evaluation of the proposed remedy to the current situation

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Mauritius and India first signed a Double Tax Agreement Treaty (DTAT) in 1983. The primary purpose of this provision was that the capital gains obtained by selling securities in India would not taxed for Mauritian residents in India.1 This agreement provides tax free benefits on capitals gains for investments if routed via Mauritius. The government of Mauritius put an end to the capital gains tax so that Mauritian-based foreign institutional investors (FIIs) would not be taxed when they invest in India.1 As such, Mauritius has made the most foreign direct investment in India, with 44% of the total FDI in India transacted through the island during the interval of 2000 and 2009.3 Investors are using the Mauritius route to invest in India to avoid taxation with allegations that overseas corporations are making use of 'notional resident permit' in Mauritius to evade taxes in India.1

Countries usually agree such treaties so that individuals and companies, with multi-national businesses, are not liable to double taxation on the same income in the country of origin and the operating one. However, problem comes up when such treaties are misinterpreted by tax authorities or such bilateral agreement are signed with offshore finance centres such as Mauritius, not charging significant income tax on domestic offshore firms which consequently provides a path for businesses to evade taxes or paying only nominal taxes.1

The root of this issue is that various so-called FIIs are, in fact, just Indian companies or individuals doing the process of 'round-tripping' through Mauritius so as to invest tax free back in India.1 Nevertheless, amending the treaty would simply move the funds to other jurisdictions such as Bahamas or Netherlands.

The Resident of Mauritius criterion

To be entitled to the benefits of India-Mauritius Treaty, one has met the criteria of being a resident of Mauritius. The government of Mauritius were able to more firmly enforce this core prerequisite under its domestic law for companies. The Central Board of Direct Taxes (CBDT) recently announced that a Certificate of Residence issued by the authority of Mauritius will be enough to prove that a company is based in Mauritius.3

This announcement created political confusion but the Indian Finance Ministry reckoned that any step to tax the FIIs with Mauritius base would cause massive outflows, harm the stock market and damage India's glowing image. Thus the Indian Finance Ministry in collaboration with the CBDT advised tax officials to allow the domestic registration of Mauritius based firms, despite being controlled from third countries, including India1.

The response from the Finance Ministry caused public interest litigation (PIL) asserting that the authority may indeed be protecting tax evaders by acting in favour of investors who are routing through Mauritius principally to evade tax. The Supreme Court considered the circular as 'bad in law' and gave the green light to tax officials to examine the veracity of corporations in their attempt for being exempt from tax charges under the DTAT.1

How did Mauritius become the preferred route for investing in India?

The 1983 Indo-Mauritius treaty précised that any capital gains derived from the selling of securities of Indian Companies by Mauritius resident would only be taxable in Mauritius and not in India. For one decade the double tax agreement treaty only existed on paper as the Foreign Institution Investors (FIIs) were not permitted to trade in Indian Stock market. However when the regulation changed in 1992 allowing FIIs to invest in India, Mauritius in the same year passed the Offshore Business Activities Act which enabled registrar of overseas companies for investing abroad.

The advantages of registering a company in Mauritius are as follows:

- Complete capital gains tax exemption

- Rapid Incorporation

- Complete secrecy of Business

- Complete Currency Convertibility


An option for India would be to modify its current domestic law to unilaterally cancel out the effect of the DTAT. The Direct Taxes Codes (DTC) Bill passed in 2009 is an attempt to amend the tax system in India. The proposals below in the DTC may probably impact on the functioning of all the 75 tax treaties of India3:

When there is bilateral agreement between the government of India and the government of another country, the actual Indian tax law grants tax reliefs or if subject to double taxation, a taxpayer eligible to the benefits of the treaty, has the possibility to abide by the domestic tax law to the point to which it is advantageous for the taxpayer. Consequently, a non-resident taxpayer with income generated in India has the choice to be ruled by either the Indian domestic tax law or the relevant tax treaty, whichever is more advantageous to the taxpayer.

The DTC also enables the central government to come to an agreement with another government to avoid double taxation and for the motive of exchanging information to prevent income tax evasion or avoidance. The DTC, nevertheless, states that neither the treaty agreement nor the code will have favoured treatment based on its being a treaty or law and if there is a divergence between the provisions of a treaty and that of the code, the one later in time will be applicable. This is indeed a major change from current regulations. India, having tax treaties with 75 countries, enacted the DTC in 2010 and will be in for on 1 April 2011, which would affect all its tax treaties including that with Mauritius. Implying that after the 1st April 2011, Mauritius-based Company transferring shares of an Indian company would be liable for taxation in India without any exemption from the treaty.

