Tax Evasion and DTAA – Part 1

Over the past week or let me say over the past few years (for the people who have been following news properly for this much time) Double Taxation Avoidance Agreement or DTAA has been a brewing topic whenever there is a question of black money involved anywhere. Before I move on to discussing what a DTAA is and what are the various important clauses of the agreement, I shall go upon the current stand of the incumbent government over the issue of black money in Switzerland by Indian nationals.

Some key terms:

What is black money?

Black money according to the government of India is the money earned through illegal means on which income and other taxes have not been paid.

Approximately how much India’s black money is stashed away in Switzerland?

According to a statement from the director of Central Bureau of Investigation, Mr. A. P. Singh in February 2012, approximately $500 billion of illegal funds (black money) are present in tax havens.

What is a tax haven?

A tax haven is a state, country or territory where certain taxes are levied at a low rate or not at all.

A few examples of tax havens.

1. Switzerland
2. Luxembourg
3. Ireland
4. Netherlands
5. Jersey
6. Isle of Man
7. British Overseas Territories include – Bermuda, British Virgin Islands and Cayman Islands

These are some of the basic ideas behind black money and tax havens, now how does an individual or a firm makes black money out of India. (This does not include any money generated out of corruption)

I will explain this with an example; let us consider a firm ABC Pvt. Ltd. This firm is not an Indian firm; let us say it belongs to some country in the European Union. Now this firm will setup a subsidiary branch in Mauritius and it will use that branch to invest in India’s stock markets and whatever gains it accumulates from the Indian stock markets (Capital gains), it will take it back to its Mauritius branch and as India has a special treaty on Double Taxation with Mauritius, India will not charge a capital gains tax on this capital gain. Now in Mauritius, there is no taxation on any amount of capital gains (To get more companies to come and setup in their country) and that is how ABC Pvt. Ltd. will have its capital gains with zero percent taxation to any of the governments.

I will stress more upon the current issue and how companies use the concept of Transfer Pricing to evade tax.

Please note that this example comes under Tax Evasion, this is how an individual or a firm can evade giving taxes to a country’s government.