The article argue that the end of the tax treaty with Mauritius will perhaps have the most farreaching impact on India’s economy as well as society.
- The 2016 budget session of the Parliament saw the ushering in of a monetary policy committee for deciding interest rates in the country, a bankruptcy code for smooth recovery of debts and end of a tax holiday with Mauritius.
- The Mauritius treaty change was an executive decision, unlike the other two, which were legislative.
- India signed a tax treaty with Mauritius in 1983 that gave Mauritius the sole right to tax investment gains made by investing in India.
- Mauritius’ tax rate on such gains was zero. Hence, a large majority of investments into India chose this attractive route.
- This was, perhaps, necessary then for India’s foreign reservesstarved economy, but it led to several unintended and unpleasant consequences over the years.
- The high profile tax disputes are well known but there’s also been a lurking suspicion of roundtripping and other malfeasance.
- But the biggest distortion of this treaty was the long shadow cast on India’s domestic tax reform agenda. The treaty led to the structural damage on India’s economy and tax structure over three decades.
- In January 2016, a committee constituted by the Securities Board of India (SEBI) under the chairmanship of Narayana Murthy recommended exemption of longterm (more than a year)capital gains tax on investments made in shares of private (not listed on stock exchanges) companies.
- The rationale was the need for a “levelplaying field” for such private equity investors on par with investors in shares of publicly listed companies.
- Investments in publicly listed shares were granted exemption from longterm capital gains tax in 2004. The rationale for that decision was to provide a “levelplaying field” to domestic investors visàvis Mauritius’ investors.
- A new tax called the securities transaction tax was imposed on stock market transactions to offset any loss of revenues from the exemption of capital gains. This higher transaction tax on shares triggered a massive shift by investors to investing in risky derivatives visàvis shares.
- The budget of 2016 increased transaction tax on derivatives to create a “levelplaying field” with shares. It all began with the 1983 Mauritius treaty.
- This treaty has led to a long tail of arbitrages across various asset classes (private vs public shares), types of investors (Mauritius vs nonMauritius), types of income (capital gains vs dividends) etc.
- This treaty has hampered India’s ability to garner enough tax resources through progressive direct taxes.
- While it is true that this treaty provided an opportunity for illegal round tripping of domestic money, the most damaging impact has been the cascading effect on India’s tax structure.
- Recently released income tax data has thrown some light on taxes foregone due to capital gains.
- During 201213, longterm capital gains income earned was Rs 90,000 crore. If these were subject to tax (say 15 per cent), the government stood to garner nearly Rs 15,000 crore in that year, equivalent to the entire budget for providing drinking water to all Indians.
- To make up for the shortfall in tax revenues from such sources, all governments in the past have resorted to increasing indirect taxes, which are more insidious, economically inefficient and ultimately unfair.
- Indirect taxation makes India’s tax system among the most regressive in the world. India’s directtoindirect tax ratio including state and central taxes is 35:65. In most other similar economies, it is the exact opposite.
- The Modi government’s move to amend the Mauritius tax treaty is not meant to merely curb offshore black money or curtail round tripping of domestic money.
- Judged in the larger context of India’s skewed tax structure and its adverse impact on income inequality, threats of foreign investor pullback from India due to the amendment of this treaty seem trivial. Longterm investment flows chase economic fundamentals, not tax arbitrage.
- This is a first step in eliminating a tall hurdle to change India’s skewed tax structure.Mauritius is still a great holiday destination, just not to dodge taxes in India.
Question : India signed a tax treaty with Mauritius in 1983 that gave Mauritius the sole right to tax investment gains made by investing in India. How far the scrapping of tax treaty with island nation will boost India’s domestic tax reform agenda. Discuss.
- 1. The discrepancies came due to the tax treaty.
- 2. The impact of scrapping of tax treaty on domestic economy.
- 3. Further suggestions.