Unpredictable business

Attacking tax havens is a cover to introduce the draconian GAAR

Written by Jaithirth Rao | Published: April 13, 2012 3:47:12 am

Attacking tax havens is a cover to introduce the draconian GAAR

A friend of mine tells me that the India-Mauritius treaty was signed in order to encourage Indian businesses to invest in Mauritius,not vice versa. Once it was signed,clever lawyers and accountants noticed that the fine print allowed companies from Mauritius to invest in India and pay no taxes on income generated from India in any of the usual forms like dividends or capital gains.

Once this loophole was discovered,verily a bulldozer was rammed through it; we saw a deluge of investments in India from this island country. Mauritius has distorted our investment flows,our fiscal regime, our domestic economy and probably our politics too. Virtually all foreign investors,irrespective of their location,routed their investments into India through Mauritius. By the time intelligent income-tax officers started pointing out that “post box” companies in Mauritius represented individuals and firms based elsewhere and that we should deny such investors the benefits of the treaty,the inflow numbers had become too large. Any attempt to go behind the Mauritius curtain to figure out the “substantive nature” of the transaction might result in “destabilising” impacts on our public markets.

Our government succumbed to the implied blackmail of the financial markets and acquiesced that a Mauritius residency certificate,which is easily obtained,would allow investors to legally avoid paying any taxes in India. Our government had an opportunity to “prospectively” re-negotiate the treaty. It chose not to do so. One fact of political economy that may have guided this decision is that many wealthy,powerful,desi investors may be using Mauritius to “round-trip” their overseas funds into India. And these wealthy,powerful investors had powerful friends (cronies?) in Delhi. The Indian government,in its wisdom,extended the treaty benefits to another island republic — Singapore. This makes any unravelling of the situation more difficult.

Let us look at the domestic scene: the absurd proposition emerged that an ordinary resident desi investor like you or me had to pay taxes on dividends and capital gains,but folks in Mauritius did not have to; if you or I moved to Mauritius or Singapore,even we did not have to. This blatant attempt at discrimination against desis was an incentive to emigrate and was becoming increasingly untenable. In situations like these,our government in imperious Delhi never tries to go back to the root of the problem and deal with it. Instead second-order sub-optimal solutions to partially deal with the root problems are preferred. Since Mauritius residents do not pay any taxes on dividends,Indian residents will also be exempted. The tax on dividends is now paid by companies. This has the regressive impact of the dividend tax affecting the middle class as much as the super-rich. Short-term capital gains is substituted with a securities transaction tax which everyone has to pay and long-term capital gains on the stock market is abolished for all.

As we trundle along,attacks on the Mauritius arrangement get shriller by the day. Once again we can rely on the ingenuity of our tax officials to take the initiative. They decide to act against Vodafone — a foreign company which uses tax havens — a soft target if ever there was one. The old issue of the “substantive nature” of the transaction is revisited.

The trouble is that our lawmakers have so tied themselves up in contradictions that the judiciary is virtually forced to rule in favour of Vodafone. Anything else might have smacked of xenophobic caprice — something that our courts will not countenance. Now,as it finds itself stuck in an awkward bind,any sensible government would have acknowledged the mistakes of the past,gracefully accepted the judicial verdict and gone back to both Mauritius and Singapore and re-negotiated the treaties prospectively. Such an act would be non-discriminatory,fair and fiscally prudent.

But do we really want to be non-discriminatory? As Hamlet would say,“Ay there’s the rub.” We want to retain discretionary powers to discriminate in favour of our friends (cronies?). We want to harass our adversaries and some other easy victims. So now we proceed to give the income-tax officer the “discretion” to decide when a Mauritius/Singapore transaction is genuine and when it has been put in place only to avoid taxes. Now the finance minister says that he won’t harass pro-note holders. But that’s hardly a legal protection. Tomorrow,your friendly ITO may disallow the invidious pro-notes. Attacking tax havens has become a convenient cover to introduce the draconian General Anti-Avoidance Rules or GAAR. (Ask an accountant to explain to you the implications of the new discretionary powers of ITOs under GAAR,which deserve a separate column altogether.)

Suddenly all business in India has become unpredictable. What do you think is the probability that influential friends (cronies?) of our political masters will be treated generously by the authorities? What is likely to happen to ordinary citizens without connections?

There is a better way out. Drop the Mauritius and Singapore tax concessions prospectively. If these countries protest,we must have the backbone to stare them down. Trust me,in a couple of years,we will more than recover the tainted levies that we now seek from the likes of Vodafone. No genuine investor would baulk at a long-term capital gains tax of 10 or 15 per cent. We should tax dividends and capital gains in the hands of all in a non-regressive manner. Be clear,succinct and lucid on what is taxable.

Drop this dangerous and tyrannical GAAR provision where the government and its functionaries have the “discretion” to decide on what they want to tax and what they don’t. We would like a government that nurtures its citizens; if that is not possible at a minimum it should not harass us. I hope our parliamentarians will not allow a law to go through which appears today to be directed against quaint Mauritius-Singapore structures but which tomorrow can be used to harass any of them. Instead,let us alter the treaties and,I may add,prospectively not retrospectively.

The writer is a Mumbai-based entrepreneur,express@expressindia.com

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