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UNCERTAINTY LOOMS OVER the taxation of FII investments in the country with the Delhi High Court quashing the circular issued by the Central Board of Direct Taxes. The court has merely set aside the CBDT authority to direct the assessing officers to go by its own criterion of residential status of these entities. Under the treaty with Mauritius, capital gains are to be reckoned as liable to taxation in the country in which the entity is resident. But it also stipulates that if an entity qualifies to be treated as resident in both states, then the tax liability would be determined by where the effective management of the entity is located. This did pose a problem. For some of these FIIs at least, effective management could well be construed as being in India and so would be liable to be taxed on their gains from market operations in India despite being domiciled in Mauritius. The suspicion that some of them represent money illegally repatriated out of India does not also help matters. In directing assessing officers to consider solely the fact of their incorporation in Mauritius ignoring the larger question of the seat of management control, the CBDT had implicitly ruled out an examination of the possibility of some of these FIIs being controlled from India. This also means a potential loss of revenue.

Prima facie, it can, thus, be argued that the CBDT circular was misconceived. But flawed logic cannot be adequate justification for ruling that subordinate officials would be entitled to disregard CBDT's administrative instructions, as the Delhi High Court ruling seems to imply. The CBDT was confronted with a simple issue — how to define `place of management' in determining if an FII is a `resident' in India for purposes of taxation in the absence of explicit criteria in the treaty itself. Rightly or wrongly, the CBDT has laid down that incorporation in Mauritius is in itself proof of `effective management' residing in that country. For the assessing officer that must be good enough for completing assessment of incomes of FIIs registered there. The suggestion implicit in the court ruling that the assessing officers could go beyond the CBDT stipulation creates a dangerous precedent that might result in a collapse of the administrative system for tax collection if extended to other realms of superintendence by the CBDT. The risk is all the greater when there is a need for harmonisation of assessment procedures or greater clarity on a point of law, as in the instant case.

The legal framework on avoidance of double taxation is riddled with inadequacies. For instance, where a source of income is exempt from taxation in one country — as capital gains are in Mauritius — whether the Government can at all enter into a double-taxation avoidance treaty is open to challenge. To compound matters, the economy in Mauritius is to some extent dependent on the funds routed through its shores. Any decision on the question, thus, has larger geo-political significance that India can ill afford to ignore at this point of time.

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