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India draws up tax haven black list for foreign funds

A negative list of tax havens, countries that levy very low or no tax, is being prepared in India to reduce the vulnerability of equity markets in the country to foreign funds, according to the Finance Ministry on 7 November 2006.

A panel chaired by Ashok Lahiri, chief economic advisor in the Finance Ministry, with members drawn from the Reserve Bank of India (RBI) and the Securities & Exchange Board of India (SEBI), had suggested such a negative list recently.

The National Security Council (NSC) under the Prime Minister's Office (PMO) had also warned that without proper checks, Pakistani or Chinese investors can route their investments into India through tax havens like Mauritius, Cayman Islands or Cyprus.

Fear were raised when the Council was told that more than 85% of foreign fund inflows into India in 2005-06 were through participatory notes (PNs) – an instrument through which the real investor is kept anonymous. In 2003-03, PNs accounted for a little over 20% of foreign fund investments in India, but the proportion rose to 42% the next year.

“Billions of rupees come into India as foreign investment but hardly any money leaves our shores as open taxable returns on investment or the repatriation of principal amounts,” the NSC note said. “This raises suspicion that some other clandestine method is used for this purpose.”

The Council suggested that existing legislation be not only strengthened but also extended to cover flow of funds into India from tax havens in order to check money laundering.

The Lahiri committee was set up at the instance of Prime Minister Manmohan Singh to examine how foreign fund inflows can be encouraged and also to check as to whether existing regulations were adequate to reduce the vulnerability of Indian capital markets to speculative capital.

The move could also be a negotiating stance to increase pressure on Mauritius, which is the largest source of foreign investment to India, to amend the current tax treaty. Reserve Bank of India figures for FDI in 2004-2005 show Mauritius as the lead external investor into India. Mauritius accounted for US$820m out of a total US$2,320 in FDI.

The Indian government has been unsuccessful in convincing Mauritius to amend the treaty. But the Mauritius government announced in October that it is to tighten up rules on the issuance of Tax Residence Certificates, and in future will issue them for only one year at a time.

Pressure on India to re-negotiate the Mauritian tax treaty has increased; particularly after stronger residence qualifications were included in a similar treaty signed recently with Singapore.

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