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External commercial borrowings - further liberalization

In September 2002 the government of India relaxed its guidelines for external commercial borrowings (ECBs) allowing companies to raise foreign loans on liberalized terms from any internationally-recognized source.

Conditions imposed earlier in the year, when the Royal Bank of India (RBI) brought pre-payment of ECBs under the automatic route, were relaxed and instead the government permitted unlimited pre-payment of ECBs until March 31 2003. The government further imposed a ceiling on borrowers of $50 million under the automatic route in a financial year. However, offers for ECBs under $5 million would not be considered.

While the RBI will announce guidelines shortly, more than one borrowing in a financial year would be required to have a minimum average maturity of three years for ECBs up to $20 million. For amounts in excess of $20 million, the average maturity would have to be five years.

The "internationally recognized foreign sources" have been identified as banks, export credit agencies, suppliers of equipment, foreign collaborators, foreign equity holders and international capital markets.

Announcing a broad ECB policy for companies registered in Special Economic Zones, the government has withdrawn the three years maturity restriction on such units. The Zone units are now permitted to raise ECBs without any maturity restrictions as long as this is done through recognized banking channels and strictly on a stand alone basis. Effectively, only units that are either subsidiaries or branches of a company registered outside India or where a company is registered independently for operating in one or more zones in the country, would qualify for stand alone criteria.

As stated in the Exim Policy, Special Economic Zone borrowers would be allowed to raise ECBs under a special window. The loan (principal, interest and any other fees or charges) can be serviced out of proceeds generated by such Special Economic Zone units subject to an annual cap of $500 million.

Indo-Mauritius double taxation avoidance convention

The 1983 Indo-Mauritius Double-Taxation Avoidance Convention (DTAC) is a popular method for foreign investment institutions (FIIs) investing in India through Mauritius because it enables attractive tax efficiency to Mauritian FIIs and because the OECD excludes Mauritius from the blacklist of countries indulging in money laundering.

Capital gains arising in India would be taxable in India as the country of accrual. Under the DTAC, a Mauritian resident would pay tax in the country of domicile. Because Capital Gains Tax (CGT) is at zero in Mauritius, an FII resident in Mauritius would pay no capital gains tax in either country. A similar advantage of lower tax on dividends, royalties and so on, is enjoyed by Mauritius-resident special purpose vehicles.

This structure became popular and as capital gains tax escaped on stock exchange investments, tax inspectors maintained that the DTAC was being abused. This resulted in the Central Board of Direct Taxes (CBDT) issuing a circular dated April 13 2000 requiring tax inspectors to accept a certificate of residence issued by the Mauritius authorities as conclusive evidence of residence under the DTAC.

In May 2002, the Delhi High Court quashed the circular holding that the DTAC contemplates tax payment in at least one country and the residence of the Mauritius company should not be in form only but should be in substance also. In September 2002, the government of India preferred an appeal to the Supreme Court against the Delhi High Court decision. The Indian government maintains that:

  1. certificates are binding on Indian tax authorities;
  2. definition of resident under the DTAC is based on "liability to pay tax" in the "contracting state" and not whether tax is actually paid;
  3. the treaty, being economic legislation, is under executive domain and is not open to judicial review.

The Supreme Court has returned the appeal papers to the Indian government giving it 15 days to correct certain flaws in the documentation. It is not known whether the Supreme Court will admit the appeal and grant a stay. Until then the circular stays quashed.

Shardul Thacker

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