India must remember that in all developed countries, greater scrutiny of taxpayers has gone hand in hand with fair, clear and predictable tax systems. Can it ensure that there are adequate safeguards in place to meet the expectations of a fair tax regime?
In 2003, the Supreme Court was quite firm in dealing with a petition filed by an Indian NGO called Azadi Bachao Andolan. The petitioners had alleged that the Indian government had mortgaged the country’s sovereignty in tax matters by entering into a treaty with Mauritius that made it extraordinarily convenient for companies to invest in India tax free by basing themselves in Mauritius. The so called Mauritius residents did not need to have a substantial economic presence in Mauritius; bells and whistles aside, all they needed was a post box address in that country. If a Mauritius resident invested in the shares of Indian companies, the tax treaty between the two countries ensured that no or very little tax would be paid on the ensuing capital gains in either of country. The Supreme Court declined to close down this route because in their opinion India and Mauritius had cut a tax deal with their eyes open, and the Indian government was aware that tax breaks would incentivise foreign investment in the country.
The Supreme Court’s decision was criticised by some tax lawyers but on the whole was accepted with little trepidation. The tax zeitgeist – the prevailing spirit in the international tax world – was indulgent of corporations and countries entering into a cozy relationship whereby companies could pretend to be resident in counties with which they had no real connections. Thirteen years later, the tax zeitgeist has changed. The world is much less tolerant of international tax arbitrage. The G20 and the OECD have entered into an unprecedented multilateral effort to combat the exploitation of tax treaty benefits by companies that are housed in jurisdictions in which their presence is nominal. Moreover, India is not in the same economic position as it was in 2003. Attracting foreign investment through tax breaks no longer appears to be a priority area for the government. On the other hand, India is increasingly concerned that shell companies are being incorporated in Mauritius to take black money out of India and bring it back as white money. Therefore, both the push and pull factors in granting foreign companies tax incentives are now less powerful than before. It is this new tax zeitgeist that explains why the recently concluded India-Mauritius tax protocol marks a decisive change in the way the government challenges international tax evasion.
The most important change brought about by the protocol is that it allows the Indian government to impose a capital gains tax on a Mauritius entity for transferring the shares of an Indian company. This change finally strikes at the heart of the tax advantage that the Azadi Bachao Andolan was concerned about thirteen years ago. The capital gains tax exemption for Mauritius companies will be phased out beginning from April 2017 until March 2019 and completely eliminated thereafter. During this period, capital gains arising from the sale of Indian company shares by Mauritius entities will be taxed at a concessionary rate.
India has also taken the sensible decision of making this tax charge prospective. The last major international tax intervention, the Vodafone inspired amendments to the Income Tax Act, 1961 in 2012, were retrospective and widely criticised by tax scholars and international investors for being patently unfair, both for attacking transactions that were done in the past in good faith and also for being a muddled piece of legislation. The government must be lauded for adopting a sensible course this time.
However, the government, in its zest to wrest control from foreign investors, has adopted other measures, which have the potential of making life quite difficult for Mauritius investors.
First, the government has introduced a limitation of benefits (LOB) clause in the India Mauritius tax treaty that would operate during the transition period, under which a Mauritius company has to show it has a reasonable economic presence in Mauritius to avail of the concessionary capital gains tax rate during the transition period. Under the LOB clause, not only must a Mauritius company undertake a certain minimum expenditure in order to be in the clear, it would also have to demonstrate an economic purpose for its existence, beyond merely a desire to save taxes by being resident in Mauritius. By insisting on an objective and a subjective test, India has followed a strict approach towards tax avoidance. A similar clause can be found in the tax treaty between India and Singapore.
Finally, the Indian government has made it clear that the general anti-avoidance rules (GAAR) are applicable from next year. The GAAR allow a wide latitude of discretion to tax authorities in challenging both domestic and international tax planning measures. GAAR is harsher than LOB clauses. Under it, the tax authorities can challenge tax avoidance transactions for directly or indirectly ‘misusing’ or ‘abusing’ tax legislation.
India has taken full advantage of the current tax zeitgeist. But it will do well to remember that in all developed jurisdictions of the world, greater scrutiny of taxpayers has gone hand in hand with fair, clear and predictable tax systems. The question now is whether India will ensure that there are adequate safeguards in place to meet the expectations of a fair tax regime. If the Indian revenue is perceived as arbitrary or worse, tyrannical by the taxpayers, India might have won the Mauritius battle but would have lost the tax war.
Nigam Nuggehalli teaches at the School of Policy and Governance at Azim Premji University, Bangalore.