Jaipuria Institute of Management, Lucknow

Term Paper on
Analysis of the trends in FDI and FII investments in India, In Addition, examine the case of round tripping of investments from Mauritius to India and steps taken by the Indian government to stop the tax avoidance.

Submitted To:
Dr. Mahima Sharma

Date Submitted:
April 6, 2013

Submitted By:
Rohit Pal Rohit Rastogi Shohrab Ahmed Mazumdar Vatsal Sharma [JL12PGDM126] [JL12PGDM127] [JL12PGDM144] [JL12PGDM173]

Acknowledgement
Perseverance, Inspiration and motivation have always played a key role in the success of any venture. So hereby, it is our pleasure to record thanks and gratitude to the people involved. Firstly, we thank Dr. Mahima Sharma, for her continuous support in this project. She was always there to listen and to give advice. She showed us different ways to approach a situation suited to our project and the need to be persistent to accomplish any goal. Without her encouragement and constant guidance we would have been unable to finish the project. She was always there to meet and talk about any query. Last, but not the least, we would like to thank all our group members who supported us throughout the project.

Table of Contents
1. Introduction ........................................................................................................................................ 1 2. Review Literature ................................................................................................................................ 2 2.1. FDI ................................................................................................................................................ 2 2.2. FDI in India.................................................................................................................................... 5 2.3. FII ................................................................................................................................................. 7 2.4. FII in India ................................................................................................................................... 10 2.5. Comparison & Analysis of FDI & FII trends ................................................................................... 11 2.6. Case of round tripping of investments from Mauritius to India .................................................... 13 2.7. Steps taken by the Indian government to stop the tax avoidance ................................................ 15 Conclusion............................................................................................................................................. 19 References ............................................................................................................................................ 20

1. Introduction
Foreign direct investment (FDI) is a direct investment into production or business in a country by a company in another country, either by buying a company in the target country or by expanding operations of an existing business in that country. Foreign direct investment has many forms. Broadly, foreign direct investment includes "mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra-company loans" Foreign Institutional Investor (FII), refers to the non local investors when invest in the financial market of a country. In other words, the term is most commonly used in India when a foreign entity i.e. an entity which is established or registered outside India proposes to make investment in the financial market of India. Foreign corporate and individuals and belong to any of the under given categories can be registered for FII:-Pension Funds, Mutual Funds, Insurance Companies, Investment Trusts, Banks, University Funds etc. Growing India needs abundant foreign capital in the form of FDI & FII for the development of basic infrastructure like Roads, Railways, Sea Ports, Warehouses, Banking Services and Insurance Services etc. Moreover, rapid industrialization since 1991 has further strengthened the need of foreign capital across various industries. Many developing countries suffer from severe scarcity of funds in highly capital intensive areas such as infrastructure. This problem can be diverted to the foreign capitalists by allowing them to invest. Other words, foreign capital are the panacea for the scarcity of all resources. The variations in the cost of capital are also one of the important factors resulting in attracting foreign capital in India. For example; Interest rates are high in India as compared to developed economies. In several countries the interest rates are as low as 1% to 3%, where as in some countries like India the interest rates are very high as 8% to 10% per annum. Thus, for enterprises in India, foreign capital is an easy route to reduce the cost of capital. Thus investors tend to invest in countries like India where they can gain maximum return on their investments. Gradual Integration of global financial markets ultimately results in explosive growth of FDI around the globe. The flow of FDI & FII accelerated the Indian economy and also gave opportunities to Indian industry for technological up-gradation, gaining access to global managerial skills and practices, optimizing utilization of human and natural resources and global competitive advantage with greater efficiency. Most importantly FDI is central for Indias integration into global production chains which involves production by MNCs spread across locations all over the world. It can be concluded that the impact of flow of FDI & FII on Indian stock market is significant.

