Budget 2012: Change won't affect FDI from Mauritius

NEW DELHI: The finance ministry has said that the Budget change in the residency law will not affect investments from Mauritius, source of maximum foreign direct investment into India, but investments inflows through other countries could face heat.

The Budget for 2012-13 announced last week says tax residency certificate from the host nation will not be sufficient for availing benefits under a double taxation avoidance agreement.

"There is no issue with regard to investors from Mauritius…the circular will prevail," said a finance ministry official.

The Central Board of Direct Taxes circular, issued in 2000, states that a certificate of residence issued by Mauritian authorities would be adequate proof of residence in Mauritius and no further enquiries could be made.

The Finance Bill 2012 proposes to amend income tax law to make submission of tax residency certificate containing prescribed particulars, as a necessary but not sufficient condition for availing benefits of the DTAA.

This had lead to apprehensions among the foreign investors that the change was largely aimed at denying capital gains tax exemption to those coming through Mauritius.

"The circular remains valid even now in the case of investors coming from Mauritius... There is no change in the situation," the official told ET.

Over 40% of foreign direct investment into India is routed through Mauritius to take advantage of tax treaty the country has with India.

In most of these cases, the government does not know the real investors behind these investments creating apprehensions of black money and round tripping - or Indian money being routed through Mauritius.

New Delhi has been trying to convince the island nation to renegotiate the tax treaty for past few years but has not made much progress. DTAAs are pacts that seek to eliminate double taxation of income or capital gains.

India-Mauritius tax treaty provides that capital gains arising in India from the sale of securities can only be taxed in Mauritius, and since the island nation does not tax capital gains, it leads to zero taxation.

The abuse of tax treaty to avoid taxes by investors of a third country - treaty shopping - is a major concern of income tax authorities. Tax experts say the move was unfair as many countries do not give a tax residency certificate, including India.

"This appears to be hastily inserted provision considering that India itself does not have any provision for issuing tax residency certificate and without realising that many countries do not issue tax residency certificate," said Amitabh Singh, partner, Ernst & Young.