A K Agnihotri: Round tripping

Round-tripping, also known as round-trip transactions or “Lazy Susans”, is defined by The Wall Street Journal, as a form of barter that involves a company selling "an unused asset to another company while at the same time agreeing to buy back the same or similar assets at about the same price.”

Recent objections reportedly have been raised by the revenue department to several proposals, particularly those involving inflow of FDI from countries such as Mauritius, UAE. The reasons cited for such objections is the need to prevent practices such as ‘treaty shopping’ and ‘round tripping’. Treaty shopping, whereby investors take advantage of a fiscal treaty between India and another contracting state, has greatly contributed in encouraging evasion of taxes.

There is a tussle between the Reserve Bank of India (RBI) and the Revenue Department in regard to the round tripping and off late RBI is leaning towards legitimizing certain types of Round Tripping. The RBI’s view on the subject is that money reinvested in India through a foreign subsidiary of an Indian company should be considered foreign direct investment and that in many parts of the world such as China these aspects have already been legitimized. It feels that doing so would boost the FDI count of the country and render it a more attractive destination for foreign investment.

However, the Revenue Department looking from a microeconomic point of view feels that round tripping should not be allowed as Indian companies may use it to evade tax by routing their money through the tax havens.

Although in such cases FDI might increase but the country would not benefit in terms of revenue. The RBI, disagreeing with the revenue department's assessment, cites the Chinese example arguing that where subsidiaries of foreign companies are levied a lower corporate tax, the incidence of round tripping is extremely high i.e. more than 25-30 per cent. However, in India where the corporate tax rates are the same for all companies the incidence of Round Tripping is only 2-3 per cent.

It is pertinent to note that the RBI stand is with regard to legitimising Round Tripping within the sphere of the International Monetary Fund’s (IMF) definition of FDI only and does not intend to accommodate Round Tripping as a means of escaping tax or laundering ill-legitimate gains. In pursuance of this, the RBI has set forth directives with regards to Participatory Notes and tighter Know Your Customer (KYC) norms.

The IMF definition of FDI includes as many as twelve different elements, namely:

• Equity capital

• Reinvested earnings of foreign companies

• Inter-company debt transactions

• Short-term and long-term loans

• Financial leasing

• Trade credits

• Grants

• Bonds

• Non-cash acquisition of equity

• Investment made by foreign venture capital investors

• Earnings data of indirectly held FDI enterprises and control premium

• Non-competition fee

However, with the singular exception of equity capital reported on the basis of issue or transfer of equity/ preference shares to foreign direct investors, India’s current definition of FDI does not include any of the other above elements, whereas the Chinese definition includes them all. In addition to this China also classifies imported equipment as FDI while India captures these as imports in the trade data.

A study undertaken by the International Finance Corporation shows if comparable definitions of FDI are used by India and China, then 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 substantial amount of Round-Tripping where large amounts of Chinese black money is recycled through Hong Kong and sent back to the mainland as FDI. Round-tripping in fact accounts for one-half of China’s FDI inflows, which has practically reduced the reported levels from USD 40 billion to USD 20 billion. In contrast, India’s figures do not conform to the standards of the IMF (as per the definition mentioned above) because it excludes reinvested earnings, subordinated debt and overseas commercial borrowings which are included in FDI numbers of other countries.

According to the “Round-Tripping” hypothesis, Chinese firms illegally transfer funds to neighbouring countries (like Taipei, Hong Kong and Macau) which in turn gets reinvested in mainland China as FDI. However, since round-tripping is essentially clandestine, accurate data is practically impossible to obtain but estimates suggest that round-tripped FDI accounts for one-fourth of China's total FDI count whereas on the hand it is an established fact that India is relatively low on Round Tripping as compared to China.

The Mauritius Story

Pursuant to the Double Taxation Avoidance Treaty (DTAT) signed between India and Mauritius in1983, any capital gain made on the sale of shares of Indian companies by investors resident in Mauritius would be taxed only in Mauritius and not in India. For the first ten years the treaty existed only on paper as FIIs were not allowed to invest in Indian stock markets. However all that changed in 1992 when FIIs were allowed into India and with the passing of the Offshore Business Activities Act, 1992 by Mauritius, foreign companies were allowed to register in the island nation for investing abroad.

There are two aspects which render Mauritius into a tax haven:

1. Firstly, a body corporate registered under the laws of Mauritius is a resident of Mauritius and thus will be subject to taxation as a resident.

2. Secondly, the Income Tax Act of Mauritius provides that offshore companies are liable to pay zero percent tax. Therefore by bringing an offshore company within the definition of “resident”, both the benefits of being an offshore company as well as that of residency allowed under DTAA are bestowed upon it. In effect, the whole exercise of avoidance of double taxation turned out to be avoidance of taxation altogether.

The advantages of registering a company in Mauritius are:

• Total exemption from capital gains tax, • quick incorporation,

• Total business secrecy, and

• A completely convertible currency.

