17 Dec 2008

New Year: ensuing changes in legal scenario

The current year is about to end, and so is the voluntary moratorium period this blog has proposed. The law, meanwhile, has taken its own course and its just not much water which has flown during this period but also new dimensions have built up the ramifications of which would have to be borne by the future generations. Let us take these one after the another;

(i) Taking cue from a constitutional bench decision of the Supreme Court in M/s Ratan Melting v. CCE, Bolpur pronounced last month, the Revenue authorities (seemingly) have been granted allowance to issue circulars for themselves and argue on the face of it that they are not supposed to follow them. In this decision which is repugant to the hitherto settled law i.e. the Department is bound by the Circulars issued by them but the assessees are not required to follow them to the extent they are prejudicial to them, has has been dwindled by this decision. In terms of the law declared by this Constititional Bench, it is open to the Department to issue a circular (based upon their understanding) and later on claim that they themselves are not bound by the interpretation they have assigned. Surprising, repelling, ... yet the law of the land and thus has to be abided by.

(ii) The long stand rule of fees collected by the States requiring to be jusitied in the sense that they were required to show the matching effort on their part towards the utilization of the said fees for the purpose for which they were collected may well be under review and subjected to change in the upcoming year itself. A seven judge constitution bench of the Supreme Court in the landmark Atyabari case and its later reaffirmation by a five judge bench in Assam Tea Company case led to the formulation of the "compensatory test" principle where the government was required to show that how the fees collected were required by them to the public in terms of it being translated into infrastructure for public use etc. It was on these lines that another five judge bench of the Court in another landmark decision of Jindal Stainless declared the Entry tax levied by the Haryana Government to be ultra vires the Constitution and thus invalid as the State Government was unable to show that the fees collected by them was put to use to built up any infrastruture as meant to be the purpose behind the collected of entry tax. However, in an appraisal of other Entry tax legislations of other States, it has been argued by the former Attorney General of India, Mr. Sorabjee that the decision in Jindal Stainless requires reconsideration which in turn implies the reconsideration of the compenstatory test principle itself. The Bench of two judges after hearing this matter for over three weeks has reserved itse decision but if the things proceed as argued by Mr. Sorabjee, the compensatory test is all test to be reviewed and examined of its utility in the present day scenario. Let us keep our fingers crossed and await the outcome for any deviation from the compensatory test principle might confer unbridled powers with the State Governments to levy fees without requiring to justify the same.

(iii) In the wake of recent Mumbai attackes the Central Government has proposed a bill to create a National Investigating Agency. The idea is worthwhile and long due but the effectiveness of such an agency is yet to be tested. The
Maharashtra government is seemingly all set to establish an internal State level police force on the lines of National Security Guards. In the wake of such diverse agencies, how would future instances of terror etc. (lets pray there aren't any) be handled and what coordinating postures would be assumed by these agencies is a vital question requiring answers. At our end, we can only hope that these and other issues are sorted out at a pilot basis itself and do not end up being exposed in real crisis situations.

(iv) Now that the judges are already having refesher courses (if one could say that) in the terms of their invovlement with the National Judicial Academy, a similar refresher system is being carved out for lawyers, atleast as far as Rajasthan is concerned. A press release reports that a dedicated acamedic institute would be set up to update the lawyers with the changes in the legal system and bring them to terms with the contemporary issues. (click here to for the full press release)

With this short update, let us set into motion our task for the upcoming year, which we hope to carry out without any interuptions like the current year.

7 Aug 2008

Exploring the nuances of Cyber Law

I – Why and what of cyber law?

Cyber law, or the law dealing with cyber-space, popularly called ‘internet’ or ‘net’, is the buzz word today in law school curriculums and across the generation of old lawyers across the world. Why? Because this is more to do with technology rather than law alone. Imagine a law providing definition of ‘meta tag’, something which any computing geek can tell you. Then the law defining an ISP. Sounds hilarious and then absurd. Why should the law attempt to define these terms when they are well known and understood in the same manner across the globe? Why purpose would be served even if the law were to define the same? The slow and steady moving law can never compete with the level of technology existing at any point of time and the speed with which it grows. So what is the point of making a law, which by the time is come to govern, it is already outdated. These and other oddities of cyber law make it an interesting subject indeed.

Well, it seems there is a purpose. The purpose is ‘regulation’, something which the law exists for. The purpose is to identify the course of events, as they take place on the cyber space, and then provide a mechanism to determine rules affixing responsibilities and liabilities on the participating actors in the transactions. Take for example a simple and every day case of a cyber-café. A goes in Xena Computings and used the café for an hour. In this time, he views Z government’s site and tries to interfere with the site-coding. He is unable to change the things and so he leaves. Now should the government whose site has been fiddled with do something? Let us say that Xena Computings is situated in Z country only but A is of Y country. Can anything be done?

Well here comes the role of cyber law. It firstly defines unacceptable code of conduct on the cyber-space (something like cyber offences) and then prescribes a mechanism or procedure to deal with the situations in which this prescribed code of conduct is breached. So in this case, unless the law of Z provides against or prohibits interference with governmental websites, Z’s government will not be able to do anything, even if A had been successful in hacking the site or otherwise. Now once this is made a cyber offence, what next? The law of Z must provide a mechanism whereby Z government could affix the liability on A or Xena Computings, as the case may be, and allow the law to take its course.

So the law needs to define technical terms like hacking, cracking, ISP, subscriber, etc. and then only any action can be taken. So the premises (or the what) or cyber of law is based upon technology or for comprehensible terms, the cyber space where the why, as we have already noted, is the regulation of cyber space. Thus cyber law comes to occupy a place as a distinct and specialised branch of law.

II – The fundamentals of Cyber law

Cyber law or cyber-space law, as the name suggests, deals with cyber space. So the core of the matter is a technology driven segment while the external paraphernalia i.e. the law itself, is static and starts with where the technological elements end. To simply, technology brings a concept, say the simple concept of ‘linking’ web-pages and website etc., and then the law follows to deal with it. Like in this case, whether linking can lead to any legal liability. For example, there may copyright violation or trade mark violations in deep-linking etc.

Therefore the fundamentals of cyber law start from where the fundamentals of cyber-space end. Cyber-space defines the area or rather the spectrum where the cyber law would operate and therefore, for example, jurisdictional issues in cyber law are a concomitant of jurisdictional issues of cyber-space. To illustrate, no country has a right over cyber-space for technically cyber-space does not fall within the jurisdiction of any particular country. There may be a case that a server hosting a website may be located within the territorial confines of a particular country but the point is that once is has hosted the site, it has fallen into public domain, an artificial spectrum (which cyber space really is) and therefore no country has jurisdiction over it.

