THIS time, last year, the flavour of the season was black money and how to tackle the same. The Government announced a slew of measures. However, the retrospective Voda amendments and the provisions relating to GAAR hijacked the discourse. Both the measures were primarily aimed at tackling tax avoidance and evasion involving entities floated in Mauritius and similar places to take advantage of our DTAA, which resulted in double non-taxation. The market initially reacted adversely. The Government hung on gamely for some time before announcing a deferment of the GAAR. The retrospective amendments became the law. However, the change of the incumbent in the Finance Ministry at that time saw a Government, worried about worsening current account deficit situation constitute a Committee tasking it to review the unpleasant decisions of Budget, 2012. Tax avoidance was put on the back burner. The Committee's suggestions having more or less been accepted by the Government and having got GAAR out of the way, vested inserts are now baying far more.

Along with GAAR and the retro-amendments, the Finance Act, 2012 had introduced an amendment in Section 90 by incorporating a new sub-Section 4 which stated that in order to avail of the benefit of DTAA, the taxpayer has to submit a certificate. The exact provision reads as follows: -

"(4) An assessee, not being a resident, to whom an agreement referred to in sub-section (1) applies, shall not be entitled to claim any relief under such agreement unless a certificate, containing such particulars as may be prescribed, of his being a resident in any country outside India or specified territory outside India, as the case may be, is obtained by him from the Government of that country or specified territory."

Read plainly, the provision says that a non-resident wishing to avail of the benefits of a tax treaty has to submit a tax residency certificate containing certain prescribed particulars. It nowhere says that mere submission of the certificate is enough. This was made abundantly clear in the Memorandum, which, inter-alia stated as follows: "…the Central Government has entered into various Double Taxation Avoidance Agreements (DTAA's) with different countries and have adopted agreements between specified associations for relief of double taxation. The scheme of interplay of treaty and domestic legislation ensures that a taxpayer, who is resident of one of the contracting country to the treaty, is entitled to claim applicability of beneficial provisions either of treaty or of the domestic law.

It is noticed that in many instances the taxpayers who are not tax resident of a contracting country do claim benefit under the DTAA entered into by the Government with that country. Thereby, even third party residents claim unintended treaty benefits.

Therefore, it is proposed to amend Section 90 and Section 90A of the Act to make submission of Tax Residency Certificate containing prescribed particulars, as a necessary but not sufficient condition for availing benefits of the agreements referred to in these Sections."

(Emphasis supplied)

Note that the provision is general in nature and is not confined to Mauritius alone.

Subsequently, on 17 th September 2012, the CBDT notified Rule 21AA to come into effect from 1 st April 2013. It mentions that the Tax Residency Certificate (TRC) should contain the following particulars: Name of the taxpayer, status, nationality, country of incorporation, unique identification number, residential status for the purposes of tax, period of validity of the certificate and address of the applicant. Note that the information sought is very basic and no particular form has been prescribed. This was perhaps for the reason that the certificate was supposed to be only a prima-facie evidence of residence of a particular country subject to verification by the Indian tax authorities. The rule could have been made more robust but that is a different story.

This year's budget focused primarily on reducing the twin deficits did not have much by way of amendments in the direct tax provisions. The expected goodies of across the board increase in tax exemption didn't materialize. In fact, this year's Finance Bill contains one of the leanest tax proposals that one has seen for a very long time.

The stock market's reaction to the budget initially was somewhat indifferent with the Sensex going up by some 100 points and then losing the gain. However, it is only after the FM's speech that the budget documents are made available. Tucked away amongst the tax proposals was a new sub-section 5 to section 90 which states as follows: "(5) The certificate of being a resident in a country outside India or specified territory outside India, as the case may be, referred to in sub-section (4), shall be necessary but not a sufficient condition for claiming any relief under the agreement referred to therein." One may wonder whether the addition of the sub-section was necessary. However, it adds nothing new. If at all, it makes explicit what was implicit in sub-section (4).

Certain commentators however discovered a new sinister motive on the part of the Indian Revenue to clamp down on the Mauritius route through this innocuous amendment. It seems that as soon as the details emerged, market players, particularly the FIIs, started selling. The market tanked about 300 points. Worried that his efforts to rein in the current account deficit will come unstuck, the FM went on a damage control exercise and explained to whosoever would care to listen that this was not a new provision; that the provision was already there in the last budget and that what has been done was a mere reiteration of the same. He also articulated the fact that there is a difference between the concept of residence and beneficial ownership; that the treaty benefits are available to a resident who beneficially owns the income involved. He even went to the extent of disowning his draft and under fire from ill-informed but out of breath journalists commented that the provision was perhaps clumsily drafted. He promised that if necessary, a clarification would be issued.

Some three or four persons, known revenue–baiters, wrote articles criticizing the move and emphasizing that the same would create ‘uncertainty' amongst foreign investors. It was argued that the revenue officers would now challenge the circular 789 issued by the CBDT.