It is worth noting that the revised draft code encloses the general anti-avoidance rule (GAAR).

The GAAR would only be activated if the taxpayer has entered into an arrangement covered by one the following conditions4:

-The main purpose was to obtain tax benefits

-characterise misuse or abuse of the provisions of the DTC

-lacks commercial substance

-entered into or carried out in a manner not normally employed for bona fide business purposes

-not created between person dealing at arm's length

India's Revenue Authority would assess and declare whether an arrangement is a permissible or impermissible avoidance arrangement. If declared impermissible, the tax official could disregard the tax treaty as well as the intermediary holding corporation and subsequently tax the income belonging to the parent company. For example, an arrangement would be apparently to have been gone through principally to be exempted of tax and the hurdle of the taxpayer is to prove that the main purpose of the arrangement was not to obtain tax benefits. Notably, the GAAR provision would not be concerned with, and could overrule, the tax treaties provisions.

If the Direct Tax Code is enforced, investors using the Mauritius route to invest in India would find themselves in a complex situation as depending on the nature of their business, the new code may prevail over the Bilateral Tax Treaty. The ability to demonstrate to satisfactory level to the Indian Revenue Authority that the underlying arrangement is employed for bona fide business purposes and is a permissible avoidance arrangement would be a key factor to obtain tax relief.

3. The terms enclosed in Section 5(1) of the Direct Tax Code states the following: "The Income shall be deemed to accrue in India, if it accrues, whether directly or indirectly, through or from2:

(a) a business connection in India;

(b) a property in India;

(c) an asset or source of income in India; or

(d) the transfer, directly or indirectly, of a capital asset situated in India.

(d) the transfer, directly or indirectly, of a capital asset situated in India.

The insertion of the word "indirectly" in the current terms of the Income Tax Act 1961 is an effort from the authority to capture the "indirect transfer" of assets funds located in India. However, the following discussion will show that altering the current provisions of section 5(1)(d) of the tax Code to bridge the gap in the Act will not be the right way to proceed2.

Consider this simple and familiar holding structure of a company2:

(a) Company A, a French-based corporation, has the fully ownership of a subsidiary in Hong Kong, S1

(b) S1 has a full ownership of a subsidiary in Mauritius, S2

(c) S2 possesses 51% shares in an Indian Company X, with two Indian companies holding the rest of the shares

(d) Company X has full-ownership of a various subsidiaries in India.

Suppose that Company A sell some of his share in S1 at a gain to another French Company B. Tax-wise, there will be three concerns from this transaction, namely:

The liable chargeable expense of the capital gains

The accounting calculation of the capital gain

The receipts of tax on capital gains

The first issue in this case is "identifying assets located in India", that to determine whether we are transferring the assets of Company X or the shares of Company X or the assets the Company X's subsidiaries. Legally, a company's shareholder has no control over the company's assets and one good reason for this rule is that estimating the costs and profits of shares is not treated the same way for physical assets.

The second issue is to observe whether taxing Company A or even Company B would be "fair", moreover, had S2 shifted its 51 percent of Company X, based on the Indo-Mauritius Treaty, capital gains tax would not be chargeable. To back this point, we can refer to the case of E-trade by stretching on the verdict of the Supreme Court in the Azadi Bachao Andolan Case where the Authority for Advance Rulings confirmed the Treaty position.

The third issue, Section 5 (1) (d) of the Code would require the corporate veil to be taken away at each stage starting from the subsidiaries of Company X to Company A, which to my mind is very unlikely as per existing law. The removal of the corporate veil is only allowed by the Case Law in limited circumstances.

The veil will be lifted if the structure is a "Fraudulent" but without evidence of the opposite, the company's holding structure does not represent a "sham" (Upheld in case KSPG Netherlands Holding B.V.).

The fourth issue is that the Code does not come with a process mapping explaining how the gains on the "indirectly transferred funds" would be computed, especially when there is no method of figuring the "cost" of the "asset" and therefore creates the inability to figure the "taxable profit" (Decision upheld in CIT v. B.C.Srinivasa Setty 128 ITR 294). This issue would be more evident had S2 held more shares in corporation based in countries other than India and the purchase price could not, as one would expect, assign a value to each entity.

