Having made no headway to amend a 26-year-old double taxation avoidance agreement with Mauritius, the finance ministry has hardened its stance against broadening India's economic engagement with the island nation.
North Block has made it clear that unless Mauritius came forward with "mutually acceptable" solutions to plug misuse of the tax treaty - such as having Indian companies "round-trip" unaccounted money into the country - India should not sign the proposed Comprehensive Economic Cooperation Partnership Agreement with the tiny Indian Ocean tax haven off the southeast coast of Africa.
Income tax officials had estimated that the treaty had been costing the Indian exchequer over Rs 4,000 crore (Rs 40 billion) annually for some years now in terms of the revenue forgone due to capital gains exemption for investors routing their funds through Mauritius-based investment entities.
Foreign direct investment equity inflows from Mauritius account for the largest share of total inflows into the country. According to the latest available data, cumulative inflows from April 2000 to June 2008 stood at Rs 1,27,554 crore (nearly $30 billion), accounting for over 44 per cent in rupee terms of total inflows of Rs 3,11,912 crore (nearly $72.5 billion). The United States was a distant second, accounting for just over 8 per cent of inflows in contrast.
CECPA, over which India and Mauritius have conducted several rounds of negotiations over the past few years, would allow the latter duty-free exports of items like textiles to India.
The Indian commerce ministry had put up a draft note on the CECPA for Cabinet discussion in April this year. Until around a month ago, crucial departments in the finance ministry, including revenue and economic affairs, had not offered their views on the proposal.
This delay, and several other trade-related issues between the two ministries, is the subject of a recent appeal by Commerce Minister Kamal Nath to Prime Minister Manmohan Singh seeking his intervention in resolving pending issues.
Mauritius has been reluctant to discuss the issue of revenue loss. Earlier this year, India had offered to monetarily compensate the island nation if it tightened the norms to move from a "residence-based system of taxation" to a "source-based" system. Those negotiations, however, failed.