While Finance Minister P. Chidambaram in his >Budget speech recognised the importance of FDI, FII or external commercial borrowings to fuel the economy, he also stated that foreign investment that is consistent with our economic objectives will be encouraged.
He has proposed certain positive policy measures, like opening up a new investment avenue for FIIs by allowing them to participate in exchange traded currency derivatives. The Finance Minister has consulted SEBI to simplify entry procedures for foreign portfolio investors. Further, in his speech, the Chidambaram has proposed formalising a rule with respect to classification of foreign investments as FII vis-à-vis FDI based on percentage of holding.
GAAR CONFUSION
There were certain other positive measures, like modification of General Anti-Avoidance Rules (GAAR) from those incorporated in the Finance Act, 2012, accepting some of the recommendations of the Shome Committee and deferral of applicability of GAAR provisions to April 1, 2015. While all these positive moves are welcome, what the investor community did not seem to welcome was a retrospective amendment whereby a Tax Residency Certificate (TRC) in the prescribed format will be “a necessary but not a sufficient condition” for claiming any Tax Treaty benefits --- leading to ambiguity about whether the intent of GAAR is already indirectly enacted. However, the latest press release by the Government should settle the uncertainty on TRC.
The ambiguity with respect to applicability of TRC as a sufficient requirement for claiming tax treaty benefits was created in the memorandum of Finance Bill, 2012. The Bill mentioned that TRC is a necessary, but not a sufficient, condition to claim treaty benefits; however, the said position did not find place in the Income Tax Act, 1961 (the Act).
It is a well-known fact that the foreign investors investing into India under FDI and FII routes have considered Mauritius as a preferred jurisdiction for cumulative reasons, which include availability of tax treaty benefits on exits. In order to be eligible to claim the benefits of the India-Mauritius tax treaty, the non-resident company should have a valid TRC issued by the Mauritius tax authorities.
It may be noted that certain tax officers have attempted to deny tax benefits in respect of capital gains arising from sale of shares, available to a company incorporated and resident in Mauritius --- irrespective of the positive Supreme Court ruling (in the Azadi Bachao Andolan case) and Circular No 789 dated April 13, 2000, issued by the Central Board of Direct Taxes (‘CBDT’) that deals with determination of residence of companies incorporated in Mauritius. Having said that, there have been recent judicial precedents which have upheld the validity of TRC to avail Mauritius Treaty benefits.
Also, the Shome Committee report accepted the stakeholders’ claim, stating that “Circular No. 789 provided that a Certificate of Residence issued by the Govt. of Mauritius would constitute sufficient evidence for accepting the status of residence of a person as well as beneficial ownership for applying the tax treaty. Currently, the Revenue cannot look into the genuineness of residence of a company incorporated in Mauritius based on commercial substance, or other criteria, once a TRC is issued by the Mauritius authorities.”
The Shome Committee report further mentioned that the Mauritius treaty itself should be revisited if policy so dictates, rather than challenged indirectly through the use of the GAAR instrument.
The above proposed amendment on TRC could have certainly lead to tax uncertainty for the foreign investors and hurt the investor’s sentiments which would impact our objective to stimulate growth and foreign investments into India.
FM’S CLARIFICATION
However, looking at the sensitivity and the market reaction, the Finance Minister in his post-Budget speech clarified that the implications of asking for more than a TRC may not be unfriendly.
He stated that this merely means that certain treaties may have two conditions -- a condition of residency and beneficial ownership. As far as residency is concerned, TRC would be acceptable and for beneficial ownership it will be a question of fact and law.
The Government of India, through a press release issued on March 1, 2013, has clarified that the TRC produced by foreign investors will be accepted as evidence for its residential status and the Income Tax Authorities in India will not go behind the TRC and question his resident status. With respect to Mauritius it was clarified that Circular no. 789 continues to be in force, pending ongoing discussions between India and Mauritius.
This is a positive move, considering our intent of welcoming and not spurning foreign investments. However, it will be interesting to read the actual provision, once the Bill is passed by the Parliament.
(The author is Co-Head of Tax, KPMG in India.)