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2. Review Literature
2.1. FDI
Foreign direct investment (FDI) is a direct investment into production or business in a country by a company in another country, either by buying a company in the target country or by expanding operations of an existing business in that country. Foreign direct investment has many forms. Broadly, foreign direct investment includes "mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra-company loans" As a part of the national accounts of a country, and in regard to the national income equation Y=C+I+G+(X-M), I is investment plus foreign investment, FDI is defined as the net inflows of investment (inflow minus outflow) to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor.[2] FDI is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. FDI usually involves participation in management, jointventure, transfer of technology and expertise. There are two types of FDI: inward and outward, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares.[3] FDI is one example of international factor movements. Methods The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods: by incorporating a wholly owned subsidiary or company anywhere by acquiring shares in an associated enterprise through a merger or an acquisition of an unrelated enterprise participating in an equity joint venture with another investor or enterprise Determinants of FDI The determinants of FDI are as followings: Size as well as the growth prospects of the economy of the country Population High per capita income or if the citizens have reasonably good spending capabilities Status of the human resources (Ex. China-Quality of work) Resource availability Inexpensive labor force Infrastructural factors like the status of telecommunications and railways. Economic policies

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Benefits of FDI The benefits associated with FDI are as followings: Economic development Transfer of technologies Development of the human capital resources Contributions to the revenues of corporate taxes Development of the manufacturing sector of the recipient country Advanced technology -Skill -Scope for new research activities Assists in increasing the income that is generated through revenues realized through taxation Opens up the export window that allows the countries the opportunity to cash in on their superior technological resources Becomes easier for the business entities to borrow finance at lesser rates of interest, especially small and medium scale Disadvantages of FDI The disadvantages associated with FDI coming into an economy are as followings: Chances are open that a company may lose out on its ownership to an overseas Company Sometimes the host countrys government has less control over the functioning of the company that is functioning as the wholly owned subsidiary of an overseas company. Economically backward section of the host country is always inconvenienced when the stream of foreign direct investment is negatively affected. Defense of a country has faced risks May entail high travel & communications Expenses Existence of differences of language and culture Importance and barriers to FDI The rapid growth of world population since 1950 has occurred mostly in developing countries. This growth has not been matched by similar increases in per-capita income and access to the basics of modern life, like education, health care, or - for too many - even sanitary water and waste disposal. FDI has proven when skillfully applied to be one of the fastest means of, with the highest impact on, development. However, given its many benefits for both investing firms and hosting countries, and the large jumps in development were best practices followed, eking out advances with even moderate long-term impacts often has been a struggle. Recently, research and practice are finding ways to make FDI more assured and beneficial by continually engaging

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with local realities, adjusting contracts and reconfiguring policies as blockages and openings emerge. Difficulties limiting FDI Foreign direct investment may be politically controversial or difficult because it partly reverses previous policies intended to protect the growth of local investment or of infant industries. When these kinds of barriers against outside investment seem to have not worked sufficiently, it can be politically expedient for a host country to open a small "tunnel" as focus for FDI. The nature of the FDI tunnel depends on the country's or jurisdiction's needs and policies. FDI is not restricted to developing countries. For example, lagging regions in the France, Germany, Ireland, and USA have for a half century maintained offices to recruit and incentivize FDI primarily to create jobs. China, starting in 1979, promoted FDI primarily to import modernizing technology, and also to leverage and uplift its huge pool of rural workers. To secure greater benefits for lesser costs, this tunnel need be focused on a particular industry and on closely negotiated, specific terms. These terms define the trade offs of certain levels and types of investment by a firm, and specified concessions by the host jurisdiction. The investing firm needs sufficient cooperation and concessions to justify their business case in terms of lower labor costs, and the opening of the country's or even regional markets at a distinct advantage over (global) competitors. The hosting country needs sufficient contractual promises to politically sell uncertain benefits versus the better-known costs of concessions or damage to local interests. The benefits to the host may be: creation of a large number of more stable and higher-paying jobs; establishing in lagging areas centers of new economic development that will support attracting or strengthening of many other firms without costly concessions; hastening the transfer of premium-paying skills to the host country's work force; and encouraging technology transfer to local suppliers. Concessions to the investor commonly offered include: tax exemptions or reductions; construction or cheap lease-back of site improvements or of new building facilities; and large local infrastructures such as roads or rail lines; More politically difficult (certainly for lessdeveloped regions) are concessions which change policies for: reduced taxes and tariffs; curbing protections for smaller-business from the large or global; and laxer administration of regulations on labor safety and environmental preservation. Often these un-politick "cooperations" are covert and subject to corruption. The lead-up for a big FDI can be risky, fraught with reverses and subject to unexplained delays for years. Completion of the first phase remains unpredictable even after the contract ceremonies are over and construction has started. So, lenders and investors expect high risk premiums similar to those of junk bonds. These costs and frustration have been major barriers for FDI in many countries. On the implicit "marriage" market for matching investors with recipients, the value of FDI with some industries, some companies, and some countries varies greatly: in resources,

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management capacity, and in reputation. Since, as common in such markets, valuations can be mostly perceptual, and then negotiations and follow-up are often rife with threats, manipulation and chicanery. For example, the interest of both investors and recipients may be served by dissembling the value of deals to their constituents. One result is that the market on what's hot and what's not has frequent bubbles and crashes. Because 'market' valuations can shift dramatically in short times, and because both local circumstances and the global economy can vary so rapidly, negotiating and planning FDI is often quite irrational. All these factors add to the risk premiums, and remorses, that block the realization of FDI potential.