Conversely, however, cyber space is not Eiffel Tower that you can see it only by going to Paris. From any where in the world you can have access to cyber space (provided of course you have a phone line and a modem and yes, a computer). Therefore, speaking from this reverse angle, any and all countries have jurisdiction over the activities committed in the cyber-space, so long as the starting or the ending point was in their country. Thus, if Mr. G-space (operating from New York) copies a copy-right-protected video from the site of Ms. YTB (hosted from Sydney), and then publishes a morphed version of the video on his site (hosted in Brussels), the only countries which (legally speaking) would have the jurisdiction to deal with the matter would be of those three cities and none else, unless an over-enthusiastic court decides to poke its nose into the matter, not being situated within these three countries.

So this way cyber law is intrinsically connected with the manner in which cyber-space operates but for the qualification that this is only as regards the facts of the matter. The situation remains just like an ordinary law for questions of law. This is to say, that in our above example, while cyber space rules would only be illustrative in the decision as to which court has jurisdiction, the actually liability in any case would be defined by reference to the principles of intellectual property law alone.

To conclude, therefore, while cyber law is invariably and irrefutably related to cyber-space, its fundamentally actually being to operate from where the fundamentals of cyber-space lead them to. To paraphrase, they have a converging point but do not overlap. They being and end with the same objectives, but operate on different areas, one purely technological and concept based, the other purely convenience and policy based and operating on a conceptual framework provided by the other.

III – Legal framework of Cyber law

Cyber law is a very intricate subject to have a legal framework upon, not because of the fact that there is too much of technology involved but also due to the fact that cyber law does not fit under any specific branch of law and rather permeates into various and almost all different branches of all. For example, we have law of contracts, law of crimes, etc. as separate branches of law. However cyber law does not fit in any of these as it involves almost all branches of law to some extent or the other like electronic contracts, cyber offences etc., which are quiet capable of fitting themselves in other branches of law but then as a matter of practical perspective, are better dealt separately as a specific branch of law involving technology, i.e. cyber law.

So we have a legal framework for this branch of law which is intricate and varied. We have a law which deals with cyber offences as a part and parcel of criminal law or rather as a separate penal code in itself. We have a law which deals with electronic transactions of commercial sense or put simply, electronic contracts, which may either be incorporated in the contract law or be kept separate as a distinct subject. Then we have separate legal codes for those areas which do not strictly fall within the ambit of the generally invoked branches of law. Therefore we have law relating to liability of the ISP, liability of the e-auctions host, etc.

But why do we need to discuss this under the legal framework of cyber law. Because, the legal framework of cyber law does not exist as one. It instead exists as a varied and assorted group of separate legal codes which are united only through the underlying theme of technology. So while technically speaking the Information Technology Act, 2000 is the sole framework of cyber law in India, it is not so legally. Legally a portion of Indian Evidence Act, 1872 (when even the T.V. was not born, forget the World Wide Web) which deals with electronic evidence, a portion of tort law (dealing with cyber torts), etc. form the actual legal framework of cyber law in India. And this is not a case with India alone. It is the same across the world.

In fact it is not worthwhile to have an exhaustive code dealing with the legal aspects of cyber transactions. The reason is simple. Law cannot expect to match the pace of technology nor its participants. It should remain content with playing the second-fiddle, unless it wants to dwell into an unknown area where not principles but the need of the markets determines the next generation’s phase and outlook. Therefore law-makers across the world are content framing legislations on the areas which are quiet settled as far as cyber-transactions are concerned and once this is done, patch-up the existing legal codes with these developments. So we have an addendum to the existing legal codes for cyber transactions.

IV – Regulation of cyber-space

When ever the term regulations comes up, there always is a sense of an external entity watch the movements of ‘the regulated’ and always ready to pound up and play its part of imposing sanctions in order to bring the deviant behaviour in line with the standard notions of the regulated regime, in line with the principles of fair-play and mutual co-existence. Initially when the World Wide Web gripped nations and there were participants across the borders, there was a fear amongst the legal scholars as to how this new arena would be regulated. No single nation could work out a way to deal with the transactions even if they took place within their territorial regime as a multitude of mitigating or aggregating factors remained outside their boundaries.

Thus a need was felt for an international consensus on the issue. But then even that one was not forthcoming. Why? Because not all countries were involved in the ‘cyber-menace’ (as it was understood at that point of time from a regulatory perspective) nor were all technologically sound and willing to support an international consensus on the issue. So the idea of an international agreement/treaty or organization was done off. The world was amateur enough not to able to support one. So independent nations took the lead and started pressing the players in the cyber arena to come out with proposals such that the online traffic could be regulated.

This is how the various regulatory agencies were born, like ICANN for web domains, etc. But then these were private entities, made quasi-governmental by the manner and nature of functions they performed. This particular entity, ICANN was so engrossed in the regulation of web domains that it even came out with a dispute settlement mechanism and thus pioneered the idea of online-dispute-resolution, which was quickly adopted by e-bay and other online platforms providing for interaction of web-participants on a commercial scale. So the regulatory agencies of cyber space can be enumerated as; government; international agencies involved in regular interactions with the cyber-space; web-hosts, and you yourself (as you have agreed to regulate your conduct in the manner as prescribed by the host though whom you operate).

But then again, the question remains, what is the link amidst these various participants which allows the cyber space to work as a regulated regime. The answer to this intriguing question is equally intriguing. It seems the cyber-space is working out to balance itself. The participants conduct themselves in order and when there is a zealous actor crossing the limits, there is always a higher and stronger participant to kick the transgressor from the offending limits, may be by legal sanctions or simply by suspending the access. So we have regulators who are also regulated and then this probably seems never to end, just like a vicious circle with just the government may be at the top of affairs.

The above erratic description may not be sensed out to be regulation in true sense but then regulation it is; just that this is a different ball-game. This is obviously because the arena is complex and it is not in the interests of anyone to have it heavy guarded and face the risk that the entire structure may crumble under the weight of itself.

7 May 2008

Concept of negative voting

The general elections are almost round the corner, and this is the apt time to discuss the topic of negative voting. Negative voting is an option of exercising one’s franchise to none of the contesting candidate. This exercising of negative voting, could be construed as an expression of discontent with the candidates or as against the political parties at large.

The need for such a provision could be argued based on the socio-political ground that people are discontented with the performance of the political parties and the leaders, and hence negative voting as a tool of expressing this dissent. Many recent elections have seen drastic fall in the polling ratio, which is being attributed to the loss of faith in the political parties. Lot of people has just stopped exercising their right to vote. When less than 50% of the voters select a government, what legitimacy of ‘people’s will’ does that win carry? Will negative voting help as an alternative to this problem, is the moot question? As such what does negative voting help? It helps to bring those who do not want to select any of the candidates to the electoral booths, and express their dissent. But even then, above mentioned condition of a candidate getting elected by very low margin of votes, as compared to the total number of votes being polled may continue, but the polling percentage has high chances of going up and thus could reflect the actual will of people. Though this would actually reflect good governance, this in no way is going to invalidate candidature of any of the contestants, but just that this helps to bring out the best of democracy. It is at last the choice of the people, and to prove the fallacy of depicting common man as a fool, who has no other option other than choosing between two people on the basis of who is less bad than the other.

