Tax haven FDI to face tough scrutiny

Written by Rajat Guha | Rajat Guha | Subhash Narayan | New Delhi | Updated: Aug 4 2011, 08:35am hrs
Investments from tax havens such as Mauritius, Cayman Islands and Cyprus are set to be treated on par with those in sensitive sectors like telecom from the regulatory perspective.

Based on a recommendation from the National Security Council (NSC), the finance ministry will trace the parentage of investors from these low-tax jurisdictions three steps back like in sensitive sectors. The firms will have to specify such parentage and give details of source of funds and give clear information of their organisational structure.

Currently, foreign firms wanting to invest in sensitive sectors like telecom, aviation and defence face intense government scrutiny. This is meant to prevent flow of black money and terror funds into the country. In other sectors, investors need to furnish only their name, bank account details and address to the Reserve Bank of India.

Tax havens are always a suspect as several companies from third countries and from India use them for routing investments to India and claim tax benefits. We want to ensure that these low-tax jurisdictions are not used for routing black money into the country. It is felt that additional checks are required to achieve this objective, said a government official privy to the development.

Sources said that the extra scrutiny will be first made applicable in case of investment proposals from tax havens that need prior government approval. Subsequently, even those investments from these jurisdictions which are put on the automatic route will be brought under the new system for additional information gathering.

The checks will include investors being asked to provide authenticated documents about their antecedents. Unravelling three stage-parentage means identifying at least two holding companies above the line to ensure that investment made into Indian companies is not round-tripping by Indian firms.

The governments concern is that a substantial portion of the countrys foreign direct investment comes from tax havens such as Mauritius, which accounts for almost 42% of countrys total annual FDI. There have been cases when companies have been found using the tax-friendly administration in Mauritius to move black money into the country. This has already prompted the department of revenue to do selective checks in FDI flows from tax havens even in sectors in the automatic route.

To ensure that Indian companies dont have to encounter extra encumbrances due to these checks, the government will initiate extra checks only after the RBI asks it to do so. In case of any discrepancy in the FDI proposals reported to it, the apex bank could recommend blocking the proposal.

The checks will not hamper investment climate if new measures are likely to be well codified. It is important that the checks are completed within a specified time to prevent delays, said Saroj Jha, partner with Delhi-based law firm SRGR.

The government drive to identify and plug sources of black money flow has already prompted the income tax department to track frequent fliers to countries such as Dubai, Switzerland and Cayman Islands. A list has already been prepared about such individuals and they will now be questioned. The government is also trying to get details of account holders who have stashed billions of dollars in overseas banks. Double taxation avoidance treaties with several countries including Mauritius are on review.

Indias FDI inflows fell sharply in 2010-11 to $18.4 billion from $25.6 billion in the previous year. The new measure will be tested for its impact of overseas funds flows.