2.2. FDI in India

Foreign investment was introduced in 1991 as Foreign Exchange Management Act (FEMA), driven by Finance minister Manmohan Singh. India has been ranked at the second place in global foreign direct investments in 2010 and will continue to remain among the top five attractive destinations for international investors during 2010-12 period, according to United Nations Conference on Trade and Development (UNCTAD) in a report on world investment prospects titled, 'World Investment Prospects Survey 2009-2012'. Policies in India FDI up to 100% is allowed under the automatic route in all activities/sectors except a few. Companies are required to obtain Statutory clearances, relating to Pollution Control FDI under automatic route does not require any prior approval either by the Government or RBI Extant policy restricts the following: Gambling and betting, Lottery Business, Atomic Energy and Retail Trading Foreign Direct Investment (FDI) inflows for the year 2012-13 Under the extant Foreign Direct Investment (FDI) policy, FDI upto 100 percent is allowed under the automatic route in most sectors/activities, except a few, where sectoral equity/entry route restrictions have been retained. FDI, under the automatic route, does not require any approval and only involves intimation to the Reserve Bank of India within 30 days of inward remittances and/or issue of shares to non-residents. Top 10 Investing Countries: Top 10 investing countries during December 2012 were: Mauritius (38 per cent), Singapore (10 per cent),U.K (9 per cent), Japan (7 per cent), U.S.A (6 per cent),Netherlands (5 per cent), Cyprus (4 per cent), Germany (3 per cent), France (2 per cent), U.A.E (1 per cent).

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Amount of FDI inflows for the financial year 2012-13 for the month of December 2012 was US$ 1.1 billion. Amount of total FDI equity inflows into India (equity inflows + re-invested earnings + other capital) for the financial year 2012-13 (from April 2012 to December, 2012) was estimated at US$ 27.19 billion. Cumulative Amount of FDI Equity Inflows (excluding, amount remitted through RBIs-NRI Schemes) (from April, 2000 to December, 2012) was recorded at US$ 187.80 billion. FDI trend in India
FDI Year 2007 2008 2009 2010 2011 Net inflows (BoP, current US $ mn.) 25227 43406 35581 26502 32190

Showing Trend of FDI from 2007 to 2011 in India Above table shows the total amount of FDI inflows in India during the last 5 years i.e. 2007 to 2011. The FDI inflow in 2006-2007 was $ 25,227 million where as in 2007-08 it was $ 43406 million. It shows the Good result in the FDI inflows in India. Little bit ups and downs in FDI inflows upto 2010-11, so we can say that the foreign investments have been on rise in India and shows a fluctuating trend. FDI has helped to raise the output, productivity and employment in

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some sectors especially in service sector. On the other side banking and insurance sector help in providing the strength to the Indian economic condition and develop the foreign exchange system in country. So, we can conclude that FDI is always helps to create employment in the country and also support the small scale industries also and helps country to put an impression on the world wide level through liberalization and globalization.

2.3. FII
Foreign Institutional Investor (FII), refers to the non local investors when invest in the financial market of a country. In other words, the term is most commonly used in India when a foreign entity i.e. an entity which is established or registered outside India proposes to make investment in the financial market of India. How FII started in India India opened its stock market to foreign investors in September 1992 Since 1993, received portfolio investment from foreigners in the form of foreign institutional investment in equities. Who Can Get Registered As Foreign Institutional Investors (FII) in India Foreign Institutional investors also known as International institutional investors need to register themselves with the Security and Exchange Board of India (SEBI) in order to participate in the Indian market. Foreign corporates and individuals and belong to any of the under given categories can be registered for FII : Pension Funds Mutual Funds Insurance Companies Investment Trusts Banks Endowments Foundations Charitable Trusts / Charitable Societies Following entities proposing to invest on behalf of broad based funds are also eligible to be registered as FIIs: Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders

