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Abhilash Chandran asked:


ROUND TRIPPING

 

 

Introduction:

 

Round Tripping refers to the capital belonging to a country, which leaves the country and is then reinvested into the country in the form of FDI.

This route attracts a lot of incentives, which are:

Firstly, enterprises set up through FDI enjoy





tax benefits,





administrative support,





easier access to financial services.





Secondly, citizens’ from countries with weak property laws prefer to remove profits from their country and invest abroad to enjoy property rights rather than reinvesting their profits.

Thirdly, Round Tripping is often used as an avenue for laundering one’s illegitimate money.

 

It is due to these reasons that tax havens like Mauritius, the British Virgin Islands, Cayman Islands, Cyprus etc. are used. These places are of immense advantage as money routed through them is exempt from capital gains tax.

 

 

Methodology:

 





Analysis of case studies.





Internet web pages and legal websites.





Legal journals, reports and opinions.





 

 

Limitations:

 

Round Tripping in itself is a very unregulated and ambiguous phenomenon so the literature available is extremely rare and deficient; therefore this report has drawn inferences from the available material to draw out a viable overview of the entire scenario.

 

Literature Reviewed/ Bibliography:

 





The Securities and Exchange Board of India Act, 1992





Articles published in The Hindu newspaper





Articles published in The Economic Times newspaper





The Law lexicon





 

Theoretical Framework:

 

The tussle between the Reserve Bank of India (RBI) and the Revenue Department

 

Lately it has been observed that the RBI is leaning towards legitimizing certain types of Round Tripping.

The RBI’s view on the subject is that money reinvested in India through a foreign subsidiary of an Indian company should be considered foreign direct investment and that in many parts of the world such as China these aspects have already been legitimized. It feels that doing so would boost the FDI count of the country and render it a more attractive destination for foreign investment.

 

However, the Revenue Department looking from a microeconomic point of view feels that round tripping should not be allowed as Indian companies may use it to evade tax by routing their money through the tax havens.

Although in such cases FDI might increase but the country would not benefit in terms of revenue.

 

The RBI disagreeing with the revenue department’s assessment, cites the Chinese example arguing that where subsidiaries of foreign companies are levied a lower corporate tax, the incidence of round tripping is extremely high i.e. more than 25-30 per cent. However, in India where the corporate tax rates are the same for all companies the incidence of Round Tripping is only 2-3 per cent.

It is pertinent to note that the RBI stand is with regard to legitimizing Round Tripping within the sphere of the International Monetary Fund’s (IMF) definition of FDI only and does not intend to accommodate Round Tripping as a means of escaping tax or laundering ill-legitimate gains. In pursuance of this, recently the RBI has set forth directives with regards to Participatory Notes and tighter Know Your Customer (KYC) norms.

 

Instances where permission has been refused

 

1. Bharti Share Transfer case

 

In 2001, the Government i.e. the FIPB on the advice of the Department of Economic Affairs (DEA) rejected two proposals from the Bharti Group for transferring shares held by UK-based Bharti Global Ltd in favour of Indian Continent Investment Ltd, Mauritius, due to the negative impact of Round Tripping of foreign direct investment (FDI) in the long run, particularly from the taxation angle.

The DEA had itself acted upon the opinion of the Revenue Department and its views on tax implications of the transfer but interestingly the proposal had enjoyed the support of the Department of Telecommunications, which was the administrative authority in the case.

 

2. Chambal Agritech Plan

 

The Birla Group’s plan to transfer ownership of Chambal Agritech Ltd (CAL) from India to Singapore was refused permission by the DEA, which categorically stated that in the absence of capital account convertibility for Indian entities, the transfer would amount to Round Tripping.

 

The Chinese Myth

 

The China-FDI story has been in the limelight for some time now. The bucketful of billions that the world seems to be pouring down the country definitely makes good copy. No other country attracts as much foreign direct investment (FDI) as China does. Recently approximately USD 60 billion poured in which is about twelve times the amount that has flowed into India. Between the years 1979 (the first year of the China Economic system reform) and 2004, China has absorbed a total of about USD 560 billion in FDI whereas India, the next most popular destination for foreign investment in manufacturing received almost USD 200 billion less in FDI than China.

