The Budget proposal, to the effect that the Tax Residency Certificates (TRC) of foreign investors is not good enough to claim tax benefits under double taxation avoidance treaties, defies understanding. On the one hand, the Finance Minister, P Chidambaram, in his Budget speech, has talked about India not having the choice “between welcoming and spurning foreign investment”. Given the need to find upwards of $75 billion annually to cover a current account deficit in the country’s external transactions, foreign investment “is an imperative”, as he rightly put it. On the other hand, the same Budget has incorporated a provision in the Finance Bill, which effectively says that for purposes of claiming tax benefits under a Double Taxation Avoidance Agreement (DTAA), a certificate of residency or TRC in the country with which India has signed such a treaty, is a “necessary, but not sufficient” condition.

The problem with the proposed amendment is that it reopens a settled principle of taxation with regard to capital gains of the bulk of foreign institutional investors (FIIs), who have opted for benefits under the DTAA between India and Mauritius. The notion of ‘residence’ in Mauritius is the sole principle underpinning the claim of relief from a burden of double taxation. By hinting at the possibility of other conditions — implicit in the phrase, “necessary but not sufficient” — that FIIs have to fulfil before becoming eligible to claim relief under a DTAA, the Government has effectively signalled that it would like to go after the incomes of Mauritius-based FIIs. These institutions have been led to believe all along that their incomes are sheltered from taxation under the Indian law. Ironically enough, the subsequent clarifications both by the Finance Minister and officials have not gone far enough in allaying these fears. They have needlessly dredged up the issue of beneficial owners of FII money residing in tax jurisdictions outside Mauritius. The point is that an investment pool with a corporate identity will always have beneficial owners located in various parts of the globe. Moreover, if the Government thinks that the DTAA with Mauritius was meant to benefit only resident individuals of that country, it is being naïve. It is an open secret that almost all FII inflows from the island nation have originated elsewhere. It is also inconceivable that the kind of sums India has mobilised could have come out of an economy as tiny as that of Mauritius. Moreover, any restriction limiting the benefit to resident individuals is not an option unless the agreement with the Mauritian government is suitably modified. In the circumstances, the FIIs would have reasons to feel insecure, unless the Government effects suitable, clear and transparent modifications in the Finance Bill.

If attracting FII capital is “an imperative” today and a benign tax regime for incomes earned by such capital is a pre-requisite, then it is clear that the Government cannot have it both ways.

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