India-Mauritius double taxation avoidance treaty : So what does the treaty offer? Business desk chiefsworld

[CHIEFS WORLD]

There was a sense of déjà vu on Dalal Street on Monday. Any talk of
revisiting the India-Mauritius double taxation avoidance treaty always
spells trouble for the Indian stock market as foreign institutional
investors resort to selling fearing that their free lunch is over.

After all, under the present dispensation, they get away without
paying capital gains tax in India as well as Mauritius.

It's been the same for the past 10 years with little progress. Given
that FIIs account for a large chunk of the Indian stock market wealth,
their pressure always forces the government to make a quick retreat
despite estimates suggesting that the treaty causes annual revenue
loss of $100 million to $500 million.

So what does the treaty offer?

In the early eighties, Indian authorities signed the tax treaty with
the island nation which stipulates that capital gains on Indian
securities which a company based in Mauritius holds would be exempted
from tax in India. Since Mauritius has no tax or negligible tax on
such income, it virtually means that FIIs registered in Mauritius pay
no tax. Mauritius says such treaties have helped it to develop a
vibrant financial services industry and also helped India attract
foreign investment.

Now, the government wants capital gains tax at source, which will be
in India. This led to panic on Dalal Street, and the sensex fell 600
points in intra-day trade before recovering. Though negotiations have
been underway for a while, there has been no discussion since 2008
when talks broke down on the issue.

Even the Indian government has been reluctant to push ahead though a
free trade agreement was linked to the revision in the agreement. In
any case, the fear of FIIs spoiling the sentiment in the capital
markets would be weighing down on a government that is low on
confidence and has not undertaken any significant reform moves in the
last few months.

The first instance of FII pressure showed in the summer of 2001 when,
during the National Democratic Alliance (NDA) rule, the income tax
department had issued notices to some FIIs sending jitters through the
share market and pulling it down by more than 350 points. In those
days a 350 point decline meant that the Sensex lost over 10%.

Finance Minister Yashwant Sinha had to step in and the government was
forced to issue a clarification to restore sanity in the financial
markets. The tax department also issued statements to boost sentiment
and allay any fears.

A few years later, a draft circular issued by the Central Board of
Direct Taxes drove FIIs to sell. As a result, on May 22, 2006 the
benchmark BSE Sensex fell 1,100 points – nearly 10% of the index --
resulting in suspension of trading following. Again, the then finance
minister, P Chidambaram, had to step in to calm nerves.

A little over a year later, FIIs did it again though this time it was
not over a tax matter. On October 16, 2007, the Sensex saw one of its
steepest fall of 1,744, around 9% of its then value, after the
Securities & Exchange Board of India decided to put in place curbs on
participatory notes, which are derivative instruments used by
investors not allowed to trade directly in Indian markets.

It was only a few days that the sentiment improved and that followed
assurances from the government and Sebi.

Again in 2010 the talk of revising the treaty surface and again the
markets panicked as FIIs pulled out.

Some tax officials say there is a reluctance on both sides to revise
the tax treaty. More than 40% of foreign direct investment to India
comes through the Mauritius route and the island nation. Similarly any
talk of banning participatory notes (a derivative instrument) which
some critics say is used for legitimising black money also revokes a
similar response from the Indian stock market.

But the intense pressure on the issue of black money has forced the
government to review its tax treaties with several countries. Critics
say that Indian authorities should insist on reviewing the treaty with
Mauritius and plug the loopholes. Tax authorities said the department
has informed the foreign ministry that they would like to hold talks
with their counterparts in Mauritius on the issue but it was up to
them to respond.

"Nothing is final. It could take 3 year to 30 years for any discussion
on the issue," one tax official, who did not wish to be identified,
said.