Now, the legality of this issue, as the position stands now is that a voter has the option to refuse to vote after he has been identified and necessary entries made in the Register of Electors and the marked copy of the electoral roll (this is in the case of Electronic Voting Machines). In the case of conventional ballot paper and ballot boxes, which was in use before, a voter could drop the ballot paper without marking his vote against any of the candidate. This is as per the Rule 49-O of the Conduct of Elections Rules, 1961, which reads a follows:

49-O. Elector deciding not to vote.-If an elector, after his electoral roll number has been duly entered in the register of voters in Form-17A and has put his signature or thumb impression thereon as required under sub-rule (1) of rule 49L, decided not to record his vote, a remark to this effect shall be made against the said entry in Form 17A by the presiding officer and the signature or thumb impression of the elector shall be obtained against such remark.

But this throws up the issue of compromising with the secrecy. Secret ballot is one of the characteristic of a democratic poll. Here the polling officials and the polling agents in the polling station have the knowledge of the choice of the voter.

So for an effective negative voting, it is important that it should have secrecy. Election Commission of India (ECI), in its electoral reforms, has recommended as follows:

The Commission recommends that the law should be amended to specifically provide for negative / neutral voting. For this purpose, Rules 22 and 49B of the Conduct of Election Rules, 1961 may be suitably amended adding a proviso that in the ballot paper and the particulars on the ballot unit, in the column relating to names of candidates, after the entry relating to the last candidate, there shall be a column “None of the above”, to enable a voter to reject all the candidates, if he chooses so. Such a proposal was earlier made by the Commission in 2001 (vide letter dated 10.12.2001).

There is a petition filed by the PUCL in 2005 ,before the Supreme Court seeking a right for the voter to cast a negative vote through the method recommended by ECI. But even though the petition is admitted, I presume the final decision is yet to come, as I cannot locate the judgment or any news item related to it in the preliminary search. As a sign of matured democracy, it is high time that such significant improvements in the electoral regime are incorporated.

Further reading: Electoral reforms proposed by Election Commission of India

28 Mar 2008

Handling Undervalued exchange rates and Sovereign Wealth Funds under WTO: A failed solution already?

It is very recently that we picked up this paper which has been posted on SSRN for sometime now but then that we have and feeling strongly on the issue, we thought it was wise to have an exclusive post on the topic. Today we are discussing in the backdrop of a Working Paper published under aegis of Peterson Institute for International Economics and developed by two economists, entitled 'Currency Undervaluation and Sovereign Wealth Funds: A new role for the World Trade Organization', available at SSRN. Though the paper is economics based, yet has enormous significance in legal arena for it deals proposes for a legal regime for two key issues facing the policy makers across the globe currently; 'Undervalued Exchange Rates' and 'Sovereign Wealth Funds'. The way we proposed to deal with the issues is first to give a basic insight into what the paper talks about and then come up with our understanding of the issues and how they are better not regulated the way the paper proposes.
What the paper proposes?
The paper is based upon two premises; (i) that currencies are artificially undervalued by countries to lag it creates to a fair international trading regime , and (ii) the accumulation of wealth as an outcome of these undervalued exchange rates and also otherwise by such countries and their consequent establishment of Sovereign Wealth Funds. Regarding the first part, the paper cites the examples of most notably China and few more countries (like UAE, Kuwait, Saudi Arabia, Vietnam, Bahrain, all oil-exporting countries) and bases its proposal to deal with the situation under the WTO for the reason that the proper valuation of these exchange rates would provide a significant boost to international trade. Regarding the second part,

To sum up (as the paper itself suggests), the paper is comprised of three parts (i) why and hows of WTO involvement, in collaboration with IMF, in dealing with undervalued exchange rates, (ii) the whys and hows of WTO involvement in regulating SWFs, and (iii) how the placing of the issues on the trade negotiating agenda could help galvanize the Doha Round.
Our views on the proposals
It was not long back that we wrote over the direction in which the Sovereign Wealth Funds are moving and the tensions that their economic might poses to geo-political relations and also generally about the failure of the WTO to come up from the contentious issue of market access (both agricultural and non-agricultural), agricultural subsidies, services and IPR in these two parts (Part - I and Part - II). In general, we have highlighted in all of these posts over how the proposals to regulate the movement of these new instruments of trade policy (basically having a foundation in developing countries) are stimulated by the enhanced fears which these strengthening of developing countries' economies pose to the self-crumbing developed economies, most notably the United States.

For example, China's accumulation of US Dollars as its foreign exchange reserve is so massive (and continues to add significantly every day) that the mere visualization of China doing away with it would send shivers to not just the United States but the consequent fall in dollar would ensue a global economic dooms day. For so long as
China keeps these funds to itself, it is fine to all. But then the United States and the international economic community as such have to find to ensure that this continues to be so and they do not get up one fine morning to find the USD collapsing in wake of China's removal of dollar from its reserve. Plus, not just the direct exodus of dollar from China, the indirect investment of China in strategic locations is the major concern. And that China is not into philanthropy, its infusion of $5bn into Morgan Stanley (which saves a liquidity crisis at this US giant) is not just seen as an act of charity but instead the gaining of lobbying power (which MS carries with it) within the United States, and thus requiring an countering act on the part of the US to mitigate any buying of political power through such economic instruments. [For more such examples, have a look at our earlier post on Sovereign Wealth Funds] Now to deal with the proposals, let us handle each issue one by one.

Undervalued exchange rates: not a new phenomenon but an ever-green subject for economic analysis and political bickering, no doubt has tremendous implications for international trade but we have out own doubts on its management under an international institution like the WTO. This is for a number of reasons as we enumerate here;

(i) Now that the impossible trinity is already a fact taken for granted and that countries grapple with the dimensions of international capital flows (installing and managing in between their own ways for promoting/inviting capital investments within their own country), a manipulated exchange rate offers a very viable and effective medium for the host countries (especially the developing countries and emerging market economies) to boost and regulate the ways capital investments flow in their country.

(ii) The flexibility and added trade advantage an undervalued exchange rate offers is not hidden from anyone. China's notorious undervaluation of its currency (Renminbi) by fixed pegging it to USD [8.2765 Renminbi Yuan to USD as wikipedia informs] and the huge trade advantage it provided to its exports (by making them cheaper artificially) is a reminder of the fact that countries with export oriented economies can strive nicely in such pegged regimes by constantly undervaluing their exchange rates.

