To check tax loss arising from treaty shopping and round tripping routing of domestic funds overseas to bring them back through tax havens like Mauritius the government has stepped up scrutiny of foreign direct investment (FDI) proposals. Several proposals, especially those involving flow of FDI from Mauritius and Cyprus, have been put on hold during recent weeks.

Officials of the finance ministry want to prevent treaty shopping or channelling of investments through countries like Mauritius with which India has double taxation avoidance treaties to evade capital gains tax.

The proposals put on hold recently include those by UK-based investment firm Ashmore, which manages funds worth around $37.5 billion, Jindals of OP Jindal Group and prominent brokerage house CLSA. The revenue department in the finance ministry has objected to the proposals of Jindals for bringing in FDI through a Mauritius-based entity for JSW Infrastructure as it believes that the deal involves round tripping.

FDI in VLCC, Ashmore put on hold FDI

The department has also objected to a proposal from Kanodias to bring in $50 million through a Mauritius-based holding entity.

The DoR has also objected to a number of proposals on the ground that there could be cases of treaty shopping and this includes CLSAs FDI in beauty and wellness chain VLCC, Ashmores bid for 74% stake in internet service provider Broadband Pacenet, ICPs plan to acquire 40% in construction firm Umang Realtech from another investment fund 2i Capital and Ruias proposal to bring in Rs 590 crore into truckmaker Asia Motor Works through Cayman Islands-based Essar Global.

The DoR had also objected to a proposal from Future Groups private equity arm Indivision to invest in security services firm Tops Security for suspected treaty shopping. However, this proposal was subsequently cleared by the Foreign Investment Promotion Board (FIPB), the nodal body for clearing foreign investment into India.
According to sources in the Department of Industrial Policy and Promotion (DIPP), the government is concerned about Indian residents parking money in tax havens to route them back here as FDI.

The clampdown comes at a time when FDI to India from tax havens such as Mauritius and Cyprus witnessed a sharp rise last fiscal even as FDI from mature economies either stagnated or declined. Last year, Mauritius and Singapore were the top source of FDI into India, while inflows from Cyprus was more than that from Germany, Japan, Netherlands and France. The total FDI from these three tax havens during 2007-08 was Rs 60,187 crore which was around 61% of the total FDI inflows into India.

Significantly, FDI numbers from mature economies to India have not been so impressive during the last fiscal as many companies from developed countries have been routing their money through these tax heavens.

Taking advantage of tax treaties for investments in India may not be a cause for worry for the government. But, round tripping of funds can often lead to practices of money laundering and breach of FDI sectoral caps. It is prudent for the government to look into these policy issues and clamp down on such practices if found suspicious, said Uday Ved, head (tax) at KPMG.