Indo-Mauritius Treaty: Mortising Legality to Tax evasion
The thin line of demarcation between tax evasion and tax avoidance is the 'scienter' or the intent of fraud. The moment the adjudicating or apex authority fails to discern the real intentions of the parties to the transaction, tax evasion vanishes leaving behind something called tax avoidance which is dignifiedly referred to as ' Tax Planning'. Tax Planning or avoidance as opposed to Tax evasion is the usage of legally permissible methods to reduce or nullify the tax burden. Of course this is what the courts reckoned while delivering the judgments.
Post the commencement of Globalisation, there have been spate of decisions with respect to tax treaties (Indo- Mauritius treaty the most popular among them). Very recently a judgment that created waves of happiness to Foreign companies having subsidiary in India is the E Trade pvt ltd, Mauritius vs DIT (International Taxation), Mumbai (passed by AAR). This is truly a landmark one which removes the doubts in foreigners on how Indian Government would view the 'conduits' in Mauritius. It says that even though the subsidiary company has it's parent company based out of US, there should not be any Capital Gains taxation on shares held in an Indian Company on the ground that US company is the controller and virtually shares the Capital Gains. Even Supreme Court legalises 'Treaty shopping'. The rationale derived by the courts is that if tax is reduced by legal transactions the same is permitted. The motive behind the transaction is immaterial as long as the transaction is not prohibited by the law. All along we were under the impression that motive behind the transaction is very important, but rationale such as the one above is really baffling and disturbing.
The following paragraph is a preface. As per clause 4 of Article 13 of the Indo-Mauritius treaty the Capital Gains on sale of moveable property other than those mentioned in clause 1 to clause 3 is to be taxed in the resident contracting state ( If the entity in the other contracting state is a Permanent Establishment then clause 1 will be applicable but a subsidiary cannot be always regarded as a PE). Unfortunately the laws of Mauritius do not tax such Capital Gains which is the disaster. But for this scenario this tax treaty is no different from others. This article claims no right to point fingers at the policies of the Mauritius Government but can always suggest the Indian Government to set up precautionary measures to grab the genuine taxation opportunities in future.
In the case of companies, Sec.6 of the Income tax act 1961 determines the residence based on the place where the control and management of the affairs of the company is wholly situated. This is as mighty as 'piercing the corporate veil' as we have got used to under the Companies act 1956. 'Piercing the Corporate Veil' is a doctrine as well as a tool to punish notorious directors of companies esp. closely held ones. All along the investors based out of Mauritius have been riding smoothly on the basis of a tax residency certificate (Azaadi Bachao Andolan case (SC) 2003). It is only now that the ITAT, Delhi has passed an order in a specific case calling for some more documents from Mauritius government to verify the authenticity of the claim. We are clearly moving to a regime where 'substance over form' is the mantra. It is still puzzling as to why the basic rules for identifying the nationality as mentioned in the IT act for normal cases should not be followed for these cases. There is no denial that Mauritius is a significant trading partner with India with of course a widening trade deficit. Implementing stringent measures should not be thought of as antagonising a particular nation.
There are circumstances where the tax law creates deeming provisions and imposes tax on such transactions disregarding their nature. Let us consider an apt example of Deemed Dividend from the Income tax act 1961.As per Sec.2(22)(e) “any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) [made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten percent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as said concern)] or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits;”
Thus law is rigorous enough to create a deeming fiction to tax those receipts which are not incomes in ordinary parlance. In the above case genuine loans which would have recovered subsequently will also have to get taxed. Perhaps the law could have been less rigid here; for e.g. by prescribing a Statutory auditor certificate on the end use and recovery of these loans and advances to be exempted from tax.
Are'nt these transactions legal? Why is there no test for gauging the motive of the parties at the threshold before taxing such receipts? The relevance of the Indo-Mauritius treaty was discussed several times in the past. Reason for offshoring a unit in a country is primarily based on commercial feasibility and tax exemptions should normally be secondary. But more and more companies have got overwhelmed by this advantage. The above treaty has paved the way for carrying out material transactions such as ownership transfers without falling in the tax net. These judgments apparently look like Global appeasement measures.
It is high time we struck a balance between taxation of genuine business transactions and sham ones and do the same consistently. There are only two measures available at our disposal,
- Investors from Mauritius will have to be subjected to the normal tests of residency as mandated under Sec.6 of the Income tax act 1961 for the purpose of exempting from taxation and not based merely on documentary evidence. Doing this would not mean discrimination since the DTAA speaks otherwise."The nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected". In fact calling for a Tax residency certificate is what is discrimination from the Indian national, which would have been severe on the investor but for the easiness in getting Tax Residency certificate from Mauritius Government.
- Deeming provisions may be appropriately introduced. This would mean complete revamping of the tax treaty which is sure to be trashed as remote possibility. But probably the income from the transaction can get taxed as Business income wherever possible taking into account magnitude and motive behind the transactions.
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