Double taxation avoidance agreement: In special reference of agreement between India & Mauritius

Abstract

Since the end of the 19th century, individual states have entered into bilateral conventions for the avoidance of double taxation. Double taxation may arise when the jurisdictional connections, used by different countries, overlap or it may arise when the taxpayer has connections with more than one country. A person earning any income has to pay tax in the country in which the income is earned (as source Country) as well as in the country in which the person is resident. As such, the said income is liable to tax in both the countries. To avoid this hardship of double taxation, Government of India has entered into Double Taxation Avoidance Agreements (DTAA's) with various countries. DTAA's provide for the following reduced rates of tax on dividend, interest, royalties, technical service fees, etc., received by residents of one country from those in the other. India and Mauritius has a DT AA between them and has been controversial in recent year due to treaty shopping. Briefly touch upon the historical importance of Mauritius in the context of total foreign direct investments in India, Mauritius tops the list with a 44% during the period lasting April 2000 to April 2009 (in contrast, Singapore stands at 9% and the U.S. at 7%). With a difference of 35 percentage points between the top two spots and Mauritius not being an investing country in its own right, it is anybody's guess that Mauritius has been used as a holding company jurisdiction for making investments in India with actual investors being tax residents of countries outside Mauritius. The reasons for using Mauritius are simple: India has a tax treaty with Mauritius providing that gains on any transfer of shares in an Indian company by the Mauritius holding company shall not be taxable in India but in Mauritius as per the domestic tax laws in Mauritius. Domestic tax laws in Mauritius do not tax capital gains. Therefore, any transaction on account of the transfer of shares in an Indian company by a Mauritius holding company is a tax free transaction both in India and Mauritius. The Indo-Mauritius tax treaty was unsuccessfully challenged in the famous case of Union of India v. Azadi Bachao Andolan and Anr. (2003). The following principles were expounded by the Indian Supreme Court in its decision: • An important principle that needs to be kept in mind in the interpretation of the provisions of the international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their basis. The main function of a treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income "falling to be taxed" in both jurisdictions. • The principles adopted in the interpretation of treaties are not the same as those in the interpretation of statutory legislation.

• There is nothing like equity in a fiscal statute. Either the statute applies or it does not. There is no question of applying a fiscal statute by intendment if the expressed words do not apply. If it was intended that a national of a third State should be precluded from the benefits of the treaty, then a suitable term of limitation to that effect should have been incorporated in the treaty.

• In a fiscal economy, certain evils like treaty shopping are tolerated in the interest of long term development. Perhaps it was intended at the time the Indo-Mauritius treaty was entered into. Whether it should continue and, if so, for how long, is a matter that should best be left to the discretion of the executive as it is dependent upon several economic and political considerations. The court capnot judge the legality of treaty shopping merely because one section of thought considers it improper. With India losing significant tax revenue due to the treaty's application, the clear option available to India's government was to renegotiate the tax treaty with Mauritius ­ especially the article on capital gains. The government apparently did try but without success. Meanwhile Mauritius decided to more strictly enforce the substance requirements under its domestic law for companies to be tax resident in Mauritius and entitled to the benefits of the Indo-Mauritius treaty. The debatable option has been whether India can change its domestic law to unilaterally nullify the effect of the treaty. The new draft Direct Taxes Code Bill, 2009 appears to be just such an attempt. The following proposals in the draft Code may potentially impact the operation of all the tax treaties India has entered into, including that with Mauritius: A. Specific legislation to the effect that the preference of the applicability of a tax treaty or the domestic tax law would depend upon the enactment, which is later in time, as compared to the existing provisions that a taxpayer could choose to be governed by either a tax treaty or the domestic tax laws, depending upon whichever was more favorable to it; and B. Introduction of general anti avoidance rules (GAAR), which has been referred to in the explanatory statements of the Tax Code, as to also partake of the nature or character of "treaty override Assuming the new Direct Taxes Code comes into effect, the use of Mauritius as a holding company jurisdiction for India appears fraught with controversy. Because provisions under the new Direct Taxes Code would be later in time, they may prevail over the Indo-Mauritius tax treaty (and other treaties).