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Govt modifies tax treaty with Mauritius, but will it curb black money?

Neeraj Thakur | Updated on: 10 February 2017, 1:49 IST
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The misuse

  • For almost three decades, investors from all over the world have abused India\'s tax treaty with Mauritius
  • Under the treaty, capital gains from the sale of shares can be taxed only in Mauritius, that too if shares are held for less than a year

The change

  • The Indian govt has moved an amendment to this treaty
  • This has been done to earn tax, as well as curb the flow of black money

More in the story

  • How will this change impact investors?
  • Will there be any negative consequences for the govt as well?

India has finally shut the door on people who invest in the country via Mauritius in order to save on capital gains tax. The government has taken this decision after years of debate and discussion.

For almost three decades, investors from all over the world have abused India's tax treaty with Mauritius. This route has also been used to pump back Indian black money into the Indian economy, as nobody has an account of the money that is routed through Mauritius into India.

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Round-tripping black money

Under the bilateral treaty between Mauritius and India, capital gains from the sale of shares can be taxed only in Mauritius. If shares are held for less than 12 months, they're treated as short-term capital gains and attract a 15% tax. But if the shares are held for more than 12 months, they are treated as long-term capital gains, and attract zero tax.

This clause in the treaty has allowed hundreds of companies to indulge in round-tripping of black money to India by setting up shell companies in Mauritius.

But now, the question is, will this treaty allow India to curb the black money economy? Will the government be able to generate more revenue as companies are forced to pay capital gains tax on transactions in Mauritius?

Shifting elsewhere

According to government data, Mauritius accounted for 34% of the FDI in India between April 2000 and September 2015. Economists and anti-black money crusaders have been pointing at this lacuna for many years.

According to Prof. Arun Kumar, an expert on the black money economy, there are 80 tax havens in the world, and investors will simply shift their transactions from Mauritius to another tax haven.

Kumar's argument looks plausible. As Business Standard had reported in December 2015, investors were aware that this amendment was in the pipeline, and had started preferring Singapore over Mauritius for investing money in India.

Between April and September 2015, India attracted $6.69 billion (Rs 43,096 crore) FDI from Singapore, while from Mauritius, it received $3.66 billion (Rs 23,490 crore).

What if govt modifies treaties with all nations?

There is no doubt that governments all over the world want to curb the black money economy. The Organisation for Economic Cooperation and Development (OECD) has agreed a new framework that will allow all interested countries and jurisdictions to work jointly for curbing the practices of avoiding capital gains tax. But it would be a herculean task to do this in a jiffy.

On the other hand, investors can shift their investment base overnight.

Even in the case of Mauritius, a two-year transition window has been given, during which the tax levied on capital gains would be half the Indian tax rate. This period can be used by investors to shift their companies to other tax havens.

Impact on FDI and FII

If one assumes that the amendment in the treaty with Mauritius will be a blow to investors, it's obvious that there would be an impact on FDI as well as Foreign Institutional Investments (FIIs) in India.

In 2015, India received $63 billion worth of FDI, which was highest in the world, overtaking the US ($59.6 billion) and China ($56.6 billion).

But a large amount of that FDI, as mentioned above, came via tax havens. Therefore, while it may help India curb tax avoidance by companies, the government may have to be content with getting less investment overall.

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First published: 11 May 2016, 9:05 IST
 
Neeraj Thakur @neerajthakur2

As a financial journalist, his interface with the two dominant 'isms'- Marxism and Capitalism- has made him realise that an ideal economic order of the world would lie somewhere between the two.

Senior Assistant Editor at Catch, Neeraj writes on everything related to business and the economy.

He has been associated with Businessworld, DNA and Business Standard in the past.

When not thinking about stories, he is busy playing with his pet dog, watching old Hindi movies or searching through the Vividh Bharti station on his Philips radio transistor.

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