Despite assurance from the FM and within a little over 24 hours, the Ministry asked the CBDT to issue a press release clarifying the government's position. The exact language of the release is as follows: -

It is in this context that it becomes necessary to examine the scope of TRC that is issued by a foreign jurisdiction. As is fairly well known the genesis of a TRC in India arose out of a similar panic reaction of the government to thwart the enquiries by the IT department about the eligibility of the India- Mauritius tax treaty in the wake of large scale selling by Mauritius based FIIs in the stock exchange. The then administration forced the CBDT to issue the now infamous circular 789. This Circular states as follows: -

"The provisions of the Indo-Mauritius DTAC of 1983 apply to ‘residents' of both India and Mauritius. Article 4 of the DTAC defines a resident of one State to mean any person who, under the laws of that State is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature. Foreign Institutional Investors and other investment funds, etc., which are operating from Mauritius are invariably incorporated in that country. These entities are ‘liable to tax' under the Mauritius tax law and are, therefore, to be considered as residents of Mauritius in accordance with the DTAC.

2. Prior to 1st June, 1997, dividends distributed by domestic companies were taxable in the hands of the shareholder and tax was deductible at source under the Income-tax Act, 1961. Under the DTAC, tax was deductible at source on the gross dividend paid out at the rate of 5 per cent. or 15 per cent. depending upon the extent of shareholding of the Mauritius resident. Under the Income-tax Act, 1961, tax was deductible at source at the rates specified under section 115A, etc. Doubts have been raised regarding the taxation of dividends in the hands of investors from Mauritius. It is hereby clarified that wherever a certificate of residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly.

3. The test of residence mentioned above would also apply in respect of income from capital gains on sale of shares. Accordingly, Flls, etc., which are resident in Mauritius should not be taxable in India on income from capital gains arising in India on sale of shares as per paragraph 4 of article 13."

(Emphasis supplied).

Thus the circular, more or less prohibits the tax department from questioning a TRC issued by Mauritius. The Supreme Court in the Azadi case has upheld the validity of the circular. However till now, the circular is restricted to Mauritius in its applicability. There are also debates about the judgement of the Supreme Court itself that was relied upon in the Vodafone case- the most recent view on the subject being articulated by Justice Verma. It is also important to note that so far, successive governments have been doling out largesse to Mauritius based FIIs without the Parliament specifically permitting the same.

The Press Note now released asserts that a 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. This goes much beyond even the circular 789. The government is saying that the TRC produced by the taxpayer is a conclusive proof of his residence in the particular contracting State. This is contrary to the practice adopted by other countries. Surely, a country cannot be bound by another country's evaluation of the facts on which residence is based and normally TRCs have no formal legal value. Therefore, this clarification, if translated into legislation through government amendment will have two serious consequences- the provision will apply to all jurisdictions and not be restricted to Mauritius and (2) there will be a legislative stamp of approval for treaty shopping.

As we have seen the TRC is only a prima-facie evidence of residence of a taxpayer in a particular jurisdiction. But, ‘residence' for treaty purposes is different from residence under the domestic law. It is not necessary that merely because a taxpayer is resident in a jurisdiction for tax purposes, the treaty benefits will automatically inure to him. As has been rightly pointed out by the FM, there has to be an examination of beneficial ownership of the income in question. Then there are treaties, which contain limitation of benefits clause. The OECD commentary points out that the concept of ‘resident of a contracting state' has various functions. For example, the person concerned, in order to avail the benefit of residence of a State, must be subject to comprehensive taxation therein. Then, even if resident for tax purposes, the person must not be subject to taxation limited to the sources in that State. Moreover, there can be cases of dual residency where each jurisdiction claims the taxpayer to be its resident. This is fairly common in tax treaty situation and that's the reason that we have the tiebreaker rule in tax treaties. Therefore, the press note issued in a hurry may come back to haunt the tax administration. For the moment though, it will allow treaty shopping to go on as business as usual.

The Supreme Court in the Azadi case had winked at treaty shopping on the ground that it was good for a developing country in the same manner as deficit financing is. Well, if deficit financing is a virtue for a developing country, the FM certainly does not seem to think so. His entire effort has been to control the deficit. As for treaty shopping, it cannot be Government of India's official view that the same is good for India's economy, as it cannot be seen to be out of sync with other countries – developing or developed who consider treaty shopping as an unmitigated evil. What is the unofficial view of the GOI is not known. Apologists do point out that treaty shopping has to be allowed if we need foreign investment.

What treaty shopping does is to exempt certain types of income of the shopper, more notably capital gains, from being taxed in India. Most probably, no income tax is paid in the home country as well. Foreign investors structure their investments through jurisdictions like Mauritius so that they do not pay any capital gains tax in India. Apologists argue that changing this scheme of things would unsettle the apple cart and the foreign investors need ‘certainty' before investment decisions are made. But this is a very non-transparent way of giving tax benefit to foreign investors. It is also totally discriminatory vis-a-vis the domestic investors who do not become foreign just to avail of the benefit. The question that can then be asked is whether it is not infinitely better that the government passes a provision exempting all foreign investors from paying any capital gains tax– whether the investment is through Mauritius or elsewhere. It will be even better if capital gains are exempted from tax altogether. Let there be an informed debate in the Parliament and if our legislators really think that it is good for the economy in the long run then pass such a legislation. That will be much better than allowing a small section of tax practitioners to sell their avoidance schemes, earn fat fees and belittle the tax administration at regular intervals. In the meantime, let concerns about tax avoidance, black money, equity, and such other esoteric concepts be kept in the deep freeze.