The Hindu : Caution in boom time

Online edition of India's National Newspaper
Thursday, Oct 30, 2003

Opinion

Opinion - Editorials

Caution in boom time

THE SUPREME COURT recently upheld the validity of a Finance Ministry circular of April 2000 that permitted investment companies incorporated in Mauritius to claim tax exemptions on their investment income from India. The implications of the verdict, which overturns a Delhi High Court judgment, go beyond its obvious fiscal dimensions and also carry immediacy. The recent surge in the stock prices has been underpinned by a substantial foreign institutional buying of Indian stocks. More than $4 billion of foreign institutional investors' money has propped up Indian equities during the year; a fourth of this has come in October. In all other emerging markets also, the influence of foreign institutional investors, including portfolio managers, over stock prices has been all-pervasive. All the countries involved, including India, have put in place a scheme of incentives to attract foreign capital to their stock markets. While yielding positive results in most cases, such a strategy has had a flip side. A policy tilt towards one category of investors can be misused. It also means discrimination against domestic investors.

The Indo-Mauritius double taxation avoidance convention is a prime instance of a promotional move to encourage foreign inflows going wrong. On the positive side, it delivered on the promise of facilitating investments into India. Between 1990 and 2002, almost a third of capital inflows from abroad came through Mauritius. Investors registered there — a certificate of residence from the Mauritius authorities was enough — could avoid paying taxes on their income from investments in India. Mauritius does not tax capital gains and for institutional investors with large trading volumes in the share market, bilateral treaties such as the one with Mauritius confer a hefty advantage. However, as pointed out by the Delhi High Court hearing a public interest case in 2002, the very simplicity of the provisions can lead to their misuse. A number of Indian companies are believed to have laundered money through the Mauritius route; they avoided Indian taxes and flouted exchange control laws. This experience has been well documented, notably by the Joint Parliamentary Committee that looked into the recent stock market scam.

Now that the Supreme Court has restored the incentives, the challenge before the regulators and tax authorities is to prevent their misuse. This task becomes critical at a time when not merely the Indian stock markets but the external account itself has been buoyed by a record infusion of foreign capital. The size of the accumulating reserves, now in excess of $90 billion, and their utilisation have been the focus of intense debate. These issues will be revisited in early November when the Reserve Bank of India reviews its monetary policy. The Government did seek to plug the loopholes. A year ago, it banned overseas corporate bodies (OCBs) from participating in the secondary market. More recently, it clamped down on OCBs investing in India, after the JPC Report recorded several abuses by these entities that are owned to the extent of 60 per cent or above by non-resident Indians. Foreign institutional investors have been asked to disclose details of their sub-accounts. Further, it has been clarified that Indian tax authorities can probe the residential status of investors even when the funds are routed through Mauritius. It may well be that India is a favoured investment destination on account of its strong economic fundamentals. Yet the present boom in the markets has prompted regulators to advocate caution. The tendency to violate tax treaties cannot be wished away and, as post-1991 India knows very well, it is during boom time that shenanigans are most likely to be perpetrated.

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