(iii) And then emerging nations have not forgotten the last decade's South East Asian crisis, which led to a downfall of many a south east Asian nations, for which the changing exchange rate was a major trigger. Most developing countries would like to vouchsafe against such avoidable exposure to market failures and herd-run.

Now why all are three objections are directed towards a developing country paradigm is for a reason. The reason is the proposed involvement of WTO to regulate the problem (though a problem only for the developed nations which lose out comparative advantage on account of an undervalued currency of another exporting country) is itself full of controversy, given the already hot-waters WTO is in being alleged with lacking the concerns for developing countries. Instead of rewriting what we have already written [for a fuller account, read out our two posts (Part - I) and (Part - II) pointing to the bones of contention and also this critic of WTO's report on six decades of multilaterlism] but suffice would be to point the fact that after the first concrete realization and demand by developing countries for a fair (and not just free) trading regime in Doha in 2001 (though the matter was first brought to light in Seattle in 1999), the WTO has already missed a number of deadlines and has been postponing the matter (as a matter of fact it has been postponed indefinitely now with no deadlines to come out with solution) with the last six years bringing out not even a harmonious discussion ground lest to talk of a solution.

In fact the formation of the G-110 alliance of the developing countries at the last Ministerial in Hong Kong in 2005 (the fact that no date for the next Ministerial Conference has been announced, which technically should have taken place in 2007, is an issue requiring an exclusive post altogether) is in itself indicative of the fact how closely the developing countries view and keep the issue of a fair trading regime which would not compromise their development objectives but would instead promote it and so long they find the WTO's working not in consonance with their inner goals, it seems that the tussle will continue and deadlocks remain.

In this scenario, the apt choice for the developing countries would be to ensure their internal economic stability by regulating their exchange rates at the national level rather than limit their ability at the expanse of an international institution (which no matter how sound economically, would no doubt bring in the political element, a proposition which even the WTO cannot deny) and thus face the risk of economic defacing just to ensure that world trade goes smoothly.

For these reasons, we are of the view that politically and on cost-benefit analysis, the option of subjecting the exchange rate regimes to be judged by an international institution like the WTO is a non-starter proposal given the lack of political consensus. This however does not even include the paradigm of strict reluctance on the part of the developing countries to subject themselves to a more stringent rule based regime under the WTO (as the undercurrents would bring out), considering which the proposal does not even merit scrutiny.

In this background let us compare the proposals. In a run down to the working paper in question, the authors argue "that (1) exchange rates have serious trade consequences and unlike trade interventions, which are being phased out all over the world, episodes of undervaluation are likely to recur; (2) the Fund, the natural forum for regulating exchange rates, has abdicated its responsibility and is unlikely—for political reasons and its own traditions—to be able to remedy this; (3) the WTO could possibly fill this gap by creating new rules on exchange rates to parallel those on export subsidies and import taxes; and (4) these rules—as many others on trade—could become the subject of disputes in the WTO, with the Fund providing inputs on technical matters as it has in relation to trade restrictions for BOP reasons."

To deal with each of these propositions; (1) even though exchange rate have a serious trade consequence, that does not imply that the same should be brought into WTO for WTO is not THE regime to regulate international trade. The Preamble to the Marrakesh Agreement establishing the WTO is catagorical to the effect that per se trade regulation comes later and it is the sustainable development and promotion of developmental goals of the developing countries that takes precedence. In such a scenario, a national management of exchange rates being a better device towards such goals, it is better that WTO keeps out of it; (2) the fact that the IMF has failed to regulate the issue (even though it is its strict mandate to ensure against artificial manipulation of exchange rates) does not imply that another institution should take over. The core principle on which WTO works is essentially different from the IMF and also the two perform contrastingly different roles in international paradigm. Neither is the WTO platform suited to it task nor is the WTO (being a legal and not economic regime) capable of ensuring that the tasks identified for ensuring fair valuation of exchange rates can be meted out at its venue; (3) the WTO can possibly fill the gaps for many other international institutions as well. The comparatively better performance and more relevance of the WTO compared to the UN in today's world does not imply that the WTO should take over UN as well. So the argument that WTO performs better the IMF is really a fallicious and non-starter; (4) the little handling of Balance of Payment (BOP) that the WTO has undertaken has been contentious and argued as unfair and ineffective. There has really been no improvement and work on the 1979 adopted Understanding on BOP effects on trade and with this experience, it is better that WTO does not go deeper in this potential minefield of disputes.

Sovereign Wealth Funds: The emerging new saga of national investments in international framework, a hot topic for economists, lawyers and most importantly the politicians to argue over. While IMF is already mulling over the possibility of bringing out a Model Code of Conduct or sorts to ensure transparency and non-political investing through these SWFs, nonetheless the issue remains to be contentions for the description in the first part above. [for more read our earlier post on SWFs].

Before we give out our own reasons as to why we think dealing SWFs under a WTO type regime is a non-starter, let us analyze why the paper argues in favour of such an approach. In sum the paper culls out two reasons for WTO to be the home for a multilateral agreement entailing a regulatory regime for SWFs; "Firstly, the WTO already, albeit somewhat opaquely, covers investments by SWFs in its services agreement—the General Agreement on Trade in Services (GATS). A second argument in favor of WTO regulation is its dispute settlement mechanism (as in the context of exchange rates). Consider a situation where a WTO member felt that a foreign SWF was behaving inconsistently with its obligations. Instead of taking unilateral action based on its own judgment—actions that can provoke retaliatory protection and spiral into a trade or investment war—the member would now have recourse to the WTO dispute settlement mechanism. The well-established mechanism would offer institutionalized consultation and, when necessary, impartial assessment of conformity with mutually agreed conditions."

The first argument does not hold scrutiny for the fact that GATS calls forth for a non-protectionist regime, requiring the grant of market access and non-discriminatory treatment, to say the least. Dispute such rules, it is being argued that the market-access offered by the developed countries to the service providers of developing countries is cluttered with indirect and perceived obstacles and thus whatever is provided is not sufficient. In this scenario, imposition of prior-check rules and retaliatory checks on inbound investments only for the fact that they arise from nations (being SWFs) and not independent parties, would not only incite more tension between the North and South but also cast doubts on the objectivity of the entire trading system as such.

The second argument is also non-workable given the legal system that WTO's Dispute Settlement Understanding provides. Even if the proposed rules find a place in WTO, at the most their coverage would be limited to transparency and mode of entry. It couldn't go further than that for doing so would imply searching for the motivations behind the investments made by these SWFs, a subjective task and not capable of judicial determination. In any case, it would be unwise for the developed countries to argue for a move towards bringing in multilateral rules for regulating SWFs for that would imply inability to act on their own volition, delays in retaliatory action (given the standard time frame required to be followed before a judicial determination can take place) and also given the inroads this would make in the ability of the nations to handle such affairs politically.

