Though I am not a keen follower of macro-economics (something I could not pick from my school days), but I was reading an article last week, which got me thinking
It read, “ Between April 2000 and February 2012 Mauritius accounted for 39 per cent of total Foreign Direct Investment (FDI) in India. it was more than the next six investing countries put together.
Given the fact that India’s Gross Domestic Product is over 200 times larger than that of Mauritius, it seems likely that there is an external factor responsible for this anomaly, namely the existence of round-tripping.”
What is round tripping?
Round tripping involves getting the money out of one country, in the above example say, India, sending it to a place like Mauritius and then, dressing it up to look like foreign capital and sending it back home to earn tax-favoured profits.
The reason primarily for sending it to a place outside the home country is to use the treaty benefits of the tax havens and save some domestic taxes in the nature of capital gain and dividends.
The problem for the home country is that domestic profits escape taxation this way. And instead of foreign capital flowing into the country, local capital just gets a free ride.
How is it round tripping done?
The process is simple, however, to show substance the financial transaction is shown as a complicated transaction designed in a way that auditors or anyone else following the money can loose track of it. Once the cash is safely out of the home country, it’s easy to place it in a jurisdiction with a favorable tax treaty and to use a shell company to send the money back home so profits become tax-free or taxed at very low rates.
Which countries are commonly used for round tripping
Round tripping can be used by any country if the holding pattern is to be changed from domestic to foreign, however, Mauritius and Singapore have topped the list and are being used most commonly. Mentioning below some facts from these countries for reference:
Since the signing of the tax treaty with Mauritius 32 years back, it has been the gateway country of choice for foreign investment in India. Companies like Caterpillar, the maker of earth-moving equipment, as well as Bank of America, Citigroup and Wells Fargo invest in India via subsidiaries in Mauritius.
The Indian government has taken a note of the same and has been challenging Indian subsidiaries of the Mauritius parent company. The primary question which has been raised is with regard to proving the substance of the parent company.
Singapore has been trying to potray itself as a tax-favored conduit for real foreign investment in India and not round tripping.
Singapore boasts that it does not allow shell companies, but rather wants a real economic presence. For the same it has introduced the Limitation of Benefits (LOB) clause which has put the standard for that at Singapore $200,000 a year spent in running a Singapore office. It has also enforced stringent conditions such as minimum capital requirements and employment conditions for companies in their jurisdictions.
Due to these steps, for the first time, in the 2013-14 fiscal, Singapore became the biggest source of Foreign Direct Investment (FDI) into India at over $4 billion from $1.6 billion an year ago.
What are the steps being taken by the government to avoid round tripping?
The government seems to be in a tricky situation as the economy is still benefitting from FDI in terms of job creation, infrastructure investment and higher overall output.
In addition to the Black Money Bill, changes in KYC norms by RBI and introducing mandatory declarations of foreign holdings in the Indian Income, the government has been discussing about imposing MAT on Foreign Institutional Investors (FIIs), which has got a cold response from the FII’s.
What should the Indian tax consultants should be careful about?
The Indian tax consultants have primarily reviewed the exposures related to withholding tax, permanent establishment, transfer pricing norms and valuation principles etc. while carrying out any structuring advice.
With so many discussions by the government around round tripping and RBI questioning certain investments in India (wherein the shareholders have Indian connection) on the same premise, the tax practitioners have to add another layer of checks before issuing any advice. The checks not only include review of the structuring being done for invound investment, but also for any outbound investment by an Indian resident or a company as to whether the foreign investee entity has any downstream investment in India.