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Agencies Regulate Foreign Institutional Investors (FII) In India RBI : The apex bank FIPB : Review all foreign investment proposals SEBI : Regulates Indias capital market Advantages of Foreign Institutional Investment (FII) In India Increases Forex reserves Increases domestic savings Increases domestic investments Availability of capital reserve Disadvantages of Foreign Institutional Investment (FII) In India Problem of inflation False representation of economy Problem for small investors Hot Money Factors contributed significantly to the FII flows to India: Regulation and Trading Efficiencies: Indian stock markets have been well regulated by the stock exchanges, SEBI and RBI leading to high levels of efficiency in trading, settlements and transparent dealings enhancing the confidence level of FIIs in increasing allocations to India. 1. New Issuance: We have witnessed extremely high quality issuance during the year from companies such as NTPC, ONGC and TCS leading to strong FII participation with successful new issuance of over $ nine billion, yet another record for the year. 2. Attractive Markets: Indian equity markets continue to be attractive to foreign investors with expected earnings growth of over 13 per cent compared with negative growth expected among competing countries in the region such as Taiwan and Korea. Indian blue chips are seen to have high quality of balance sheets with net debt to equity of the top 30 companies being negative, with net cash on the balance sheets. However earnings growth is expected to be lower than last year and upside in stock prices will be subject to sentiments in the global markets and foreign flows to emerging markets. However high quality new issuance from PSUs and other large corporates will continue to see good demand from FIIs. However domestic mutual funds have been net sellers of equities during 2004 with risk aversion still prevalent among local investors after seeing several short periods of high volatility. With the booming stock markets presently catching the headlines in local press, this trend will hopefully reverse during 2005.

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3. Outsourcing: The rhetoric over outsourcing of jobs to India has died down after the US elections and demand will soar for Indian BPO and software services companies. However Indian software companies will need to enhance margins by going up the value chain to high level consulting and scaling up the project sizes. Significant outsourcing opportunities will also open up in textiles and drugs with dismantling of quotas for textiles and introduction of product patent regime for pharmaceuticals. 4. Infrastructure: Woefully inadequate infrastructure is the biggest bottleneck for the growth and profitability of Indian corporations. The administration needs to move much faster in privatisation of Projects in the areas of power, transportation, ports, airports and other urban infrastructure to enhance competitiveness. This is particularly relevant due to the fact that competing countries in Asia Pacific and China have moved at a much faster pace during the last five years and have in place a first world infrastructure. 5. Capex Cycle: With strong balance sheets, high liquidity in the banking system, supportive capital markets and growing demand for goods and services we expect to see a strong wave of capital expenditure cycle during the year leading to tremendous opportunities for Indian equities. 6. Dollar Weakness: Analysts continue to look for a weak US dollar with the US twin deficits (budget and trade deficits) unlikely to be resolved anytime soon. Studies have shown that flows into emerging markets rise significantly during times of dollar weakness and India will continue to be a beneficiary of this trend. Indian Rupee is expected to strengthen further during 2005 which will be particularly favourable for domestic demand oriented businesses such as banks and automobiles. 7. Rising Commodity Prices: Demand supply dynamics in both crude and metals call for higher prices during 2005 with increasing Chinese demand and economic recovery in Japan. This has inflationary implications for India going forward, though it will be a boon for commodity counters. 8. Consolidation: FII activity has been focused on large cap companies due to liquidity reasons, and hence several high quality mid cap companies trade at a valuation discount due to lack of investor demand. We expect to see significant merger activity among mid caps which will enable them to gain better valuations under the institutional radar screen, in addition to consolidation efficiencies. While China attracts significantly higher FDI, India with its highly developed capital markets will be a beneficiary of FII flows at increasing pace each year. To summarise, Indian markets have successfully absorbed the gains seen during 2003 and

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consolidated well during 2004 with a modest gain and look set to outperform the global financial markets during 2005.

2.4. FII in India FII

Year Net Investment (US $ mn.)

2007 2008 2009 2010 2011

6709 16040 -11356 30253 32226

Showing Trend of FII from 2007 to 2011 in India The Indian stock markets have come of age where there are significant developments in the last 5 years that makes the markets on par with the developed markets. As it is clearly visible from the above table that the investment in stock market plunged from $6709 million in the year 2006-07 to $32226 million in the year 2010-11. However, in the year 2008-09, the swing in the market forced FIIs to withdraw their money from India market and invest their dollars in other

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emerging markets. The foreign capital is free and unpredictable and is always look out of profit. Fll frequently move investments and those swings expected to bring several price fluctuations resulting in increasing volatility.

