Round Tripping of Funds

ROUND TRIPPING				hypothesis, Chinese firms illegally transfer funds to
				neighbouring countries (like Taipei, Hong Kong and
				Macau) which in turn gets reinvested in mainland
Introduction:				China as FDI.
				However, since round-tripping is essentially
Round Tripping refers to the capital belonging to a				clandestine, accurate data is practically impossible to
country, which leaves the country and is then				obtain but estimates suggest that round-tripped FDI
reinvested into the country in the form of FDI.				accounts for one-fourth of China's total FDI count
This route attracts a lot of incentives, which are:				whereas on the hand it is an established fact India is
Firstly, enterprises set up through FDI enjoytax				relatively low on Round Tripping as compared to
benefits,administrative support,easier access to				China.
financial services.
Secondly, citizens’ from countries with weak				The Mauritius Story
property laws prefer to remove profits from their
country and invest abroad to enjoy property rights				Pursuant to the Double Taxation Avoidance Treaty
rather than reinvesting their profits.				(DTAT) signed between India and Mauritius in 1983,
Thirdly, Round Tripping is often used as an avenue				any capital gain made on the sale of shares of Indian
for laundering one’s illegitimate money.				companies by investors resident in Mauritius would be
				taxed only in Mauritius and not in India. For the first
It is due to these reasons that tax havens like				ten years the treaty existed only on paper as FIIs
Mauritius, the British Virgin Islands, Cayman Islands,				were not allowed to invest in Indian stock markets.
Cyprus etc. are used. These places are of immense				However all that changed in 1992 when FIIs were
advantage as money routed through them is exempt				allowed into India and with the passing of the
from capital gains tax.				Offshore Business Activities Act, 1992 by Mauritius,
				foreign companies were allowed to register in the
				island nation for investing abroad.
Methodology:				There are two aspects which render Mauritius into a
				tax haven:
Analysis of case studies.				1.
Internet web pages and legal websites.				Firstly, a body corporate registered under the laws of
Legal journals, reports and opinions.				Mauritius is a resident of Mauritius and thus will be
				subject to taxation as a resident.
				2.
Limitations:				Secondly, the Income Tax Act of Mauritius provides
				that offshore companies are liable to pay zero
Round Tripping in itself is a very unregulated and				percent tax.
ambiguous phenomenon so the literature available is				Therefore by bringing an offshore company within
extremely rare and deficient; therefore this report				the definition of “resident”, both the benefits
has drawn inferences from the available material to				of being an offshore company as well as that of
draw out a viable overview of the entire scenario.				residency allowed under DTAA are bestowed upon it.
				In effect, the whole exercise of avoidance of double
Literature Reviewed/ Bibliography:				taxation turned out to be avoidance of taxation
				altogether.
The Securities and Exchange Board of India Act,
1992				The advantages of registering a company in Mauritius
Articles published in The Hindu newspaper				are:total exemption from capital gains tax,quick
Articles published in The Economic Times newspaper				incorporation,total business secrecy, anda completely
The Law lexicon				convertible currency.
				Therefore the financial entities setting up companies
Theoretical Framework:				in Mauritius do so without almost any establishment
				costs.
The tussle between the Reserve Bank of India (RBI)
and the Revenue Department				The economic importance of Mauritius to India can be
				clearly understood by the Hon’ble Supreme
Lately it has been observed that the RBI is leaning				Court’s decision in Union of India v. Azadi Bachao
towards legitimizing certain types of Round Tripping.				Andolan1, where the entire Mauritius treaty was
The RBI’s view on the subject is that money				questioned. The Supreme Court’s decision clearly
reinvested in India through a foreign subsidiary of an				reflected the underlying policy of the Government to
Indian company should be considered foreign direct				attract FDI into the country at any cost despite the
investment and that in many parts of the world such				known fact that the treaty is depriving the Indian
as China these aspects have already been legitimized.				Exchequer of millions of dollars due to Round Tripping
It feels that doing so would boost the FDI count of				and tax evasion.
the country and render it a more attractive				The policy in itself has become a catch-22 situation
destination for foreign investment.				for the Government as any stringent norms with
				regard to Mauritius might result in future FII
However, the Revenue Department looking from a				investment being targeted away from India and
microeconomic point of view feels that round tripping				working out for the benefit of South East Asian
should not be allowed as Indian companies may use it				countries or FIIs looking at alternate options like
to evade tax by routing their money through the tax				Cyprus and Singapore to invest into India.
havens.				One has to understand that in a growing economy
Although in such cases FDI might increase but the				much in need of FDI any scenario decreasing FDI
country would not benefit in terms of revenue.				inflow is unfeasible and therefore Round Tripping, a
				side effect has to be accommodated with.