However, it is important to note that the Chinese FDI statistics are bloated up from Round Tripping whereas India’s figures are understated.

 

Before delving further we have to comprehend the IMF definition of FDI.

The IMF definition of FDI includes as many as twelve different elements, namely:





equity capital





reinvested earnings of foreign companies





inter-company debt transactions





short-term and long-term loans





financial leasing





trade credits





grants





bonds





non-cash acquisition of equity





investment made by foreign venture capital investors





earnings data of indirectly held FDI enterprises and control premium





non-competition fee





 

However, with the singular exception of equity capital reported on the basis of issue or transfer of equity/ preference shares to foreign direct investors, India’s current definition of FDI does not include any of the other above elements, whereas the Chinese definition includes them all. In addition to this China also classifies imported equipment as FDI while India captures these as imports in the trade data.

A study undertaken by the International Finance Corporation (FE, 5/6/02) shows that if comparable definitions of FDI are used by India and China, then FDI would constitute around 1.7% of India’s GDP as compared to 2.0% for China.

Besides this China’s FDI numbers include a substantial amount of Round-Tripping where large amounts of Chinese black money is recycled through Hong Kong and sent back to the mainland as FDI. Round-tripping in fact accounts for one-half of China’s FDI inflows, which has practically reduced the reported levels from USD 40 billion to USD 20 billion in the year 2000. In contrast, India’s figures of USD 2-3 billion do not conform to the standards of the IMF (as per the definition mentioned above) because it excludes reinvested earnings, subordinated debt and overseas commercial borrowings which are included in FDI numbers of other countries.

According to the “Round-Tripping” hypothesis, Chinese firms illegally transfer funds to neighbouring countries (like Taipei, Hong Kong and Macau) which in turn gets reinvested in mainland China as FDI.

However, since round-tripping is essentially clandestine, accurate data is practically impossible to obtain but estimates suggest that round-tripped FDI accounts for one-fourth of China’s total FDI count whereas on the hand it is an established fact India is relatively low on Round Tripping as compared to China.

 

The Mauritius Story

 

Pursuant to the Double Taxation Avoidance Treaty (DTAT) signed between India and Mauritius in 1983, any capital gain made on the sale of shares of Indian companies by investors resident in Mauritius would be taxed only in Mauritius and not in India. For the first ten years the treaty existed only on paper as FIIs were not allowed to invest in Indian stock markets. However all that changed in 1992 when FIIs were allowed into India and with the passing of the Offshore Business Activities Act, 1992 by Mauritius, foreign companies were allowed to register in the island nation for investing abroad.

There are two aspects which render Mauritius into a tax haven:





Firstly, a body corporate registered under the laws of Mauritius is a resident of Mauritius and thus will be subject to taxation as a resident.





Secondly, the Income Tax Act of Mauritius provides that offshore companies are liable to pay zero percent tax.





Therefore by bringing an offshore company within the definition of “resident”, both the benefits of being an offshore company as well as that of residency allowed under DTAA are bestowed upon it. In effect, the whole exercise of avoidance of double taxation turned out to be avoidance of taxation altogether.

 

The advantages of registering a company in Mauritius are:





total exemption from capital gains tax,





quick incorporation,





total business secrecy, and





a completely convertible currency.





Therefore the financial entities setting up companies in Mauritius do so without almost any establishment costs.

 

The economic importance of Mauritius to India can be clearly understood by the Hon’ble Supreme Court’s decision in Union of India v. Azadi Bachao Andolan1, where the entire Mauritius treaty was questioned. The Supreme Court’s decision clearly reflected the underlying policy of the Government to attract FDI into the country at any cost despite the known fact that the treaty is depriving the Indian Exchequer of millions of dollars due to Round Tripping and tax evasion.