The paper discusses other perspectives as well (such as SWF investor protection etc.) as arguments for a multilateral trading regime on SWFs but then these are only incidental and if the main purpose is not sufficed, we doubt that countries would choose to exercise their political might for a half-efficient solution. After all the scenarios are better dealt with under an economic framework but then when it turns to geo-economics, it brings in geo-politics as well and the ten years of working of the WTO have proved just the same.

27 Mar 2008

Regulatory Structure under Competition Laws: Case of EC and India


Competition law differs from other branches of law for various reasons. It is not about the fairness or morality to be instilled in the actions which mark societal behaviour. Instead the rules of competition reflect economic principles, designed to render the operation of the markets in a manner beneficial to the common good. These rules are of immense importance as they not only vouchsafe against the monopolistic and exploitative tendencies of the bigger market players, they are also instrumental in providing the smaller and newer entrants in the markets to work towards achieving self-sustaining levels.

Their importance is noted well in by the US Supreme Court when it observed, “the antitrust laws … are the Magna Carta of free enterprise. They are as important to the preservation of economic freedom and our free enterprise system as the Bill of Rights is to the protection of our fundamental freedoms”. [
United States v. Topco Associates Inc., 405 US 596 at 610 (1972)]

To speak of the European Economic Communities (
EEC), the rules relating to competition to be observed in the common markets of the EEC flow from Article 81-86 of the EC Treaty. From these are derived the three central legal provisions upon which this law operates;

  • Article 81, prohibiting anti-competitive agreements,
  • Article 82, prohibiting abuse of dominant positions, and
  • The EC Merger Regulation (ECMR), prohibiting anti-competitive merges, acquisitions and joint ventures.

Each of these rules apply in different circumstances but the underlying purpose beneath them is one and the same: to prevent the problem of welfare loss that can arise when an undertaking or a coordinated group of undertakings exercise certain market power. To effectuate this legal framework, the EC Treaty also vests the powers and functions of regulation upon various bodies functioning under the EC and national member states. The aim of this paper is to examine the regulatory structure in vogue under the EC competition law and to identify the key traits which may as well be applicable for the recently formulated Competition Commission of India, in its quest towards rendering competition workable in the Indian markets.


The competition law framework, as originally envisaged under the EC Treaty concentrated upon the EU Commission as the sole benefactor and regulator of market actions pertaining to competition in the EEC markets. This framework underwent substantial reform (w.e.f. May 1, 2004) whereby the EC’s modernized competition regime took effect. Thereunder, devolving responsibility for enforcing competition law from the European Commission to national competition authorities (NCAs) and courts in the EU member states, an entirely new framework was given effect to. Known as the European Competition Network (ECN), the system was designed to effectuate a shift in policy. There was a move away from a system of advance clearance or exempting of agreements to a retrospective exception system.

Since the aim is to comparatively examine the EC Competition law structure, it is this new framework which forms the subject-matter of study of this project. With this background, let us proceed towards the attainment of our objectives.

(a) The legal regime for competition in the EC

As with other Community policy areas, EC Competition law is established and developed via a variety of legal sources. At the top of the legal hierarchy is the EC Treaty. By itself the Treaty does not provide sufficient detail to permit the existence of a fully and completely functioning legal order, and a considerable quantity of secondary legislation has been made. Article 249 of the Treaty lists the types of secondary legislation that may be adopted by the EC, which are, regulations, decisions, and directives. Thus EC competition law may be enforced by way of decisions made by the EC Commission and Article 249 provides that a ‘decision shall be binding in its entirely upon those to whom it is addressed’.

The legislations may further be interpreted by the European Court of Justice (ECJ) or the national courts. Thus these decisions serve as the third source of EC competition law. Further, the notices and guidance issued by the EC Commission are also binding instruments of state policy and thus serve as another important source of the competition law.

As noted above, Article 81 and 82 comprise the bulk of the substantive competition rules of the EC. However what is important as regards their implementation is the objective set forth in Article 2 of the EC Treaty, which includes ‘a high degree of competitiveness and converging economic performances.’ Further, Article 3(g) provides that the activities to be undertaken for the purpose of achieving the objectives of Article 2 include, the development of ‘a system ensuring that competition in the internal market is not distorted. In these one may find the broad objectives upon which the functioning of the EC competition law regime is based.

(b) The EC Regulatory Authorities

While Articles 81 and 82 form the bulk of the substantive rules, Articles 83 and 85 provide the mechanism for the implementation of these substantive rules. Article 83 makes a provision for the enactment of ‘any appropriate regulation or directives to give effect to the principles set out in Articles’ 81 and 82. Thereunder various regulations have been made, the major ones being Regulation 1 of 2003, block exemption regulations, etc.

In this framework, Article 85 confers upon the EC Commission the primary role in the enforcement of the EC Competition law by requiring it that it ‘shall ensure the application of the principles laid down in Article 81 and 82’. In this regard, the Commission is required to investigate infringements of law and in cases of breach, it is duty bound to ‘propose appropriate measures to bring it to an end’. Thus our study proceeds with the examination of the EC Commission.

(i) EC Commission

Given the importance of the institution and its pivotal role in rendering the EC competition law effective, the Commission has been described as the ‘guardian of the Treaty’, or the ‘watchdog of the Community’. Established under the Treaty itself, the rules relating to the Commission are set out in Articles 211-19 of the Treaty with Article 211 providing that the Commission should ensure compliance with the EC law, and exercise specific powers given to it by the Council of Ministers.

The Commission consists of 27 Commissioners, nominated by the Member States. Administratively the Commission is divided into Directorates General, with one Directorate General having responsibility for competition policy, which includes the contentious areas of state aids, and merger policy as well as ‘antitrust’.

The role of the Commission, as at present, is to supervise the operation of competition policy and to play the lead role in the formulation of that policy as change is needed. The Commission has the power to investigate infringements of the law, and to take appropriate action, on its own initiative, or in response to complaints. However, each Member state is also required to apply the law in specific areas with the use of the appropriate national procedures applied by the relevant national competition authority. The Commission is also required to submit an annual report to the European Parliament detailing its activities in competition law over the last year.

The change in the role of the Commission came with the EU Council of Ministers adopting Regulation 1/2003 in November 2002 (which came into force from May, 2004), replacing Regulation 17/62 which set out the hitherto existing procedural rules for enforcement of Articles 81 and 82. This Regulation introduced fundamental changes to the process by which EC competition law was enforced and also the roles of the various authorities.