Assuming that Company A's capital gains are taxable in India, the problem that comes up for the Revenue Authority is how to get the receipts of the capital gains tax from Company A, which does not have any assets in India. Collection of the tax revenue from Company A would not be possible and nor is the tax collectable from Company X without any provisions of this matter in the Act. The only recourse left for the Revenue Authority is to pursue Company B B u/s 201 of the Act for failing to subtract tax when paying Company A and hold it to be an assessee deemed in default. Again, as Company B has its assets outside India, this would be difficult.

The above discussion shows that the provisions made on the Section (1) (d) of the Direct Tax Code are unclear and also worth mentioning is that the above arguments are only some of the delicate concerns involve in the proposed Code. It is very likely that these provisions will cause deleterious effect on the foreign investment flow in India.


Can we, therefore, learn from the efforts of some other countries in this direction?

Indonesia has recently introduced a law to tax capital gains arising from the sale of shares in a foreign tax haven country which holds shares in an Indonesian company by specifically providing that such a sale will be deemed as a sale/transfer of shares in an Indonesian Company and that the capital gains will be deemed to be 25% of the selling price. The withholding tax will be 20% or in other words 5% of the selling price.

The ambit of the recent Indonesian legislation in this regard is prospective and clearly defined and it does not apply to foreign companies resident in countries with which Indonesia has DTAAs but merely applies to sale of shares of the company in the tax haven country.

A comprehensive relook on the issue is, therefore, required keeping a balance between the desire of the Revenue authorities in India to tax the transactions under consideration on one hand and the international practices including the economic aspects on the other hand. If India wishes to remain an attractive destination for foreign investment, it must ensure its tax laws are crystal clear and do not lead to protracted disputes between vendors, acquirers and the Tax Authorities.


The High Court of Mumbai's verdict was that Vodafone International Holdings B.V, a Holland subsidiary of Vodafone Group PLC, was responsible to deduct Indian capital gains tax for the transaction involving the acquisition of 67 percent of Hutchison Essar, an Indian mobile phones operator, in 2007. Hutchison Essar was a subsidiary of a Cayman Islands company, Hutchison Telecommunication International Ltd. 5

Interestingly, the Indian Tax Authority stated that India had tax claims right over an acquisition completed fully outside of India between non-Indian companies. Following this statement, the Indian tax authority could have right on deals effected outside of India, but concerning indirect transfers of interests in Indian entities.5

Holland-based Vodafone International Holdings BV acquired Cayman Islands CGP investments from Hutchison Telecommunication International Ltd. CGP investments involve various Mauritian and BVI subsidiaries which altogether held 67 percent holdings in Hutchison Essar Limited6. The Tax Department of India claimed that the acquisition of CGP investments constituted the transfer of underlying Indian assets, Holland-based Vodafone subsidiary was liable to deduct the Indian capital gains tax of around $2.1 billion from the payment of $11 billion to Hutchison. 7


The argument of Vodafone was that if the stocks of the underlying Mauritius-based companies were sold in India, the bilateral treaty would have given capital gain tax relief.6 Even though, the High Court of Mumbai reckoned that the intermediate subsidiaries in conjunction with the Cayman target and Hutcheson Essar were incorporated in Mauritius, had a valid Certificate of Resident of Mauritius, the criteria to get Indian capital gain tax relief under the indo-Mauritius Tax Treaty, the High Court initiated proceeding against Vodafone.6

After the High Court analysed the facts of the case in deep, discussed due diligence document, interim and final annual report and regulatory disclosures, they observed that the operation comprised the transfer of few rights and entitlements other than the shareholding in the Cayman entity alone. These encompassed a premium for more control on the cellular sector, the Hutch brand's right in India, a non-competition with the Hutch group accord, the handover of intra-group loan obligations and some option rights on specific Indian entities. These facts showed that Vodafone had "significant nexus" with India and enough for the High Court to take actions against Vodafone.7