The policy in itself has become a catch-22 situation for the Government as any stringent norms with regard to Mauritius might result in future FII investment being targeted away from India and working out for the benefit of South East Asian countries or FIIs looking at alternate options like Cyprus and Singapore to invest into India.

One has to understand that in a growing economy much in need of FDI any scenario decreasing FDI inflow is unfeasible and therefore Round Tripping, a side effect has to be accommodated with.

 

Recently as of September 15, 2007, Mauritius has started getting tough on Round Tripping. The Financial Services Commission (FSC) of Mauritius, the regulator supervising the non-banking financial services sector & global businesses, has carried out reforms in the Financial Services Act and improved the framework of the tax resident certificate.

In pursuance of this it has been decided that all resident corporations proposing to conduct business outside Mauritius would have to compulsorily apply to the FSC for a global business license. Even though there are no restrictions on any business activity, the FSA now specifically mentions that a license will not be granted, or would be revoked, if found that the activity “is unlawful and causes serious prejudice to the good repute of Mauritius as a financial services centre.”

The salient features of the reforms are:





Global Business Companies (GBC) would now have to compulsorily hold board meetings in Mauritius,





appoint at least two resident directors in Mauritius, (big deterrent as it would now make these directors liable for any unscrupulous activities)





maintain there principal bank accounts in Mauritius, and





carry out their auditing in Mauritius.





All GBCs have to get a certificate from the auditors stating that all requisite conditions have been complied with.

Moreover in the same month it was announced that the DTAA with Mauritius would be brought under the same umbrella as that with Singapore, which contains exclusive clauses to check Round Tripping of Investments.

 

OCB Investment Ban

 

In 2003 the RBI imposed a blanket ban on Overseas Corporate Bodies (OCBs) investment in the stock market sector. The move was primarily intended to restrict Round Tripping of money by Indian residents through their NRI counterparts overseas.

Conversely this move also resulted in a substantial amount of genuine FDI being curtailed as the RBI circular in this regard seemed to take away the special status given to genuine NRI businessmen who were looking at doing business in India.

It is to be noted that one of the main avenues for FDI in China is courtesy of Non-Resident Chinese individuals present in regions like Hong Kong, Macau and Taipei.

In contrast, foreign companies can invest in the country even if they have their base in tax havens such as the Cayman Islands. So basically the Automatic route for FDI is open to foreign owned companies whereas there is a blanket prohibition in case of OCBs with NRI ownership.

 

The PN predicament

 

Lately Participatory Notes (PNs) have come under the scanner for their alleged role in Round Tripping. The RBI as well as SEBI has shown their concern about the inflow of money coming into the country through PNs.

PNs are instruments issued by registered FII brokerages in India to foreign funds or investors who are not registered with SEBI, but are interested in trading in Indian securities. FII brokers buy and sell securities on behalf of their clients on their proprietary account and issue such notes in favour of such foreign investors. PNs are mostly used by entities that are not welcome by SEBI as well as by non-resident Indians who do not want to directly invest in Indian securities. SEBI’s worry is that the ultimate owner or beneficiary of PNs is not known as these PNs are transferable. On a similar track, RBI feels that the non-transparent nature of these instruments make them ideal money-laundering vehicles. The unstated fear of the regulators is that money belonging to Indian residents is being “round-tripped” through the PN route.

 

However as of 2007, SEBI has banned PNs in the off-shore Derivative Segment (to be applicable within a period of 18 months). It has cited the reason as a security measure and as a means of curtailing Round Tripping.

 

 

Conclusion/ Recommendations:

 

The laws present today dealing with Round Tripping are adequate, however the emphasis has to be on enforcing them rather than curtailing the route itself. The trick lies in essentially enforcing laws that are there to prevent round-tripping and encouraging foreign money including NRI and OCB money. Merely because a company is owned by an NRI, one should not discriminate against it investing and the solution lies in either abolishing what remains of capital gains tax, or in taxing foreigners’ profits made in Indian markets. Both would inevitably reduce instances of Round Tripping by rendering it less viable.

1 (2004) 10 SCC 1 : (2003)132 TAXMAN 373