Under the new regime, the Commission is not required to be notified in advance about their proposed actions whereas earlier the companies were required to notify agreements to the Commission in advance for clearance confirming that the arrangements do not infringe Article 81(1) or an exemption confirming that the arrangements infringe but are exempted under Article 81(3). Under the new regime, companies will now have to form their own view on whether the agreement is compliant and would survive an attack by a regulator or other third party during the life of the arrangements or even after they are concluded. Thus the market players have been vested with the power to declare that the conditions of Article 81(3) are satisfied so as to protect arrangements from attack; an instance of self-regulation.

Nonetheless, in order to assist the players in arriving at decisions regarding compatibility of their actions with the competition law, the Regulation does not formally prevent parties applying to court for a declaration as to the status of an agreement. Further, in respect of novel or unresolved questions on the application of Articles 81 and 82, the Commission retains the power to provide informal guidance.

It may also be noted that now the power of regulation is decentralized with the National Competition Authorities (NCAs) and the national courts of the Member states also allowed enforcing Articles 81 and 82. This may, depending on the geographical spread of the arrangements, give aggrieved parties a range of potential venues. Nonetheless the parental role of the Commission is retained with the Regulation requiring each NCA to send the Commission drafts of its intended decisions at least 30 days before the NCA intends to adopt the decision. This would allow the Commission to detect any inconsistency in the application of Articles 81 and 82 and, if necessary, take over the investigation.

It is now widely believed that under the aim of modernization the purpose is instead to allow the Commission to focus its attention on the enforcement of competition law; moving from being a regulator to a policeman, a belief which has been reinforced with present Competition Commissioner Mrs. Neelie Kroes’ handling of the Microsoft case. Under the new regime, the Commission deals only with complaints that have a sufficient ‘Community interest’. This is brought out by the draft Commission notice on the handling of complaints which may be only in cases wherein;

  • One or more agreements or practices have effects on competition where there are cross-border markets covering more than three member states or several national markets; or
  • Where a Community decision is required to develop Community competition policy or provide effective enforcement.

This emphasizes the Commission’s new role as dealing only with matters that are strategic or of EU-wide significance.

(ii) The Advisory Committee

Article 14 of Regulation 1/2003 makes provision for an Advisory Committee on Restrictive Practices and Dominant Positions, which must be consulted before the Commission takes various decisions, in particular those which have an adverse affect on those to whom they are addressed. It is the forum where experts from the various competition authorities discuss individual cases and general issues of Community competition law. It is consulted at the request of the Commission or a Member State and is composed of ‘representatives of the competition authorities of the Member States’. [Article 14(2) of Regulation 1/2003] Thus this Committee serves as an important link between the Commission and the Member States. The Commission is required to take an utmost account of the opinion delivered by the Committee. [Article 14(4) of Regulation 1/2003]

(iii) National Competition Authorities & European Competition Network

With the modernization in 2004, an important role was assigned to the National Competitions Authorities (NCAs) in the effectuation of the EC competition law regime. While earlier they had been responsible for giving effect to the national competition laws and the orders of the Commission in so far as they pertained to their states, now they also vested with the powers to apply Article 81 and 82 of the EC Treaty, a power which was hitherto vested solely with the EC Commission.

Towards this end, Article 5 of Regulation 1/2003 sets out the basic role of the national competition authorities. It states,

“The competition authorities of the Member States shall have the power to apply Articles 81 and 82 of the Treaty in individual cases. For this purpose, acting on their own initiative or on the complaint, they may take the following decisions:

- requiring that an infringement be brought to an end,

- ordering interim measures,

- accepting commitments,

- imposing fines, periodic penalty payments or any other penalty provided for in their national law.

They may also decide that there is no ground for action. However their importance in the EC competition law framework is derived from Article 11(1) of Regulation 1/2003 which provides that ‘the Commission and the competition authorities of the Member States shall apply the Community competition rules in close cooperation’. Thus from being independent observers and actors, the NCAs have been formally instituted as the lower tier of the EC competition regime, supplementing the functions of the Commission.

The purpose of this new system is the expected faster resolution of competition cases than it has been in the past where the Commission was the sole arbiter in such matters. In its zeal to maintain constant communication between the two tiers of regulators, Article 11 of the Regulation 1 of 2003 imposes upon the Commission the requirement to send the NCAs copies of important documents in its possession, and the NCAs in turn are required to tell the Commission whenever they commence formal investigative measures. Similarly, the NCAs intending to take infringement actions or accepting commitments etc., are required to inform the Commission and provide a summary of the case and a copy of the proposed decision. Thus it is seen that significant powers have been conferred upon the NCAs but nonetheless they are required to act in close coordination with the EC Commission. [To this effect, the Commission has also produced a Notice on cooperation with the Network of Competition Authorities (2004) OJ C101/43]

In order to maintain close coordination amongst the various authorities responsible for implementation of the EC competition law and to avoid inconsistencies in their actions, the Regulation 1 of 2003 also created a framework, known as the European Competition Network (ECN). This ECN consists of the European Commission and the competition authorities of the 25 Member States. It was established during the modernization reform of the EC antitrust rules as a forum for discussion and cooperation of Member States competition authorities in cases where Articles 81 and 82 of the EC Treaty are applied. The ECN ensures an efficient division of work and an effective and consistent application of EC competition rules.

This creates an effective mechanism to counter companies which engage in cross-border practices restricting competition. As European competition rules are applied by all members of the ECN, the ECN provides means to ensure their effective and consistent application. Through the ECN, the competition authorities inform each other of proposed decisions and take on board comments from the other competition authorities. In this way, the ECN allows the competition authorities to pool their experience and identify best practices.


The above examination of the regulatory model for the implementation of competition law in the EC may serve some purpose in the re-evaluation of the competition model proposed for India. Let us analyze the same.

(a) Regulatory Structure under the Competition Act, 2002

Enacted on the lines of the recommendations of the Raghavan Committee, the Competition Act of 2002 marks a significant shift in the economic policy of India. It can broadly be stated as the second tier of reforms after the broad and swift changes in 1991 in the industrial policy of India. Repealing to a large extent the Monopolies and Restrictive Trade Practices Act of 1969, the Competition Act of India is in line with the international state of affairs as regards their attempts to regulate markets giving full effect to competitive positions.

Chapter III of the Act provides for a ‘Competition Commission of India’, which is the sole authority under the Act to give vigor to the substantive provisions and also to ensure its implementation. Of this, Sections 7 to 17 deal with the establishment, composition, conditions of membership etc. However what is relevant for our purposes is Chapter IV which entails the ‘duties, powers and functions of the Commission’.

