The India-Mauritius treaty as a subject has evoked intense debate, that normally reaches its peak before the Union Budget gets finalised. The Mauritius treaty is a frequent reference point for cross-border transactions. Generally capital gains exemption via the Mauritius route has been viewed suspiciously by the tax authorities, but then the show goes on. It is relevant to note that during the period 2000-2010, a staggering $50,164 million has come into India as Foreign Direct Investment via Mauritius.

India has entered in to double taxation treaties with around eighty countries and Mauritius seems to top the popularity chart. In structuring outbound transactions, the Netherlands, Switzerland and Singapore seem to be the current preferred jurisdictions and in respect of inbound transactions, it is Mauritius, Cyprus and Singapore. All treaty clauses are framed to achieve the overall economic agenda of the respective countries and Mauritius is no exception.

Rules tightened

A Mauritian tax residency certificate is necessary for invoking the beneficial provisions of the India-Mauritius Treaty. In recent times, the Government of Mauritius has also tightened the rules of the game by strengthening the compliances to be undertaken for getting the tax residence certificate. Besides being subject to a yearly review by the Mauritian authorities, the certificate can now be obtained only if the company cumulatively satisfies the following:

Have two Mauritian directors with the appropriate calibre;

Hold all the board meetings in Mauritius;

Maintaining all accounting records in the Mauritian registered office;

Have Mauritian residents as auditors and company secretary; and

Channel all banking transactions through a bank account in Mauritius.

However, the question crying for answers is whether the courts can disregard the Mauritius conduit if it is used only to avoid taxes. While this issue is fact-specific, it has unfortunately created needless doubt in putting through even genuine transactions via the Mauritius route.

CBDT circular

The controversy began with the issue of Circular number 789 by the Central Board of Direct Taxes, which stated that an assessee who furnishes the tax residency certificate from Mauritius can avail of the beneficial provisions of the India-Mauritius Treaty. The circular was challenged and was declared invalid by the Delhi High Court in the case of Shiv Kant Jha Vs Union of India 2002 (256ITR563).

However, the Supreme Court vide its decision in the case of Union of India Vs Azadi Bachao Andolan (263ITR706) reversed the Delhi High Court decision.

Recently, the Authority for Advance Ruling has followed the decision of Azadi Bachao Andolan in the cases of E Trade Mauritius Vs DIT (324ITR1) and Praxair Pacific Limited Vs DIT(326ITR276).

In the case of E Trade Mauritius, it was held that there was no legal taboo against ‘treaty shopping'. It was also held that a resident in a third country may avail of the benefits of the India-Mauritius treaty by setting up a subsidiary in Mauritius and carry on the activities through the subsidiary as long as subsidiary has the tax residency certificate.

In the case of Praxair Pacific Ltd, it was held that the sale of shares by the Mauritian company would not be taxable in India as per the beneficial provisions of the India-Mauritius Treaty.

In spite of favourable decisions the controversy continues unabated and there exists an atmosphere of uncertainty over the issue since Mauritius companies making investments into India are subjected to greater scrutiny than other countries. In the case of SMR Investments Vs DDIT (2010-TII-66-ITAT-DEL-INTL), the tax authorities challenged that the place of effective management of the tax payer company was in India, despite the fact that the tax payer was incorporated in Mauritius.

Taking into account the fact that around 42 per cent of the FDI inflows into India are through Mauritius, there is a pressing need for a long-term policy framework on India-Mauritius treaty. There is no doubt that FI investments into the Indian stock market via the Mauritius route has propelled the share prices to dizzy heights, but then one has to view the same in the context of the overall economic good for the respective countries than evaluating the same through only the sweetener, viz capital gains exemption.

In the Direct Tax Code the original proposal of the provisions of the Act to override the treaty has since been dropped and therefore the Mauritius excitement is bound to continue unless of course General Anti Avoidance Rules (GAAR) is invoked. With Direct Tax Code coming into operation in April 2012, it is unlikely that any major jolt will be created in the budget of 2011 affecting the India's approach to bilateral agreements. All the same we do need a long-term solution to this issue rather than a year-on-year debate, which becomes more philosophical than a rational analysis of the problem on hand.

(The author is Tax Partner, Ernst & Young).

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