The Indian provisions of the draft direct taxes code could cause a major setback to the flow of foreign investments into India through tax treaty countries such as Mauritius, according to Indian tax experts and industry representatives.

The tax code proposes to override international treaties such as the double taxation avoidance agreements that India has with Mauritius and 75 other countries. The Indo-Mauritian agreement has served as a vehicle for routing investments into India because of the tax benefits it offers.

“The investments flowing into India from countries like Mauritius would certainly be impacted, if the proposals get implemented. But by how much, only time will tell,” said Vikas Vasal, executive director of KPMG. Unlike India, Mauritius has no capital gains tax and its corporate tax is less than three per cent. A foreign investor can take advantage of this by channelling investments through Mauritius into India. The method is also called treaty shopping. Since 2000, India has received $81 billion FDI, of which more than 40 per cent or $ 35.18 billion has come from Mauritius. In the past 3 years, between 2006-07 and 2008-09, FDI from Mauritius is estimated to be Rs 124,141 crore.

However, once the code comes into effect, it will take precedence over international treaties and routing such investments through a third country may become a thing of the past.

“The main aim of the government is to stop treaty shopping. Some companies misuse these treaties, to channel funds from countries like Mauritius,” S B Gupta, adviser to Ficci on taxation. Vishal Shah, associate director of Price WaterhouseCoopers concurs and say that the proposals of the code once implemented would impact the applicability of treaties with countries such as Japan, USA, the UK and Mauritius.

Shah added that new proposals could also hurt India’s image in the world community. “At a glance it looks a retrograde step by the government which could be interpreted as India not wanting to honour its international commitments,” he said.

“The government had tried in the past to make amendments to the treaty with Mauritius. However, since it could not (Mauritius was not agreeable to it), the government has tried to bring a stop to such activities, through this provision,” Gupta said.

Venugopal Dhoot, chairman and managing director of Videocon Industries said, “Government has the authority to override international treaties and agreements. Though as a company, we welcome it but we still need to see what form it takes,” he said.