Section 19 of the Act required the conducting of ‘inquiry into certain agreements and dominant position of enterprise’. This may be proceeded to upon the basis of a complaint alleging contravention of the provisions of the Act or by the Commission on its own motion. Similarly Section 20 requires ‘inquiry into combination by the Commission’. Section 22 provides for the Benches of the Commission and Section 23 provides for the ‘distribution of business of Commission amongst Benches’. Thereupon there are other provisions providing the procedure for investigation and its necessary fallouts.

This provisioning for the exercisal of the quasi-judicial functions of the Commission may as well be comparable with the various Tribunal operating in India. However the fact that that the Commission is entrusted with both investigative and adjudicatory powers is concomitant with its existence as a market regulatory, on the lines of SEBI. Similar positioning is also found of the various commissions under the competition laws of other nations.

It is noteworthy that the arrival of the Competition Act of 2002 of India coincides with the British reform of its competition law, also enacting the Competition Act of 2002, wherein the powers and functions of the Competition Commissions under the two enactments is largely the same.

(b) Lessons from the EC model for India

The EC Competition law model is a unique one as it envisages two tiers of regulatory structure (pursuant to the 2004 reform) and the situation is almost unparallel across the world. Even the United States, with 50 states to manage, operates with the Federal Trade Commission as the sole arbiter to manage the federal anti-trust statues. The coordination between the federal and state authorities is not that pronounced as in case of EC.

Given the existing situation, the Competition Commission of India (CCI) is at best comparable as a NCA of the EC framework, being required to administer the Competition Act of 2002 alone. However in my opinion it would be worthwhile to develop the CCI on the lines of the EC Commission as the first tier of regulator. This presupposes institution of the second tier of regulator, which may in case of India, may be best instituted as the various competition commissions of the states. This may not necessarily mean that there would be requiring a competition commission for each state but the jurisdiction could be divided on the basis of geographic lines and dominance of economic activities. However that is for the administration to decide.

What I propose is that in its quest for competition to spurt from the grass root levels and thereupon to gush up to the top, the aspect of regulation should be decentralized to these local commissions with the CCI to monitor their functioning and involved in the designing of the policy framework, being equipped with all the relevant information and filled with the experience of these commissions.

Thus I propose a second tier of competition commissions, initially divided on geographic lines (like one for north, south, east, and west regions each) and later on one for each state, which are primarily entrusted with the responsibility and functions of investigation, monitoring compliance etc., on the lines of the NCAs in the case of EC. They would act in close coordination with each other and with the CCI at the top to assist them and regulating their activities.

This would serve three fold purposes. Firstly, the CCI would be rendered divested from the investigative functioning and thus it can devote its resources towards designing of policy framework for competition in India and spearheading the litigation at the level of higher courts of India. Secondly, with the second tier of commissions being responsible with the investigative aspects and there being close coordination and sharing of information between these commissions, with a proper reporting system available with the CCI, the CCI would be able to monitor the competition scenario on a national and holistic level in India. This would also equip it with the necessary data for the formulation of guidelines and issuance of directions, a niche area with the capital market regulator SEBI has perfected well. Thirdly, with the localization of the regulatory functioning through the second tier of commissions, the markets in the India would be more closely monitored and the vastness of geographic markets would not be an issue which could arise in proper administration of the competition policy of India.

To this effect, I am aware that this may be termed as premature for India given the fact even the CCI has not yet come into full vigour even five years of the enactment. Nonetheless, keeping in line with the reform aspect of the Indian economy, I believe the germination of competition model requires such close regulatory supervision.


The position of EEC is unique in world economy history and continues to fascinate the researchers as to its efficient working despite divergent considerations posed by the member states. With the shift in policy approach and the redesigning of framework in 2004 owing to the joining of 10 more members, the EC competition law model has send signals to the world as regards the improvements that may be made in the existing state-of-affairs in regulation of competition.

In tandem with India's transition from a highly controlled to liberalized economy, the Competition Act 2002 has replaced the earlier focus on concentration of economic power with a focus on effects on competition, thereby bringing Indian competition law substantially in line with international practice. However the country is yet to witness an efficient competition regulator.

It is imminent that by the time a proper competition framework becomes operationalized in India, there may be yet other changes in the EC competition law regime. However we may fail in our commitments towards making the Indian economy self regulatory and providing means to all irrespective of the size if we are unable to incorporate the lessons learned from abroad in our system. The redesigning of the regulatory functions and the established of ECN in the EC regime marks the beginning of dual system of regulators in competition law frameworks. India would be tremendously benefited by incorporating such changes in it own system, definitely only when the correct time come for bringing such changes.

23 Mar 2008

Indo-Mauritius Double Tax Convention: The story untold

Today I am writing on an issue over which a lot has been written, litigation culminated with a rhetoric decision of Supreme Court and lot of political hue and cry been witnessed by the Parliament and yet the matter is as it was earlier, yet unresolved and ailing for a cure. Yes, I am speaking of the contentious Double Tax Convention between India and Mauritius, which allegedly has led a lot of black money flowing in the Indian capital markets and has also allowed the flight of profits earned in India without the payment of tax thereon. However what I intend is to instill a new dimension to the debate, taking cue from the US model DTC's 'Limitation of Benefits' clause and aim to improve the situation in manner acceptable both politically and legally. So let us first begin with what the problem is, its magnitude, its causes, before discussing its cure.

Indo-Mauritius DTC: Tracing the timeline

India and Mauritius signed a Double Tax Avoidance Agreement on 24-08-1982. Formally titled the 'Convention between the Government of the Republic of India and the Government of Mauritius for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes of Income and Capital Gains', the Convention came into force on 06-12-1983 [vide Notification F. No. 501/20/73-FTD]. Under this Convention, taxing rights were allocated between the two countries and also various reliefs for the tax payers hit by the tax systems of both the countries were provided (in the form of 'double tax reliefs'). Thus crux of the issue was however the low tax rates and the absence of capital gains tax in Mauritius, as we shall see later.

The situation was normal for almost a decade and investment began to flow under the DTC until 2000 when the background for a raging debate was being built. In the year 2000, in the wake of heightened reports about evasion of tax and treaty shopping, few Income Tax Assessing Officers required the entities operating on India-Mauritius route to prove that their Residence was established in Mauritius in accordance with the principles for determination of Residence, as provided for under Section 6 of the Income Tax Act, 1961 and as developed and clarified by the courts. This was alleged by the affected entities as an indirect violation of the DTC as there was no such requirement in the DTC. To clarify (and seeming to settle the matter) the Central Board of Direct Taxes (CBDT) issued a Circular [No. 789 of 2000] clarifying that a certificate of residence issued by Mauritius would constitute sufficient evidence for accepting the status of residence as well as ownership for applying the provisions of the DTC. This implied that the Certificate would override the Income Tax Act, 1961 and therefore was challenged in a public interest litigation.

