NOVEMBER 05, 2014

By Naresh Minocha, Our Consulting Editor

BJP's resolve to bring back black money lying in secret overseas accounts is like missing the woods for the tree. Tonnes of black money regularly flow back into the country through different channels. Successive Governments have been lax towards such capital flows.

Such investments include round-tripping and foreign institutional investment (FII) especially the one coming through participatory notes and other similar instruments collectively referred to as offshore derivative instruments (ODIs).

The round-tripping has been camouflaged through tax treaty shopping, towards which Foreign Investment Promotion Board (FIPB) has been benign. This is notwithstanding the relentless opposition from Department of Revenue (DOR) for several years.

It remains to be seen whether the NDA Government or the Supreme Court would empower Special Investigating Team (SIT) to also probe such investments to find out whether it is same or similar black money that they are targeting.

The need for such a probe would become clear by taking up two latest instances relating to FIPB cases. These instances also reflect on the NDA Government's lack of policy initiative in this area.

One case relates to rejection of an application for ex-post facto approval of Rs 50-crore investment which income tax department (ITD) considers as unaccounted money. The investment was made by two British Virgin Island (BVI)-based investors in the BSE-listed Veritas (India) Private Limited (VIPL).

The second case relates to FIPB's ex-post facto approval of FDI aggregating to Rs. 350 crore in Soma Tollways Private Limited (STPL). This includes investment through two Swiss numbered accounts, Geneva 4813 and Geneva 7631 accounts, whose ownership continues to remain a top secret.

On 29th August, FIPB trashed VIPL's representation against its thrice-rejected application for post-facto nod for issue of warrants to two "foreign collaborators". FIPB had first rejected this application in March 2012, second time in June 2012 and later in November 2013 for want of details of the sources of funds invested by the collaborators.

Under the consolidated FDI policy, warrants can be issued to overseas entities only after Government's approval. The subscribers are required to pay 25% upfront to the company on issue of warrants and the balance 75% on their conversion into equity shares within in 18 months under Government route.

VIPL contravened this policy guideline by seeking approval after conversion of warrants into equity shares. Such Ex-post facto clearances are given subject to a penalty referred to as 'compounding by Reserve Bank of India.'

FIPB rejected VIPL's representation by taking on record mind-blowing disclosure/allegation made by DOR.

As put by DOR, the assessing officer from Income Tax Department (ITD) for VIPL has stated that the company failed to furnish any evidence to establish that foreign investors made investments aggregating to Rs 50 crore from their known and declared sources of income.

DOR has alleged that the investment by two BVI-based entities named Aventia Global Limited and Onix Assets Limited was "an arranged affair between the applicant company and the family of the Director Shri Nitin Didwania to introduce unaccounted money as share capital/share premium in the books of accounts through BVI-based dummy companies." (Nitin Kumar Didwania is Chairman & Director of VIPL and holds controlling stake in the company.)

DOR's charge continues: "Further, during the assessment proceedings, the said receipt of foreign investment of Rs. 50 crore, has been considered as deemed income within the meaning of Section 68 of the Income Tax Act and an addition to this effect was made to the total income of the applicant company in the assessment order passed u/s. 143(3) of the Act dated 10.03.2014. In view of these DoR does not support the case."

If this charge is ultimately upheld by the judiciary, it might well turn out to be first case of black money that did not pass off as foreign investment.

VIPL's annual report for 2013-14 shows 'income tax demand pending appeal' as contingent liabilities of Rs 27.55 crore as on 31st March 2014 as compared to nil on the corresponding date of previous year. A reader can make his own judgement whether this liability relates to the disapproved foreign investment or to some other disputed income.

A reader flipping through the annual report would find it hard to miss its tagline that dubs VIPL as "A business that consistently enriches lives in a wealthy business."

Another aspect that can't be overlooked is the change in VIPL's stance about investment by Aventia and Onix, aggregating to 16.52% equity stake. VIPL had described these entities as "foreign corporate bodies" in the extraordinary general meeting (EGM) notice issued in November 2009 seeking shareholders' approval for issue of warrants to them.

In its latest shareholding pattern, VIPL has categorised Aventia's 4.13% stake and Onix's 12.39% stake under the sub-head 'public shareholding other category'.