The RBI disagreeing with the revenue department's
assessment, cites the Chinese example arguing that				Recently as of September 15, 2007, Mauritius has
where subsidiaries of foreign companies are levied a				started getting tough on Round Tripping. The Financial
lower corporate tax, the incidence of round tripping is				Services Commission (FSC) of Mauritius, the regulator
extremely high i.e. more than 25-30 per cent.				supervising the non-banking financial services sector
However, in India where the corporate tax rates are				& global businesses, has carried out reforms in the
the same for all companies the incidence of Round				Financial Services Act and improved the framework
Tripping is only 2-3 per cent.				of the tax resident certificate.
It is pertinent to note that the RBI stand is with				In pursuance of this it has been decided that all
regard to legitimizing Round Tripping within the sphere				resident corporations proposing to conduct business
of the International Monetary Fund’s (IMF)				outside Mauritius would have to compulsorily apply to
definition of FDI only and does not intend to				the FSC for a global business license. Even though
accommodate Round Tripping as a means of				there are no restrictions on any business activity, the
escaping tax or laundering ill-legitimate gains. In				FSA now specifically mentions that a license will not
pursuance of this, recently the RBI has set forth				be granted, or would be revoked, if found that the
directives with regards to Participatory Notes and				activity “is unlawful and causes serious prejudice
tighter Know Your Customer (KYC) norms.				to the good repute of Mauritius as a financial services
				centre.”
Instances where permission has been refused				The salient features of the reforms are:
				Global Business Companies (GBC) would now have to
1. Bharti Share Transfer case				compulsorily hold board meetings in Mauritius,appoint
				at least two resident directors in Mauritius, (big
In 2001, the Government i.e. the FIPB on the advice				deterrent as it would now make these directors liable
of the Department of Economic Affairs (DEA)				for any unscrupulous activities)maintain there principal
rejected two proposals from the Bharti Group for				bank accounts in Mauritius, andcarry out their auditing
transferring shares held by UK-based Bharti Global Ltd				in Mauritius.
in favour of Indian Continent Investment Ltd,				All GBCs have to get a certificate from the auditors
Mauritius, due to the negative impact of Round				stating that all requisite conditions have been
Tripping of foreign direct investment (FDI) in the long				complied with.
run, particularly from the taxation angle.				Moreover in the same month it was announced that
The DEA had itself acted upon the opinion of the				the DTAA with Mauritius would be brought under the
Revenue Department and its views on tax				same umbrella as that with Singapore, which contains
implications of the transfer but interestingly the				exclusive clauses to check Round Tripping of
proposal had enjoyed the support of the Department				Investments.
of Telecommunications, which was the administrative
authority in the case.				OCB Investment Ban

2. Chambal Agritech Plan				In 2003 the RBI imposed a blanket ban on Overseas
				Corporate Bodies (OCBs) investment in the stock
The Birla Group’s plan to transfer ownership of				market sector. The move was primarily intended to
Chambal Agritech Ltd (CAL) from India to Singapore				restrict Round Tripping of money by Indian residents
was refused permission by the DEA, which				through their NRI counterparts overseas.
categorically stated that in the absence of capital				Conversely this move also resulted in a substantial
account convertibility for Indian entities, the transfer				amount of genuine FDI being curtailed as the RBI
would amount to Round Tripping.				circular in this regard seemed to take away the
				special status given to genuine NRI businessmen who
The Chinese Myth				were looking at doing business in India.
