the problem.

The controversy started after the CBDT issued a circular that a certificate of residence issued by Mauritius will be sufficient evidence for accepting the status of residence as well as ownership for applying the provisions of the treaty.

The above circular was, however, declared invalid by the Delhi High Court (256 ITR 563). But the Supreme Court reversed the decision of the high court and declared the circular as valid (Union of India versus Azadi Bachao Andolan (2003) 263 ITR 706).

It was thought that the controversy had been resolved. But Finance Minister P Chidambaram had reportedly said that the Mauritius route is being used by some Indian companies to do round-tripping of funds. The Mauritius deputy prime minister stated that they should not be singled out. He said that keeping in view historical, cultural, political and diplomatic ties between the two countries, there is a need for global solution that should not penalise Mauritius.

In the meantime, the Mauritius Income-Tax Act has also been amended in respect of tax residence certificate.

The controversy of the Indo-Mauritian tax treaty has again surfaced during negotiations for the proposed Comprehensive Economic Co-operation Partnership Agreement. The Indian finance ministry feels that the tax treaty is being grossly misused. Tax officials estimate that the treaty has been costing to the Indian exchequer over Rs 4,000 crore every year. This loss is due to exemption from tax on capital gains for investors routing their funds through Mauritius-based investment entities.

The contention of the Indian revenue officials is: There is a phenomenal loss of tax to the Indian exchequer due to the exemption of

capital gains tax. The investors use Mauritius-registered companies and offshore trusts to hold assets abroad beyond the reach of Indian tax laws. This is round-tripping, where Indians re-route their money stashed abroad through the Mauritius route, leading to misuse of the tax treaty.

Further, the residents of a third country also take advantage of the Indo-Mauritius tax treaty and escape paying capital gains tax in India. This practice is called treaty shopping and results in revenue loss to India.

On the other hand, foreign direct investment equity inflows from Mauritius account for the largest share of the total inflows into the country. According to the latest available data, cumulative inflows from April 2000 to June 2008 stood at Rs 1,27,554 crore (nearly $30 billion), accounting for over 44per cent in rupee terms of total inflows of Rs 3,11,912 crore (nearly $72.5 billion).

In this context, the government should seriously consider the observations of the Supreme Court in the case of Azadi Bachao Andolan (supra):

In developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital or technology. They are able to grant tax concessions exclusively to the foreign investors over and above domestic tax law provisions. In this respect, it does not differ much from other similar tax incentives given by them, such as tax holidays, grants, etc. The developing countries allow treaty shopping to encourage capital and technology inflows, which developed countries are keen to provide. The loss of tax revenues could be insignificant compared to the other non-tax benefits to the economy.

Double Taxation Avoidance Agreements are treaties between two Sovereign States. They should be properly honoured by the respective governments. Voicing of dissent or dis-satisfaction whether at bureaucratic level or at ministerial level is highly undesirable. It sends wrong signals to foreign investors. The finance ministry should pay heed to the sane advice of the Hon'ble Supreme Court rather than issue statements which will only discourage inflow of funds into India.