Author: Dr Uttam Gupta
Publication: The Observer
of Business and Politics
Date: September 13,
2000
In early April 2000,
the income tax authorities issued notices to foreign institutional investors
(FIIs) based in Mauritius for payment of tax on capital gains from their
operations in India. Although, the demands were raised on a select few
of them, and for small amounts, the total revenue involved by way of bringing
all the concerned FIIs within the ambit of the tax net could run into a
few thousand crores. In fact, according to a public interest litigation
now pending before the Delhi High Court, the total financial implications
of the government move to bail out these FIIs is estimated at about Rs
3,000 crore.
The decision led to consternation
in the FII circles who even threatened large scale withdrawal of funds
from the country. The reverberations of this were even felt on the bourses
with the BSE Index showing a precipitous decline in the next couple of
days. Sensing the hostile mood and the possibility of greater damages,
finance minister Yashwant Sinha met FII representatives on April 6, and
assured them that they would not be taxed in India. Within a week, the
Central Board of Direct Taxes (CBDT) issued an appropriate circular on
April 13, thereby facilitating withdrawal of the notices.
The government decision
to withdraw the notices has since been challenged by a PIL in the Delhi
High Court. In its submission to the court, the CBDT has argued that while
raising the demand, the assessing officials erred in interpreting the relevant
provisions of the Double Tax Avoidance Convention (DTAC) with Mauritius.
Considering the fact that the issue had far reaching ramifications, not
only in terms of the potential revenue loss but also by way of impinging
on the overall environment for attracting investments, one cannot imagine
the officials acting without the nod from the top bosses. In other words,
the entire government appeared to be solidly behind the move and that the
attempt to disassociate was only an afterthought.
While issuing the notices,
the assessing officers had argued that FIIs are not residents of Mauritius,
that they are residents of countries other than Mauritius and India, and
therefore not entitled to the DTAC benefits. This was despite full knowledge
of the fact that these companies are incorporated in Mauritius and had
offices located there. Clearly, the government was not inclined to take
the existence of an office in Mauritius on its face value. And it was indeed
on the right track.
In the true sense of
the term, incorporation of a company in a particular country connotes that
it should be engaged in normal business activities. Specifically, it means
that a major share of its transactions should be conducted in that very
country. From a closer Crook at the underlying economic conditions in Mauritius,
it would appear that majority of these FIIs cannot justifiably fall within
the meaning of doing normal business. Mauritius is a small island nation
and the only economic activity it can boast of is tourism, besides sugarcane
production. On this basis alone, it is virtually impossible to justify
the presence of as many as 400 FIIs for normal business activities. One
cannot escape the conclusion that the concerned FIIs had set up bases in
Mauritius with the prime objective of taking advantage of the DTAC.
In view of above and
even as the government was fully justified in proceeding against these
FIIs, unfortunately, it was flummoxed by the intensity of protests and
concomitant threat of large-scale withdrawal of foreign investments. The
government beat a hasty retreat. In this context, the CBDT circular of
April 13, makes an interesting reading. It stated: 'A certificate of residence
issued by the Mauritius government will be taken as sufficient evidence
for accepting the status of 'resident' as well as ownership' under the
DTAC.' In simple words, it meant the officials should not have questioned
the motives of these FIIs in setting up shops in Mauritius.
Considering the far reaching
financial implications, the government should have anticipated the outrage
and accordingly prepared itself to deal with it. And if the assessment
was that it could not do so, then notices should not have been issued in
the very first place. But, by going through the motion and then backtracking,
it had ended up lowering its own image. The argument that the concerned
officials had erred does not cut much ice.
It is difficult to anticipate
at this stage the outcome of the proceedings on the PIL and as to whether
or not this would help in changing the course of events. In any case, till
the verdict is given, the FIIs will have a Peaceful time. However, the
finance ministry mandarins need to do some introspection and look beyond
the narrow focus of keeping FIIs in good humour. They need to adopt a course
which is logical and consistent with the spirit of the DTAC. Its benefit
cannot be given to these FIIs as they are not carrying normal businesses
in Mauritius. This bonanza is all the more reprehensible when, it is at
a huge cost to the national exchequer.
If, the government continues
to sleep over the issue, it will create an anomalous situation whereby
the domestic companies will be at a serious disadvantage vs the FIIs. A
regime under which the latter continue to be exempt from capital gains
tax 'Could even prompt the former to transfer funds to tax havens like
Mauritius only to be re-invested in India, ala the FIIs route, and make
windfall.
The apprehension that
an attempt to tax FIIs will affect the pace of foreign investment is baseless
in this context, the major deterrents continue to be an uncertain and fluctuating
policy environment on the one hand and the maze of approvals/ clearances
involved in implementing projects on the other. If only these are effectively
tackled, then even without tax sops, foreign funds will come in at the
desired pace.
The government should
put things back on the rails, by proceeding against these FIIs. It it could
even make amendments in the DTAC Act. For instance, a company should be
accorded resident status only if it generates a certain minimum percentage
of its overall turnover from business within Mauritius. Companies which
do not meet this criterion should have no grudge paying tax.
(The author is the chief
economist with the Fertiliser Association of India, New Delhi)
