My first class on taxes in the early 1990s started with the professor telling the class “there is no equity in tax, there is no logic in tax, do not seek either”. I was not convinced, I’m not convinced still. The fundamentals of fairness and equity surround the entire ecology of rule of law and there is no reason taxation principles should live wholly outside that.
The power to tax, based on the legislative process, is an expression of national sovereignty. Two forms of taxation exist worldwide for income based in another country. The first is the “residence-based taxation”. Countries applying such a principle tax their residents on their worldwide income, wherever derived. The second is “source-based taxation” where tax income is derived from sources in their territory, regardless of the residence of the person deriving the income. Most countries apply a combination of residence-based and source-based taxation.
According to a UN paper (UNCTAD), double taxation most often occurs when both the source country and the country of residence concurrently exercise their taxing right without providing full relief for the other country’s tax. Countries enter into double tax treaties to minimize the double taxation arising out of this intersection and the resulting unfairness.
In this world, view of minimizing unfairness out of overtaxing, there is really no space for maximizing unfairness which arises out of use of tax havens to pay no tax anywhere. Secondly, in the world where Indians pay tax on capital gains, given that we are primarily a source-based tax system, it is apartheid for foreign residents to pay no taxes.
Thirdly, the gain occurs primarily in dubious cases. Where a resident, for example of the US, invests in India via Mauritius, the resident ends up paying zero tax in India but up to 50% tax in the US. If Mauritius were not placed between the countries, the Indo-US tax treaty would more evenly divide the tax between India and US.
In other words, Mauritius is a route for transferring India taxpayer money to the US government. These are the non-dubious cases. Dubious cases are where the profit is milked in the tax haven and the beneficiary is a resident of another tax haven. In other words, the profits are all secreted out and neither India nor US will get to tax. Fourth, the opacity of using tax havens means they are a breeding ground for parking bribe money, circulating money laundering proceeds or other movements of international crime money. Panama.
Most Western countries are capital exporting countries and therefore they maximize their revenues by charging their residents for global income rather than bothering about the source income. However, they impose source-based tax on sale of real estate as foreign investors often end up buying local real estate. So foreign investors in their shares, though not in property, are typically exempt. They use the residence test in their self interest, except when it doesn’t suit them.
Conversely, capital hungry countries like India do not deploy much money overseas and rather attract foreign capital. We use source-based income test as it will maximize our sovereign tax collections. Indeed, there are several countries in the West which tax source-based income of gains in their territory, for instance Spain and Israel. This is rational self-interest of India and there is no use copying Western countries which are doing what is in their self-interest.
No matter which way you cut it, unfairness of double taxation is never an excuse for encouraging tax havens. The provision of an anti-abuse provision has been in the works for many years and has been sought to be implemented with effect from 2017. This information of Mauritius going away as a haven has been in the works for a long time and foreign investors in fact would have seen it coming.
Secondly, in these relatively happy times for India, this is a good time to introduce a small tax (mainly on unlisted securities, as listed securities held for a year are exempt), on the outsized returns foreign investors can expect.
Thirdly, the announcement detracts from a sudden change in taxation and grandfathers all investments made till next year and is an added benefit and a shock absorber rather than an announcement for taking away a benefit.
The anti-apartheid law should be welcomed by all, even foreign investors whose tax will help make the infrastructure to further improve their post-tax return.
