Treaty Shopping and Round Tripping
The revenue department in the finance ministry has recently raised concerns over the problems of “Round Tripping” and “Treaty Shopping” involving inflow of FDI from countries such as Mauritius, UAE and Cyprus.
In Treaty shopping, a resident of a third country invests by taking advantage of a fiscal treaty between India and another contracting state. This has greatly contributed in encouraging FDI in the country but has been a medium of tax evasion. The Supreme Court has also noted in the Azadi Bachao Andolan case that treaty shopping opportunities could be an additional factor to attract such investments.
- The roots of the Treaty shopping are in the inconsistencies among international tax regimes. If there is a dissimilarity of tax systems, it can lead to distortion of investment flows.
- The underlying principle of bilateral tax treaties, i.e. the principle of reciprocity is impeded when a third-country resident derives benefits from a treaty intended to serve only the interests of residents of the two treaty partners.
- Treaty shopping can be controlled by introduction of a limitation of benefit clause (LOB) and other clauses which limit the benefits to the residents of the two countries only. For instance, in the India-Singapore treaty, pursuant to a Protocol in 2005, India provided for capital gains tax exemption to a Singapore resident who sells shares of an Indian company. However, at the same time the introduction of a limitation of benefit clause (LOB) deters treaty abuse.
- With this, a Singapore resident will not be entitled to capital gains tax exemption if its affairs are primarily designed to take advantage of capital gains exemption.
- India Round Tripping, money is routed back into the country by local investors through tax havens like Mauritius.
- We all know that India receives maximum FDI inflows through the Mauritius Route. During the 2000-2010 period Mauritius pumped in $47.24 billion into the country constituting 43 per cent of the total FDI inflow.
- Our government suspects that it is losing, revenue due to the Round Tripping. India and Mauritius have signed the double tax avoidance agreement (DTAA).
- But, India has signed the same treaty with many other countries as well. Then, why we suffering loss from Mauritius investments.
- The culprit is Round tripping. Round tripping refers to money from one country going out through unofficial channels and being invested back into the same country from outside to avail of tax benefits under the double tax avoidance agreement (DTAA).
Round Tripping makes the government lose large amount of revenue because the domestic firms, route the investment through Mauritius. So, now finally CBDT (Central Board of Direct Taxes) proposes that the Domestic companies routing their investments through Mauritius would soon have to pay capital gains tax. For this, a review of the capitals gains tax provisions is required and CBDT is pressing for it.
Round tripping is not regarded to serve any purpose apart from aiding in the evasion of tax in India. Round tripping is not prohibited under Indian laws as of now. It is, however, argued that such a practice severely impacts revenues from capital gains tax. Mauritius has recently introduced stringent KYC requirements, yet most of the tax havens do not wish to impose penalties to curb round tripping as it may whisk away investors.