In the same Circular the CBDT had also clarified that the test of Residence would also apply to income from capital gains on sale of shares. Thus, FIIs Resident in Mauritius would not be taxable in India on income from capital gains arising in this country on sale of shares. This exemption from capital gains tax was also challenged as arbitrary, discriminatory and against the spirit of the Act.

Satisfied that it was beyond the powers of the CBDT and contrary to the Act, the Delhi High Court declared the Circular invalid and quashed it as inapplicable. [Shiv Kant Jha v. Union of India, (2002) 256 ITR 563]. However in another public interest litigation [Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706], which reached the Supreme Court, a three judge bench headed by Justice Ruma Pal took quiet a contrary view. Stating that in terms of Section 90 and 90A of the Income Tax Act, the Government of India was entitled to make provisions necessary to adopt/implement the DTC with a foreign country and since the CBDT Circular was only clarifying the provisions of the Indo-Mauritius DTC, they were within the legal ambit and thus valid.

The Supreme Court categorically held that the mere fact that the government was losing revenue payable to it on account of tax leviable but not charged because of the DTC, was not a valid reason for holding the provision ultravires for it was within the mandate of the Parliament as reflected from Section 90 which allowed the Government to enter into DTCs for promoting India’s trade etc. Thus the Supreme Court decided to play a deaf year to the administrative and fiscal concerns for the stance adopted by the Government was legally justified.

This authoritative and unambiguous decision of the Supreme Court did put an end to the litigation but did not reduce the criticism of the existing scenario in any manner. It was pointed out (and continues to be so) that huge amounts of revenue [Rs. 4000 crores according to last estimate] flow out of India without being subject to tax and that this has a number of demerits for India; (i) this promotes treaty shopping and consequently a lot of evasive structures come into being to operate in India, (ii) Indian government loses out on the revenue it is legitimately entitled to tax and collect, (iii) the burden of loss of revenue is to be shared and met by all those already paying the tax and complying with the system, (iv) the infrastructure provided for and used in India by these companies is not compensated for because of the foregone tax to be collected on these, and so on and so forth. For this reasons, there was hue-and-cry from almost everyone aware of the system to call for a revision of the DTC.

Consequently, after serious consideration to the matter, the Mauritius Government was requested by India to review the DTC in early 2007. However recently it has come out in news that the Mauritius government has refused to reconsider the treaty and therefore the situation would continue to be so for some more time.This is true despite the alleged offer on the part of the Government of India (though I do not know how such a thing in possible in India given the constitutional setup and control of the legislature over the executive) to compensate the Mauritius Government in terms of revenue on account of the proposed revision of the Treaty. Let us now see why this all has happened and then how to deal with it.

Why Mauritius route at all?

Investment coming into India from Mauritius is peculiar for a special reason which in international tax terms is known as the ‘Residence/Source’ principle. We have dealt with these in quiet some detail in one of our earlier posts but then we may need to look back at them for some understanding of this problem.

Under a ‘Residence’ approach, a country taxes all the income of the persons Resident in the country. For this purpose, ‘Residence’ is defined under the Income Tax laws of the country and is generally associated with the number of days stayed in the country in a particular year or in a number of preceding years or a combination of both. For example, for Indian context, ‘Residence’ is defined under Section 6 of the Income Tax Act, 1961 which states; An individual is said to be resident in India in any previous year, if he (i) is in India in that year for a period or periods amounting in all to one hundred and eighty-two days or more; or (ii) having within the four years preceding that year been in India for a period or periods amounting in all to three hundred and sixty-five days or more, is in India for a period or periods amounting in all to sixty days or more in that year.

Under the ‘Source’ rule context (which applies when the person in question is not a Resident of the country seeking to apply tax), the country taxes only that portion of income of the person which arises or relates in part to the country in question. For example for a person Resident in South Africa giving management advice to an Indian company and getting paid management fees for such advice would only be liable to pay tax on that potion of Management fees received in India and not on anything more.

This Residence/Source principle has been the major driver for the problem in India-Mauritius DTC. In Mauritius, there is no charge of capital gains while in India capital gains are chargeable to income tax at two rates; 10% and 30+% on short term and long term capital gains respectively. This has the following outcome;

  • For a person resident in India, capital gains are chargeable to tax at the given rates [because of the ‘Residence principle’].
  • For a person not resident in India, capital gains are again chargeable to tax at the given rates [because of the ‘Source principle’].
  • For a person who is resident in Mauritius, no capital gains tax is chargeable because of the Indo-Mauritius DTC.

Therefore one can see that there is a lot of advantage for the tax payer if the Residence is located in Mauritius. This also means there is an added reason to opt for bringing your investments into India (if you are not an Indian tax Resident) and this is why Mauritius route becomes interesting. But then having looked through the implications, let us also see how this is done. Is it that easy to gain the residence status of Mauritius or is it just hype that has been created.

Under the Mauritius laws, for a company to derive the benefit under the Indo-Mauritius DTC, the Mauritius Offshore Business Activities Act 1992 (MOBAA) comes into play. Under this Act, in order to gain the benefits of the DTC, certain requirements must be met by the company whereupon it is granted a ‘Certificate of Residence’ in Mauritius. These conditions are;

  • There must be two local (i.e. of Mauritius) directors in the company, who have been approved by the MOBAA authority,
  • The company’s bank accounts must be in Mauritius, and
  • The company is required to comply with the Mauritius corporate law formalities. Once these conditions are met and the Certificate granted, the company is deemed to be a Resident of Mauritius for the purposes of both Mauritius tax law and as well as under the Indian Income Tax Act, 1961.

Onces these conditions are satisfied, the company is granted as 'Certificate of Residence' for Mauritius, and as we saw above, this Certificate is sufficient under the Indian laws to let the income of the person tax free in India. This problem (for India) is particularly enhanced by the fact that Mauritius promotes itself as a off-shore activity business centre. This implies that the country offers significant advantages for companies based in Mauritius but engaged in activities outside Mauritius. [For a quick look, have a look here and here] Thus the Mauritius government itself advocates for companies from abroad to set their subsidiaries to get incorporated (or otherwise become Resident) in Mauritius and thereupon invest outside Mauritius (typically India because of the tax benefits which come into being) and thus the problem which we have been discussing for long, comes into being.

I have thought of a 'Limitation of Benefit' clause type solution for this problem. However given the lengthy post that this has already become, I will discuss it soon in a subsequent post.

Further readings;

1. Fenwick & West LLP's advice on investment in India through Mauritius
2. A nice background to the Azadi Baachao Case.
3. Hindu article on LOBs in Indo-Mauritius DTC
4. Recent update on Indo-Mauritius DTC.
5. List of India's Double Tax Avoidance Treaties