2.5. Comparison & Analysis of FDI & FII trends

Trends in FDI & FII ( US $ mn.) FDI FII 25227 6709 43406 16040 35581 -11356 26502 30253 32190 32226

Year 2007 2008 2009 2010 2011

Showing trend of FDI & FII from 2007 to 2011 in India In this age of transnational capitalism, a significant amount of capital is flowing from developed world to emerging economies. Positive fundamentals combined with fast growing markets have made India an attractive destination for foreign institutional investors (FIIs). Although the Foreign institutional investors (FIIs), whose investments are often called 'hot money' because they can be pulled out at any time, have been blamed for large and concerted withdrawals of capital from the country at the time of recent financial crisis, they have emerged as important players in the Indian capital market. With over 20 million shareholders, India has the third

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largest investor base in the world after the USA and Japan. Over 9,000 companies are listed on the stock exchanges, which are serviced by approximately 7,500 stockbrokers. The Indian capital market is significant in terms of the degree of development, volume of trading and its tremendous growth potential. In India, FII has a positive impact on the stock market, corporate transparency and governance norms. Equity Research, in particular, has significantly benefitted and compelled investment banks to invest in a previously neglected resource. FII is a short term flow and though it may appear as a regular flow, it has to be segregated from FDI and constantly monitored. Developing countries like India are generally capital scarce. This is because of low levels of income in comparison to other developed countries, which in turn means savings and investments are also lower. The Indian stock markets have come of age where there are significant developments in the last 15 years that make the markets on par with the developed markets. The important feature of developed markets is the growing clout of institutional investors and this paper sets out to find whether our markets have also being dominated by institutional investors. In the course of capital market liberalization, foreign capital has become increasingly significant source of finance. Hence there has been growing presence of FIIs in Indian stock market evidenced by increase in their nut cumulative investments. This shows that Indian stock markets have become lively in terms of their composition of various constituents of the market. On the other side, the increasing presence of this class of investors leads to reform of securities market in terms of trading and transaction systems, making local markets at par with the international markets. In developing countries like India, foreign capital helps in escalating the productivity of labour and to build up foreign exchange reserves to meet the current account deficit. The increase in FIIs investments brings inflow of capital and the country can have access to foreign capital; however, there are limits in India for FII investment in a single firm. On the flip side, foreign capital is free and unpredictable and is always on the lookout of profit, the reason being, the portfolio managers of these FIIs are always on their toes for booking profits for their dynamic portfolios across countries. There are speculations of broader range on the expectations of foreign institutional investors. It is essential to understand when they withdraw their funds and when they pump in more money. Hence, increased volatility associated with FII investments result in severe price fluctuations which cannot be ignored. Trends in World FDI flows show that developing countries makes their presence felt by receiving a considerable chunk of FDI inflows. India shows a steady pattern of FDI inflows during 1991-2007. The annual growth rate of developed economies was 33%, developing economies was 21% and India was 17% in 2007 over 2006. During 1991-2007 the compound annual growth rate registered by developed economies was 16%, developing economies was merely 2%, and that of India was 41%. The major sectors attracting FDI inflows in India have been Services and Electrical & Electronics amounting to US$ 30,421millions or 32 % of total FDI.

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Service sector tops the chart of FDI inflows in 2008 with India emerged as a top destination for FDI in services sector. FDI in India dropped in 2010: India has dropped six places in the global trade body's 2010 rankings of highest foreign direct investment (FDI) compared to the 2009 list. India's ranking has dropped to 14th place in 2010 from 8th position in 2009. India attracted FDI worth $25 billion last year, much lower than the inflows of $36 billion seen in 2009. FDI to South Asia declined to $32 billion, reflecting a 31 percent slide in inflows to India and a 14 percent drop in flows to Pakistan. But inflows to Bangladesh increased by nearly 30 percent to $913 million. While inflows to India slowed down, FDI in China has increased in 2010. FDI inflows and outflows slumped in all three sectors (primary, manufacturing and services) in 2009. The global economic and financial crisis continued to dampen FDI flows not only in industries sensitive to business cycles such as chemicals and the automobile industry but also in those that were relatively resilient in 2008, such as pharmaceuticals and food and beverage products. In 2009, only a handful of industries generated higher investments via cross-border M&A s than in the previous year; these included electrical and electronic equipment, electricity services and construction. Telecommunication services also continued to expand, protected by resilient demand and a slightly lower internationalization than in other industries e.g. in the United States, FDI in the information industry, which includes telecommunications, rose by 41 per cent in 2009 compared to 2008.

