End of tax treaty shopping for India?

Options for tax evaders are getting limited with base erosion becoming a global issue

Cyprus, a tiny island in the Mediterranean Sea, hardly has anything in common with India, with only 0.01 per cent share in our total trade and Indians comprising barely 0.17 per cent of its population. Yet the European Union country evoked interest from the Indian government to such an extent that the Income Tax law was amended to facilitate blacklisting of Cyprus as a "non-cooperating" jurisdiction.

Cyprus, Mauritius and Singapore are the three countries that have a double taxation avoidance agreement (DTAA) with India wherein the right to levy capital gains is not with India while the capital gains tax is nil in these countries. Thus, investors routing their investments into India through these nations don't have to pay tax anywhere in the world, and that is the issue India is trying to address.

Steps taken to check Round tripping of money and tax evasion

• Income Tax Overseas Units set up in Mauritius, Singapore, Cyprus, France, Germany, Japan, Netherlands, the UAE, the UK and the US to unearth black money
• Section 94A was introduced in the Income Tax Act in 2011, allowing India to notify a country as non-cooperating if there is lack of effective exchange of information
• Negotiation of tax treaties with other countries and renegotiation of existing treaties to allow for better exchange of information and check tax evasion
• General Anti-Avoidance Rules notified for those foreign investors who avail of benefits under treaties and the tax benefit in an arrangement is more than Rs  3 crore
• Directorate of Criminal Investigation was created in 2011 to gather intelligence and investigate cases including tax information received from other countries
• To prevent shifting of profits out of India and erosion of tax base, select international transactions are analysed every year in accordance with transfer pricing provisions

In the tax treaty with Singapore there is a Limitation of Benefit (LoB) clause, which restricts benefits under the bilateral agreement only to resident investors who fulfil certain conditions. Some people still find their way to reroute black money stashed abroad through this channel, but Singapore is not that big a problem as Cyprus and Mauritius are for the Indian government.

Since the benefits are not limited to resident investors in treaties with these countries, India had proposed to renegotiate the DTAAs. After great reluctance the process started with Mauritius a couple of years ago, but not much headway has been seen, so far. India wants source-based taxation for capital gains so that both foreign and domestic investors in the country are taxed on par on short-term capital gains, but Mauritius has clearly said 'no' to that. It agreed to put an LoB clause akin to Singapore in the treaty, which was signed about 30 years ago, but India said the way clauses were worded, it didn't serve any purpose. The tax haven proposed more stringent clauses when an Indian delegation visited the country recently.

Though the renegotiations may not conclude anytime soon, Mauritius may start losing sheen as the most attractive destination for routing investments into India. Currently, capital inflows from Mauritius account for about 38 per cent of the total foreign direct investment (FDI) in India-the highest among all countries-followed by 10 per cent from Singapore, 9 per cent from the UK and 8 per cent from Japan. Cyprus accounts for 4 per cent of the total FDI flows into the country. "Singapore is becoming more attractive than Mauritius because there is a fear of the unknown. Investors don't know in what shape the renegotiated treaty with Mauritius would come. In case of Singapore LoB provisions are already established and there is a certainty that if those conditions are fulfilled, treaty benefits would not be denied," says a finance ministry official.

This left India with the Cyprus problem. Tax authorities admit while Mauritius has been effectively sharing information even before renegotiation of the treaty, such was not the case with Cyprus.

Consequently, India notified it as a 'non-cooperating' jurisdiction last month, making it difficult for investors to do business with Cyprus, as they lost many tax benefits provided otherwise. The tax haven immediately got into course correction mode and agreed to resume treaty renegotiation talks. However, just like Mauritius it has also refused to give India the right to tax capital gains.

"This is the end of treaty shopping to a great extent so far as Cyprus is concerned. But other routes are still available to investors. The effort is to effectively deal with that too," said the official.

  India had thought that blacklisting Cyprus would send a strong signal to other non-cooperating jurisdictions too, but unfortunately that has not happened, so far. Capital gains tax is just one part of the problem.

Despite tax information exchange pacts, many countries are not sharing information that could help Indian authorities in trailing tax evaders who have stashed money abroad.Problems have been faced in exchange of information with countries like the UAE, Singapore, Switzerland, Hong Kong, Samoa and Seychelles, but as some of these are our large trading partners compared to Cyprus, tax authorities are wary of taking any action against them, as it could spoil ties.

To address the problem, India is becoming part of a global crusade against tax evasion. India is working closely with G20 on formulation of Common Reporting Standards (CRS). This will allow all the member countries to automatically share information pertaining to tax. India is working towards putting in place its IT infrastructure for CRS, which is likely to come into force by 2015.

India was ranked the fifth largest exporter of illicit money between 2002 and 2011, with over $343 billion sent abroad, according to a recent report.

It may be difficult to completely end treaty shopping, not just for India but for any other country. However, the options for tax evaders are certainly getting limited with base erosion becoming a global issue.