New Delhi: Signalling a climbdown, the government on Friday said it would bring changes in the Finance Bill to address concerns of foreign investors over tax residency certificates (TRCs), and thereby allaying fears of investors who use tax havens such as Mauritius for investing in India.
The Finance Bill was introduced in Parliament on Thursday as part of the budget for 2013-14.
Besides issuing a formal clarification, the finance minister also made a statement. “It has not become law yet. It’s a Bill. When I read that clause again, I said it is clumsily worded,” P. Chidambaram said in an interview with ET Now television channel.
The amendment on Thursday had said the TRC, which effectively exempts the holder from paying taxes in India, “shall be necessary but not a sufficient condition for claiming any relief” under the double-taxation agreements (DTAAs).
Foreign investors had expressed worries that India could begin to question the validity of those certificates altogether. Stocks rebounded on Friday after hitting three-month lows in the previous session, following the government’s clarifications over TRCs.
“I think the market should gradually move up from here,” said Sandip Sabharwal, chief executive officer of portfolio management services at Prabhudas Lilladher Pvt. Ltd, adding that he expects a 5% upside in key indices in March.
“The budget did not have any big negative or big positive announcements for the market. It was very realistic. So, now that the major event is over and since the market is oversold, any positive development should drive it higher,” he said.
BSE’s benchmark 30-share S&P Sensex gained 0.3% to 18,918.52 points on Friday, while the National Stock Exchange’s 50-share Nifty index lodged a 0.5% gain at 5,719.70 points. The Sensex had declined 1.52% and the Nifty had fallen 1.79% on Thursday.
In a statement on Friday, the government also upheld the primacy of Circular 789 issued in 2000. The circular provides that the TRC issued by the Mauritius Revenue Authority is sufficient evidence for claiming tax treaty benefits.
“In the case of Mauritius, Circular No. 789...continues to be in force, pending ongoing discussions between India and Mauritius,” the finance ministry said in a statement.
A foreign investor has to obtain a TRC from the resident country to claim tax benefits under DTAA India has with other countries.
With the capital gains tax close to zero in Mauritius, the island nation is a preferred route for entities investing in India. Nearly 40% of investments in India comes through Mauritius.
Thursday’s budget announcement had a clause inserted in the Income-Tax (I-T) Act that said a TRC was a necessary, but not sufficient condition for obtaining tax benefits under a bilateral treaty. This had led to apprehensions among foreign institutional investors (FIIs), who route their investments into India from Mauritius, that a TRC issued by the country may not be enough.
Chidambaram, in a post-budget press conference on Thursday, had clarified that a TRC only satisfies the residency aspect, but not the beneficial ownership part. Both these conditions are relevant under a DTAA in case of interest income and dividend income or royalty, he had pointed out.
The ministry of finance said that “since a concern has been expressed about the language of sub-section (5) of section 90, this concern will be addressed suitably when the Finance Bill is taken up for consideration”.
The government cleared the doubts over the TRC, said Mukesh Butani, chairman of BMR Advisors Pvt. Ltd.
“There were fears that the legislation will override Circular 789,” he said.
The finance ministry statement went on to add that the I-T department will not question the TRC produced by the investor.
“The tax residency certificate produced by a resident of a contracting state will be accepted as evidence that he is a resident of that contracting state and the income-tax authorities in India will not go behind the TRC and question his resident status,” the statement said.
Under the DTAA, capital gains from the sale of securities can be taxed only in Mauritius.
India has been in talks with Mauritius to amend the DTAA for the past few years to check so-called round-tripping and other potential abuses. Round-tripping entails moving money out of one country to another, and getting it back under the garb of foreign capital.
Mauritius has, however, been reluctant to make changes in this bilateral pact.
“The language of the clause has wide ramifications. It is not only restricted to foreign institutional investors, but to all non-resident investors. It will also be applicable to all treaties. It is also not just restricted to capital gains, but applies to dividend and interest income and royalty,” said Sunil Jain, a tax partner at J Sagar Associates.
“In a large number of treaties, the term beneficial ownership is associated with dividend income and royalties, and not with capital gains. The clarification will only rule out investments from Mauritius where capital gains tax is applicable,” he added.
The budget did not offer clarity on various direct and indirect tax provisions affecting both domestic and foreign companies, although the finance minister had reiterated the government’s promise to provide clarity in tax laws and a non-adversarial tax regime.
Analysts pointed out that this may lead to continued uncertainty and litigation.
While the budget was silent on transfer-pricing transactions and did not provide any clarity on share valuation and marketing tangibles that have been a cause of recent disputes, it also failed to provide clarity on retrospective amendments to indirect transfers.
On the indirect tax front, the finance minister didn’t address valuation disputes arising from the Supreme Court judgement in the Fiat case pertaining to excise duty payment.
The Supreme court ruled last year that Fiat will have to pay excise duty on the basis of cost of production plus a notional mark-up, rather than on the selling price, which was substantially lower as the auto maker cut prices to capture market share.
Ami Shah and Anirudh Laskar in Mumbai, and Reuters contributed to this story.