2.6. Case of round tripping of investments from Mauritius to India

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

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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 Honble Supreme Courts decision in Union of India v. Azadi Bachao Andolan1, where the entire Mauritius treaty was questioned. The Supreme Courts 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 their principal bank accounts in Mauritius, and Carry out their auditing in Mauritius.
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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.

Thus, 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

2.7. Steps taken by the Indian government to stop the tax avoidance
India, like several other developing countries, has been experiencing huge revenue losses due to tax evasion and capital flight. Globalization had aggravated the problem because of increase in trade transactions as a share of national income, increased concessions on the flow of resources, and reduced regulation. Here, however, we shall confine to the efforts being made by Indian government through tax reforms under the proposed Direct Taxes Code Bill and some of the recent international initiatives to deal with the problem of tax evasion, tax havens and banking secrecy. Direct Taxes Code (DTC) The Direct Taxes Code Bill introduced recently in the parliament raises expectations that there will be streamlining of the entire system of direct taxes by improving transparency, rationalizing the tax structure, mitigating room for litigation, and plugging loopholes that lead to tax avoidance and tax evasion. The DTC Bill aims at a comprehensive reform of direct taxes by replacing the existing Income Tax Act. The expectation is that it will result in substantive reduction in revenue losses not only through tax competition, tax concessions and tax expenditure, but also by reducing the scope for tax avoidance and tax evasion. Here, we shall confine to five areas of concern in tax evasion and tax avoidance, viz. a) concept of residence, b) taxation of capital gains, c) tax incentives with specific reference to special economic zones (SEZ), d) double taxation avoidance agreement (DTAA) vis--vis domestic law, and e) general anti-avoidance rule (GAAR). a) Concept of residence in the case of a company incorporated outside India Lack of clarity on the residence of a company incorporated outside India has often been a source of loss of tax revenue and is sometimes a source of prolonged litigation. Chapter IV of the DTC Bill deals with
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the question and lays down that a foreign company whose control and management is partly in India will be treated as a resident of India and, thus, liable for taxation in India on its global income. The term place of effective management is clearly defined in the Tenth Schedule to the Code. b) Taxation of capital gains Capital gains is another source of tax evasion due to lack of clarity, especially in the case of non-residents. Chapter X of the DTC Bill lays down that income from transactions in all investment assets will be computed under the head capital gains. The DTC provides that gains arising from the transfer of investment assets will be treated as capital gains. The capital gains will be subjected to tax at the rate of 30 per cent in the case of nonresidents, and in the case of residents, at the applicable marginal rate. (The provisions in the DTC Bill, it is hoped, will help avoid the kind of litigation involved in the Vodafone case annexed here.) c) Tax incentives and special economic zones (SEZ) As documented earlier, there has been a plethora of tax incentives or tax competition resulting in huge tax revenue losses in India. Of particular concern has been the concessions given in the name of export promotion and attracting foreign direct investment, as in the case of special economic zones (SEZs). Tax incentives are usually classified into business tax expenditure and social tax expenditure. It observes: Ordinarily, tax incentives are inefficient, iniquitous, impose greater compliance burden on the taxpayer and on the administration, result in loss of revenue, create special interest groups, add to the complexity of the tax laws, and encourage tax avoidance and rentseeking behaviour. The Parliamentary Standing Committee on Finance has recommended a comprehensive review of the tax incentives so that they are limited and confined to exceptional cases. The DTC, based on a comprehensive review, decided that all business tax expenditures, other than for activities that create externalities, would be withdrawn. The social tax expenditures like incentives for savings, medical treatment, handicapped, etc., will continue to be allowed. The DTC without hesitation comes out in favour of grandfathering (read removal) of area-based exemptions on the ground that it creates economic distortion, i.e. allocates or diverts resources to areas where there is no comparative advantage, and that such exemptions also lead to tax evasion and avoidance. But it is not so categorical about grandfathering on profit-linked exemptions to ventures in special economic zones (SEZs), though it observes that profit-linked deductions are discretionary in nature as they create an incentive to inflate profit as well as to transfer profits from a taxable entity to a non-taxable one. The DTC is relatively soft on SEZs. As a policy, it decides not to extend the scope of the period of profit-linked deductions. However, specific provisions for protecting such deduction for the unexpired period have been Centre For Education and Communication (CEC) provided in the DTC in the

