Caving in

THE MANNER IN which the Government has bent over backwards to avoid ruffling the feathers of a few foreign institutional investors (FIIs) shows just how much power these funds have come to wield over Government policy and administration. The issues involved in the tax demands raised on seven FIIs who were routing investments through Mauritius were no doubt complex. But there was an unseemly speed with which the Government was willing to rescind decisions taken by its revenue officials, alter its position from day to day and finally change policy altogether just to meet the concerns of the portfolio investors and calm the stock markets.

The facts of the controversy are clear enough. There are 506 registered FIIs which since 1993 when they were allowed to operate in the country have made a net investment of $11.4 billion. The official estimate is that as much as 60 to 65 per cent of these investments have been routed through Mauritius. The ``Mauritius route'' is the preferred choice of the FIIs because the island nation has a liberal tax regime and it has a double taxation avoidance treaty with India. The attraction of Mauritius is particularly strong since long and short-term capital gain incomes attract taxation in India but are free from any tax in Mauritius. The issue concerning Indian tax officials was how many of the FIIs were genuinely resident in Mauritius, whose effective management was vested there, and how many were just ``name board'' firms in that country. The tax officials in Mumbai investigated 37 FIIs based in Mauritius, cleared 13 of them, decided that 24 called for further investigation and made tax demands of Rs. 9 crores on seven FIIs. This was enough to set off an extraordinary chain of events leading up to the Finance Ministry permanently clearing all the Mauritius-based FIIs as long as they provided certificates of residence from that country. Though the Government first took pains to state that the investigations did not mean an across-the-board withdrawal of the provisions of the Indo-Mauritius tax treaty and then even stayed the tax demands on the seven FIIs, neither was enough for either the FIIs or the stock markets. A few offshore funds stopped dealings on the rather flimsy ground that the tax demands made it difficult for them to quote an accurate net asset value, the chartered accountants of some FIIs stated that they could not authorise repatriation of either dividends or sale proceeds, the FIIs made it known that they were worried about Government policy and share prices on the secondary market suffered one of their biggest-ever one-day falls. In short, an atmosphere of a crisis of confidence was created. Though the Union Finance Minister, Mr. Yashwant Sinha, first blamed ``speculative'' forces for unsettling the market, the very next day the Central Board of Direct Taxes decided to permanently cancel the tax demands on the FIIs and announced that this issue would not be raised at all in the future, provided Mauritius certificates of residence were produced.

Rather than stand up to the FIIs and make it clear that while there would be no harassment the tax officials would be allowed to distinguish the genuine from the non-genuine FII, the Government just caved in. Therefore, Mr. Yashwant Sinha's claim that the decisions taken by his Ministry will not encourage ``treaty shopping'' (look for the best tax treatment) by foreign investors sounds hollow. The record of FIIs in developing country markets around the world has been to flee at the first sign of trouble. Here, just the fear that some of the FIIs may act similarly when presented with arguably legitimate tax demands persuaded the Government to go out of its way to please them. With such a message, the actions of the FIIs when they are next involved in a dispute with the Government need not be guessed.

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