Treaty Shopping Must Be Forbidden

Updated: Aug 26 2002, 05:30am hrs
In the earlier part the issue of residential status of Mauritius entities was critically examined in view of the recent Delhi High Court Judgement.

The Honble Court while deciding on the powers of the CBDT to issue circulars, stated as follows:- The power of the CBDT to issue instructions to subordinate authorities is limited. Such an instruction can be issued only for proper administration of the provisions of the Income-tax Act and not otherwise. It cannot issue any instructions which would be de hors the provisions of the said Act. By reason of the impugned circular for all intent and purport, the CBDT had directed the income-tax authorities to accept the circular of residence issued by the authorities of Mauritius as sufficient evidence as regards its status of residence and ownership of the companies. The said circular purports to direct all the authorities to accept the certificate of residence without further questioning the correctness or legality thereof whenever a benefit is claimed under double taxation treaty. It further directs that the individuals and companies would not be taxed as capital gains in India if the companies are declared to be residents of Mauritius in terms of such certificate.

Having said that, the Honble Court proceeded to make far reaching remarks which need close attention. These were :- The function of the ITO is quasi-judicial in nature. It is for the purpose of finding out as to whether an assessee can take shelter under double taxation avoidance treaty or not that he is entitled to make such enquiries which are permissible in law. For the said purpose it not only is entitled to lift the corporate veil but also is entitled to find out not only as to whether a company is actually a resident of Mauritius or not and/or whether it is paying income-tax in Mauritius or not or in fact the company is not a resident of Mauritius at all. In revenue and taxation matters the Courts have very often lifted the corporate veil. Even a corporate entity is disregarded when it was used for tax evasion or to circumvent tax obligation or to perpetuate fraud. It is also lifted for determining whether a transaction is sham or illusory or a device or ruse. Income-tax authorities are entitled to penetrate the veil covering it and ascertain the truth and ascertain reality behind the legal facade, assessing authority can go into the genuineness or validity of a document or to see as to whether a transaction is collusive or fraudulent. Conclusiveness of a certificate of residence granted by the Mauritius tax authorities is not contemplated under the treaty or under the Act. Whether a statement shall be conclusive or not must be provided for under a legislative act, e.g., Indian Evidence Act. When evidence in relation to a matter under issue is produced before the authorities exercising judicial function by reason of a circular issued by the CBDT it cannot be prescribed that such evidence shall be conclusive. Such a provision as regards conclusiveness of a certificate must find place in the statute itself, as for example we may notice that such a certificate of citizenship having regard to the provisions of section 9(2) of the Citizenship Act read with rule 30 of the Citizenship Rules speaks of such a contingency.

An abuse of the treaty or treaty shopping is illegal and thus necessarily forbidden. Thus, the extent to which the tax officer can go behind the apparent facts has been duly highlighted. At the cost repetition, note the words An abuse of the treaty or treaty shopping is illegal and thus necessarily forbidden. Such clear and emphatic words are difficult to find in authoritative decisions on this subject. Note also further remarks on similar lines of the Honble Court, In any event, taking undue advantage of a scheme only for the purpose of avoidance of tax cannot but be deprecated.

Treaty shopping which amounts to abuse of the Indo-Mauritius Bilateral treaty, may amount to fraudulent practice and cannot be encouraged. Avoidance of double taxation would mean that a person has to pay tax at least in one country. Avoidance of double taxation would not mean that a person do not have to pay tax in any country whatsoever..

To conclude, since space constraints will not permit going into more detail, the Delhi High Court, on the above, grounds, quashed the aforesaid circular. The impact of this cannot be understated particularly for all companies that are using Mauritius as a base for paper entities and it would be no exaggeration to say that an astonishingly large proportion of such entities are indeed paper entities.

The Central Government now faces a tough decision - either come forth and quash this evil of treaty shopping and unintended tax avoidance - or be braver and transparent and allow such tax benefits by changing the law itself. Till that time, there will be hair-splitting over the wordings of this decision and nail-biting anxiety to assessees who may face huge liabilities.