IPL and Mauritius connection

Indian Premier League (IPL) has built-up into a huge $4 billion big money package of sponsors, TV rights and other franchises, charges and other proceeds. Recently, many IPL activities have been suspected to be unscrupulous, illegitimate and even illegal. Politicians and others are alleged to be doing the practice, called round-tripping, of converting their black money into legal money via Mauritius and other jurisdictions, even though officially recognised, have secrecy of their identities through shell companies and "benami" (False) names. There have been claims about match fixing and fixing of bids for team franchises as well as bribes, tax evasion, illicit betting and violation of foreign investment rules.9

Tax officials ordered the Board of Control for Cricket in India (BCCI) to release the IPL's balance sheet, the ownership and holding structure of franchisees and their agreement with IPL. Failure to do so, the tax official would then have recourse to the lifting of the corporate veil and track down information from the registered companies' country, which in many cases is found to be Mauritius. There is a problem when Indian investors route their investments through Mauritius for money laundering purposes. The Indo-Mauritius taxation treaty includes the provision on exchange of information which tax officials will use to obtain information on the Mauritius-based companies' ownership. However, there will be a legal procedures taking place before the banking information is divulged to another country.8

The transaction may not be as simple if taxpayers have been jumping jurisdictions to conceal their identity and sources of funds. For example, Tax officials may be forced to look not only in Mauritius to follow the source of fund if the Mauritius-based company borrowed fund from entity from another jurisdictions such as Cayman Islands or Bermuda, two countries where India does not have tax information exchange agreement. However, after the G20 summit, Tax havens have agreed to employ the exchange of information agreements in accordance to the standards set by the Organisation for Economic Cooperation and Development (OECD). Bank secrecy will no longer prevail and refusal to disclose the details on the home-based companies can make the country black-listed for harmful tax practices.8

INDIAN TAX SOLUTIONS (2010) INDO-MAURITIUS DOUBLE TAXATION AVOIDANCE TREATY [ONLINE] Available from: http://indiantaxsolutions.com/old_site/main.php?t=28011995&d=1159080586 [Accessed 15.11.2010]

BUSINESS STANDARD (MAY 2010) DIRECT TAXES CODES: A WILD GOOSE CHASE TAXING OFFSHORE TRANSACTIONS? [Online] Available from : http://www.business-standard.com/india/news/direct-taxes-codewild-goose-chase-taxing-offshore-transactions/395845/ [Accessed 15.11.2010]

TAX RATES (SEP 2009) MAURITIUS TAX: WILLTHE MAURITIUS ROUTE BE BLOCKED AFTER INDIA'S NEW DRAFT DIRECT TAXES CODE? [Online] Available from: http://www.taxrates.cc/html/0909-india-direct-taxes-code.html [Accessed 16.11.2010]

CONYERS DILL & PEARMAN (Oct 2010) INDIA'S DIRECT TAX CODE [Online] Available from: http://www.conyersdill.com/publication-files/178_10_10_29_India_Direct_Tax_Code_THE_LAWYER.pdf [Accessed 16.11.2010]

DLA PIPER (SEP 2010) Vodafone Essar: International trend of taxing indirect transfers by non-resident continues [Online] Available from: http://www.dlapiper.com/vodafone-essar-international-trend-of-taxing-indirect-transfers-by-nonresidents-continues/ [Accessed 30.01.2011]

Finance 3.0 (SEP 2010) Vodafone Decision: All is Not Lost, Perhaps Nothing [Online] Available from: http://www.finance30.com/forum/topics/vodafone-decision-all-is-not [Accessed 30.01.2011]

THE ECONOMIC TIMES (AUG 2010) Hearing on Vodafone tax plea ends [Online] Available from: http://economictimes.indiatimes.com/news/news-by-industry/telecom/Hearing-on-Vodafone-tax-plea-ends/articleshow/6333239.cms [Accessed 30.01.2011]

THE ECONOMIC TIMES (APRIL 2010) IPL'S DECEPTIVE MONEY TRAIL [Online] Available from: http://economictimes.indiatimes.com/opinion/policy/ipls-deceptive-money-trail/articleshow/5870218.cms [ Accessed 30.01.2011]

FINANCIAL TIMES (APRIL 2010) INDIA'S SCAM-RIDDEN IPL IS A NATIONAL CELEBRATION [Online] Available from: http://www.ft.com/cms/s/0/48f5cc8c-51bd-11df-a2a2-00144feab49a.html#axzz1BbDPns8z [Accessed 30.01.2011]