Therefore the financial entities setting up companies in Mauritius do so without almost any establishment costs.

The economic importance of Mauritius to India can be clearly understood by the Hon’ble Supreme Court’s decision in Union of India v. Azadi Bachao Andolan, where the entire Mauritius treaty was questioned. The Supreme Court’s decision clearly reflected the underlying policy of the Government to attract FDI into the country at any cost despite the known fact that the treaty is depriving the Indian Exchequer of millions of dollars due to Round Tripping and tax evasion. The policy in itself has become a catch-22 situation for the Government as any stringent norms with regard to Mauritius might result in future FII investment being targeted away from India and  benefitting the South East Asian countries or FIIs looking at alternate options.

The situation of decreased FDI inflows because of tighter norms has severe pitfalls for a growing economy and therefore to satiate the need for increasing foreign inflows, the ills of Round Tripping have to be ignored. In 2007, Mauritius started getting tough on Round Tripping. The Financial Services Commission (FSC) of Mauritius, the regulator supervising the non-banking financial services sector & global businesses, has carried out reforms in the Financial Services Act and improved the framework of the tax resident certificate. In pursuance of this it has been decided that all resident corporations proposing to conduct business outside Mauritius would have to compulsorily apply to the FSC for a global business license. Even though there are no restrictions on any business activity, the FSA now specifically mentions that a license will not be granted, or would be revoked, if found that the activity “is unlawful and causes serious prejudice to the good repute of Mauritius as a financial services centre.”

The salient features of the reforms are:

• Global Business Companies (GBC) would now have to compulsorily hold board meetings in Mauritius,

• Appoint at least two resident directors in Mauritius, (big deterrent as it would now make these directors liable for any unscrupulous activities)

• Maintain their principal bank accounts in Mauritius, and carry out their auditing in Mauritius.

All GBCs have to get a certificate from the auditors stating that all requisite conditions have been complied with. Moreover in the same month it was announced that the DTAA with Mauritius would be brought under the same umbrella as that with Singapore, which contains exclusive clauses to check Round Tripping of Investments.

OCB Investment Ban

In 2003 the RBI imposed a blanket ban on Overseas Corporate Bodies (OCBs) investment in the stock markets. The move was primarily intended to restrict Round Tripping of money by Indian residents through their NRI counterparts overseas.

Conversely, this move also resulted in a substantial amount of genuine FDI being curtailed as the RBI circular in this regard seemed to take away the special status given to genuine NRI businessmen who were looking at doing business in India.

It is to be noted that one of the main avenues for FDI in China is courtesy of Non-Resident Chinese individuals present in regions like Hong Kong, Macau and Taipei.

In contrast, foreign companies can invest in the country even if they have their base in tax havens such as the Cayman Islands. So basically the Automatic route for FDI is open to foreign owned companies whereas there is a blanket prohibition in case of OCBs with NRI ownership.

The PN predicament

Lately Participatory Notes (PNs) have come under the scanner for their alleged role in Round Tripping. The RBI as well as SEBI has shown their concern about the inflow of money coming into the country through PNs. PNs are instruments issued by registered FII brokerages in India to foreign funds or investors who are not registered with SEBI, but are interested in trading in Indian securities. FII brokers buy and sell securities on behalf of their clients on their proprietary account and issue such notes in favour of such foreign investors. PNs are mostly used by entities that are not welcome by SEBI as well as by non-resident Indians who do not want to directly invest in Indian securities. SEBI's worry is that the ultimate owner or beneficiary of PNs is not known as these PNs are transferable. On a similar track, RBI feels that the non-transparent nature of these instruments make them ideal money laundering vehicles. The unstated fear of the regulators is that money belonging to Indian residents is being “round-tripped” through the PN route.

However as of 2007, SEBI while banning PNs in the off-shore Derivative Segment cited the reason as a security measure and as a means of curtailing Round Tripping.


The interest rate differential between India and the other major economies is now lending itself to an arbitrage opportunity for major players in India. Diamonds and gold are the preferred route for these since the high value transaction on small quantities facilitates easy transfers. The risk however in such arbitrage is evident in the fact that corporates suffered huge losses in the international derivative markets leading to considerable litigation between the bankers who advised in the instruments and the corporates which saw the bottom fall out in July/August 2008.

The recent budget of 2011/2012 has two schemes to encourage repatriation of foreign funds held by Indians abroad. The 15% tax on dividend repatriated and the infrastructure bonds will have a very positive effect in moving away from the needs of FDI. Whether the schemes will succeed or not depends on our “friendly neighbourhood TAXMAN”- with apologies to Spiderman.

PS: The above article has taken the liberty of culling material from sources all of whom cannot be acknowledged but as Aristotle said “Art is Imitation”- “the poet”, he said, “being an imitator, like the painter or any other artist, must, of necessity, always imitate one of three things,—either such as they were or are; or such as they are said to be or appear to be; or such as they ought to be.”