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case of SEZ developers. A similar provision to protect profit-linked deductions of units already operating in SEZs for the unexpired period will also be incorporated. d) Double taxation avoidance agreement (DTAA) vis--vis domestic law The DTAAs, particularly like the one between India and Mauritius, have become a source of tax evasion and also litigation. The litigation often arises due to conflicting interpretations of the DTAA in relation to domestic tax laws. Chapter XXII of the DTC Bill deals with relief from double taxation. Ordinarily, countries follow both residence-based taxation and source-based taxation. However, if two countries tax the same income, one based on the principle of source, it could lead to double taxation of the same income. Hence, countries have agreed on certain principles to avoid double taxation and, accordingly, enter into DTAAs. However, these DTAAs are often used for treaty shopping, resulting in tax evasion. (See the annexed case by Azaadi Bachao Andolan) The DTC provides that neither a DTAA nor the code have preferential status by reason of being a treaty or law. In the case of a conflict between the provisions of a treaty and the provisions of the code, the one that is later in point of time shall prevail. This may involve some treaty override. This limited treaty override, according to DTC, is in accordance with the internationally accepted principles. The DTC also points out that since anti-avoidance rules are part of the domestic legislation and they are not addressed in tax treaties, such limited treaty override will not be in conflict with the DTAAs. Further, this will not deprive any taxpayer of any intended tax benefit available under the DTAAs. One hopes that the expected shift from treaty shopping to limited treaty override under the DTC regime will help prevent tax evasion through DTAAs. e) General Anti-avoidance Rule (GAAR) The GAAR (General Anti-Avoidance Rule) The GAAR (General Anti-Avoidance Rule) was introduced in March 2012 by the then Finance Minister Pranab Mukherjee, as a measure to limit the scope of transactions that are undertaken primarily to evade taxes. The main targets of this rule were enterprises and investors who had set up shell companies in Mauritius to route investments into India. A tax-friendly treaty between India and Mauritius encouraged both Indian and multinational firms to set up subsidiaries in Mauritius, solely for the purpose of investing in India, without having any core business interest in Mauritius. According to data from the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, total FDI equity inflows from Mauritius to India between April 2000 and April 2011 amounted to USD 55 billion, or 42 percent of total FDI equity flows. In fiscal year 2010-11, FDI equity flows from Mauritius were close to USD 7 billion, or 36 percent of the total flows. There was a strong outcry against these measures by both domestic and foreign investors. Since the GAAR announcement followed closely on the heels of a proposal to review and retrospectively tax all acquisitions with a substantial transfer of Indian

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assets, the general economic mood took a dip downwards. Coupled with the perception of general policy drift of the current government, this measure was seen as a signal that the government was not interested in foreign investment flows. Other criticisms of the GAAR have centered on the following points: It becomes a tool in the hands of the Income Tax Department to harass investors Lack of training for officials to implement GAAR enhances the scope for faulty implementation The sudden introduction of the proposal, without prior consultations, was perceived as arrogant and unnecessary The shadow of black money The introduction of GAAR needs to also be seen in the context of the public debate surrounding black money (unaccounted cash) in India. Global Financial Integrity (GFI), a US -based nonprofit research organisation, estimates that USD 462 billion has left India between 1948 and 2008. This amount is equivalent to 40 percent of Indias GDP. Some of these funds are allegedly routed via Mauritius, back into the Indian economy, giving rise to the allegation of round tripping, where purported FDI inflows into India are actually India domestic funds being converted from black into white money. The Shome Committees Revisions Giving in to domestic and international investor outcry, Prime Minister Dr Manmohan Singh, while holding the finance portfolio in July, appointed an expert committee headed by Parthasarathi Shome, a former advisor in the finance ministry to review the GAAR recommendations and suggest a suitable way forward. The Shome Committee released its interim findings in early September and its key points included: Bringing external experts, from outside the government on the panels for deciding each case Making mergers tax neutral Exempting both domestic and foreign enterprises from paying taxes on the gains from listed securities Providing specific exemption of GAAR from those entities that are legitimately established in Mauritius Keeping Indias GAAR at the same level as other nations; it was proposed that only those transactions that were made with a specific intent to avoid tax should be covered under GAAR Not allowing tax officers to invoke GAAR to meet their collection targets (this would reduce the scope for harassment and corruption) It was proposed to invoke GAAR provisions only when the tax benefit was more than INR 3 crore (USD 555,000) GAAR and the Indian government A symbol of drift? The Indian economy is currently facing significant challenges, including high inflation, a rising fiscal deficit, falling industrial production and lower GDP growth. While the government took some steps last week to correct the situation, with steps such as a diesel price hike, reduction in