Let us now shift focus to Soma Tollways Private Limited (STPL). On 1 August 2014, FIPB adopted an ostrich-like stance by overlooking its own previous decision to ask for the identity of beneficiaries of Swiss accounts, Geneva 4813 and Geneva 7631 accounts and the balance 20% of the total investment of Rs 350 crore. See ice cubes dated 24th March 2014 - Unravel JP Morgan affiliate-aided FDI from Secret Swiss accounts in STPL.

In the minutes of its meeting, FIPB did not disclose whether this issue has been resolved or not.

According to the minutes of meeting held on 1 st August, "The proposal has been considered by FIPB and deferred on few occasions, as DOR was not satisfied with the source of funds and ultimate beneficiaries. DOR representative, in the meeting stated that their concern is now confined to "treaty abuse". The Board overruled the concern of DOR regarding treaty abuse and recommended the proposal for approval, subject to compounding by RBI."

Does this mean STPL disclosed complete information about ultimate beneficiaries of the investment? Does it mean DOR backed down from its demand for complete disclosure?

Such lack of transparency in disposal of sensitive cases brings us to the need for taking a clear stand on the source of FDI or FII in all cases.

If NDA Government is indeed really concerned about black money, then it must ask for the ultimate origin or beneficiary of investment routed through several countries ostensibly to avail of tax arbitrage opportunities.

Hardly any company from any OECD country would grudge such disclosures because they know sooner or later they would be caught by tax authorities at home.

FIPB's benign attitude about treaty shopping has helped dubious Indian money parked abroad to be invested either as FDI or portfolio investment via ODIs. Indian money parked in tax heavens is also routed through companies that are listed on London Stock Exchange's Alternative Investment Mechanism (AIM).

To quote a study jointly published by The Research and Information System for Developing Countries (RIS) and The Institute for Studies in Industrial Development (ISID) in September 2011, "It is relevant to underline here that a good number of companies listed on the London Stock Exchange which have operations in India and which appear to be controlled by Indians are registered in tax havens. Some of these in turn have set up SPVs in Mauritius to invest in India."

The study captioned 'India's FDI Inflows-Trends and Concepts' adds: "While we do not know how the shareholding of the founders was financed, in a few cases institutional investors appear prominently in the list of shareholders. To that extent, it suggests that FII funds instead of coming directly into the Indian stock market, in which case they would have been classified as portfolio capital, are coming via the LSE listed companies into India as FDI. Had they subscribed to GDR/ADRs of Indian companies, the funds would again have been classified as foreign portfolio inflows. This was the case with some other non-Indian controlled LSE listed companies as well. As we shall see later, since a good part of such inflows was not subjected to the FIPB/SIA route, one could say that it is neither subjected to FII nor FDI regulations."

The study found that "portfolio investors and round–tripping investments have been important contributors to India's reported FDI inflows thus blurring the distinction between direct and portfolio investors on the one hand and foreign and domestic investors on the other. These investors were also the ones who have exploited the tax haven route the most." It has estimated the share of round-tripping investments as 14 per cent of the total USD 81 billion inflows during September 2004-December 2009.

It is here pertinent to quote FIPB Review January-December 2008. It says: "The DOR also examines the question of both "Treaty Shopping" and "Round Tripping". In the case of "Treaty Shopping", a resident of a third country invests by taking advantage of a fiscal treaty between India and another contracting state. The Supreme Court of India in the case of Azadi Bachao Andolan has not found the mechanism unlawful. Conversely, in the case of "Round Tripping", money is routed back to the country by local investors through tax havens like Mauritius. This is regarded as aiding tax evasion in India and severely impacts revenues from capital gains tax. While the FIPB discourages "Round Tripping", it has no objection to "Treaty Shopping"per se if it results from a valid treaty and the DOR does not have any specific and verifiable objection to the proposal."

It adds: "The two departments of the Ministry of Finance have differing views on the issue and there is a need for an integrated and holistic approach to it."

The differences are at present as sharp as they were in 2008, reflecting UPA Finance Minister's utter governance failure on this count. It remains to be seen whether the incumbent Arun Jaitley would iron out these differences and generate the Ministry's single stand on round tripping and treaty shopping.

By going soft on round tripping, treaty shopping and participatory notes, successive Governments have institutionalized them as deemed immunity scheme for bringing back black money to India.