				It is to be noted that one of the main avenues for
The China-FDI story has been in the limelight for				FDI in China is courtesy of Non-Resident Chinese
some time now. The bucketful of billions that the				individuals present in regions like Hong Kong, Macau
world seems to be pouring down the country				and Taipei.
definitely makes good copy. No other country				In contrast, foreign companies can invest in the
attracts as much foreign direct investment (FDI) as				country even if they have their base in tax havens
China does. Recently approximately USD 60 billion				such as the Cayman Islands. So basically the
poured in which is about twelve times the amount				Automatic route for FDI is open to foreign owned
that has flowed into India. Between the years 1979				companies whereas there is a blanket prohibition in
(the first year of the China Economic system reform)				case of OCBs with NRI ownership.
and 2004, China has absorbed a total of about USD
560 billion in FDI whereas India, the next most				The PN predicament
popular destination for foreign investment in
manufacturing received almost USD 200 billion less in				Lately Participatory Notes (PNs) have come under
FDI than China.				the scanner for their alleged role in Round Tripping.
However, it is important to note that the Chinese				The RBI as well as SEBI has shown their concern
FDI statistics are bloated up from Round Tripping				about the inflow of money coming into the country
whereas India’s figures are understated.				through PNs.
				PNs are instruments issued by registered FII
Before delving further we have to comprehend the				brokerages in India to foreign funds or investors who
IMF definition of FDI.				are not registered with SEBI, but are interested in
The IMF definition of FDI includes as many as twelve				trading in Indian securities. FII brokers buy and sell
different elements, namely:equity capitalreinvested				securities on behalf of their clients on their
earnings of foreign companiesinter-company debt				proprietary account and issue such notes in favour of
transactionsshort-term and long-term loansfinancial				such foreign investors. PNs are mostly used by
leasingtrade creditsgrantsbondsnon-cash acquisition of				entities that are not welcome by SEBI as well as by
equityinvestment made by foreign venture capital				non-resident Indians who do not want to directly
investorsearnings data of indirectly held FDI				invest in Indian securities. SEBI's worry is that the
enterprises and control premiumnon-competition fee				ultimate owner or beneficiary of PNs is not known as
				these PNs are transferable. On a similar track, RBI
However, with the singular exception of equity capital				feels that the non-transparent nature of these
reported on the basis of issue or transfer of equity/				instruments make them ideal money-laundering
preference shares to foreign direct investors, India's				vehicles. The unstated fear of the regulators is that
current definition of FDI does not include any of the				money belonging to Indian residents is being
other above elements, whereas the Chinese definition				“round-tripped” through the PN route.
includes them all. In addition to this China also
classifies imported equipment as FDI while India				However as of 2007, SEBI has banned PNs in the
captures these as imports in the trade data.				off-shore Derivative Segment (to be applicable within
A study undertaken by the International Finance				a period of 18 months). It has cited the reason as a
Corporation (FE, 5/6/02) shows that if comparable				security measure and as a means of curtailing Round
definitions of FDI are used by India and China, then				Tripping.
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				Conclusion/ Recommendations:
substantial amount of Round-Tripping where large
amounts of Chinese black money is recycled through				The laws present today dealing with Round Tripping
Hong Kong and sent back to the mainland as FDI.				are adequate, however the emphasis has to be on
Round-tripping in fact accounts for one-half of				enforcing them rather than curtailing the route itself.
China’s FDI inflows, which has practically reduced				The trick lies in essentially enforcing laws that are
the reported levels from USD 40 billion to USD 20				there to prevent round-tripping and encouraging
billion in the year 2000. In contrast, India’s figures				foreign money including NRI and OCB money. Merely
of USD 2-3 billion do not conform to the standards of				because a company is owned by an NRI, one should
the IMF (as per the definition mentioned above)				not discriminate against it investing and the solution
because it excludes reinvested earnings, subordinated				lies in either abolishing what remains of capital gains
debt and overseas commercial borrowings which are				tax, or in taxing foreigners’ profits made in Indian
included in FDI numbers of other countries.				markets. Both would inevitably reduce instances of
According to the “Round-Tripping”				Round Tripping by rendering it less viable.

Global Trade

Round Tripping of Funds