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subsidies of gas cylinders, approval of 51 percent FDI in multi-brand retail trading and 49 percent in civil aviation, these may not be enough to lift investor sentiments. The proposal of GAAR also reintroduced uncertainty into Indian economic decision making, which frightened investors into believing that the economy had returned to the pre-liberalisation period before 1991, where the License Raj *a licensing regime+ was used by the government to harass entrepreneurs and industrialists. Given the distance that the Indian economy has traversed since then, such a step was retrograde and unnecessary. It appears to suggest that that the government has run out of ideas. There are several areas in the economy that require more government attention, including power, infrastructure, agriculture, land reforms and employment generation. While the previous finance minister and current President, Pranab Mukherjee, was seen as emblematic of an earlier era of government guidance of the economy, the current Finance Minister, P Chidambaram, is expected to develop a more investor-friendly environment.

Conclusion
The flow of FDI & FII accelerated the Indian economy and also gave opportunities to Indian industry for technological up-gradation, gaining access to global managerial skills and practices, optimizing utilization of human and natural resources and global competitive advantage with greater efficiency. Most importantly FDI is central for Indias integration into global production chains which involves production by MNCs spread across locations all over the world. The impact of flow of FDI & FII on Indian stock market is significant. However, there are problems associated with lots of FII coming into an economy. As happened in case of Indo-Mauritius leading to round tripping of investments (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/FII), which resulted in enormous amount of tax revenue loss to Indian government. To overcome this persistent problem the government took following steps: Direct Taxes Code (DTC) The Direct Taxes Code Bill introduced recently in the parliament raises expectations that there will be streamlining of the entire system of direct taxes by improving transparency, rationalizing the tax structure, mitigating room for litigation, and plugging loopholes that lead to tax avoidance and tax evasion. The DTC Bill aims at a comprehensive reform of direct taxes by replacing the existing Income Tax Act. The expectation is that it will result in substantive reduction in revenue losses not only through tax competition, tax concessions and tax expenditure, but also by reducing the scope for tax avoidance and tax evasion. Here, we shall confine to five areas of concern in tax evasion and tax avoidance, viz. a) concept of residence, b) taxation of capital gains, c) tax incentives with specific reference to special economic zones (SEZ), d) double taxation avoidance agreement (DTAA) vis--vis domestic law, and e) general anti-avoidance rule (GAAR).
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The General Anti Avoidance Rule (GAAR)- proposed by the then Union Finance Minister Pranab Mukherjee during the annual budget 2012-13- is anti-tax avoidance rule, drafted by the Union Government of India, which prevents tax evaders, from routing investments through tax havens like Mauritius, Luxemburg, Switzerland. According to the draft, GAAR will come into effect from 1 April 2013. As per the guidelines, FII not opting for treaty benefits and ready to pay taxes will not come under GAAR, but those who do opt for dual taxation avoidance agreements will come under its purview. The Union Government was forced to defer the rules until 1 April 2013, as foreign investors had expressed their reservation about the language used in the rules. Investors had maintained that the ambiguous language used in the draft of the GAAR could lead to the misuse of the rule. 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.

References
Agarwal, Chakarbarti and Trivedi & Nair (2003), Determinants of Flls Investment Inflow to India. Paper Presented in 5th Annual Conference on Money & Finance in the India Economy, Indira Gandhi Institute of Development Research, Jan. 30-Feb. 1, 2003. David Carpenter, Partner Mayer, Brown, Row & Maw LLP (2005), Foreign Investment in India, Journal of Financial Research, Vol. 19. Dhamija Nidhi (2007), Foreign Institutional Investment in India, Journal of Research in Indian Stock Volatility, Vol.14. Stanely Morgan (2002), Flls influence on Stock Market. Journal of Impact on Institutional Investors, Vol. 17. www.Sebi.gov.in www.moneycontrol.com http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD http://www.indiainbusiness.nic.in/economy/economy.html "White House Touts Growing Foreign Direct Investment In The U.S.". ABC News. June 20, 2011. Retrieved November 2, 2012. "What is Foreign Direct Investment, Horizontal and Vertical Knowledge Base". Guidewhois.com. Retrieved 2012-11-17

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