Round tripping involves a practice where funds originating from India are routed through various offshore entities[1] and subsequently reinvested in India. Most of the time, this practice of round tripping is disguised as Foreign direct Investment. Furthermore, round tripping involves an establishment of shell companies[2] in the jurisdiction of favorable tax regime or limited regulatory oversight such as Mauritius, Singapore or British Virgin Islands etc.
Generally, such practice of “Round tripping” is employed to avail tax benefits under Double Taxation Avoidance Agreement or is used to regularize certain undeclared asset (black money) in the formal economy. Certainly, a Double Taxation Avoidance Agreement is a bilateral tax treaty signed between two countries as to ensure that a tax payer is not taxed twice on the same income in both of their country of residence and the country where the income is generated (source).
Moreover, under Section 3[3] of the Foreign Exchange Management Act, 1999 clearly states that “all dealings in foreign exchange must comply with the provisions of the Act and Rules made thereunder. Section 3(d) of the Foreign Exchange Management Act, 1999 explicitly states that “prohibited for any person from entering into any financial transaction in India in association with acquisition or creation or transfer of a right to acquire any asset outside India by any person”. This forms a legal basis for regulatory action against round tripping agreement.
Further, Foreign Management (Transfer or issue of any Foreign Security) Regulation, 2004[4] includes Regulation 6 that states conditions for Overseas Direct Investments in India by Indian Entities.
One of its provisions that is, Section 6(2)(ii) states that it prohibits investment in foreign entities that have invested or intend to invest back into India with Specific exceptions. A clear word to word provision states as “An Indian Party may make investment in an Overseas joint Venture, provided that the Indian Party shall not make investment in foreign entity engaged in Real Estate business or Banking business without prior approval of the RBI”.
Regulation 19(3) of FEMA (Overseas Investment Directions) Rules, 2022[5] states that an Indian Resident is permitted to make a financial commitment in a foreign entity that has already invested or subsequently invests back in India, provided that resulting structure shall not exceed “two layers of subsidiaries”.
INTERSECTION BETWEEN PMLA & FEMA
There exists a meeting point between PMLA and FEMA in addressing round tripping and it offers a comprehensive approach to tackling problematic financial flows.
Under Section 3 [6]of the PMLA, clearly criminalizes money laundering and defines it as a process of disguising illicit origin of funds. Exact text of Section 3 of PMLA reads as “Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering”. This provides a broad scope of the provision allows authorities to investigate and prosecute complex financial arrangement designed to conceal the origin of funds including round tripping structure.
JUDICIAL CASE LAWS
In Vodafone International Holdings B.V. v. Union of India[7], wherein the Supreme Court of India defined round tripping and states that “Round tripping can take many formats like under invoicing and over invoicing of exports and imports. Round tripping involves getting the money out of India, say to Mauritius and then come to India like FDI etc. Further, Article 4 of the Indo-Mauritius, Double taxation avoidance agreement mentions “Resident” as any person, who under the laws of contracting states is liable to taxation therein, by reason of his domicile, residence, place of business etc. An Indian Company, with the idea of Tax evasion can also incorporate a company offshore or create a wholly owned subsidiary in Mauritius after obtaining a Tax Residency Certificate may invest in India. Large amount can be routed back to India using Tax Residency Certificate as a defense, but once establishes that such investment is with black money or capital that is hidden, it is nothing but a circular movement of capital known as round tripping. Then, Tax Residency Certificate can be ignored, since the transaction is fraudulent and against the National Interest”.
In Lavasa Corporation vs Union of India[8], the Bombay high court examined the investment made by Indian Citizen in Overseas Joint Ventures that subsequently invested in Indian Company. The High Court observed that “Purpose of FEMA, facilitate external trade and payment and to promote the orderly development and maintenance of foreign exchange market in India. To achieve this purpose, the RBI must have the authority to look behind the veil of the complex corporate structure as to discern the true nature of fund flows.
Notes:
[1] Offshore entities are legal structure ie., Partnerships, trusts, company incorporated in a jurisdiction outside owner’s primary country of residence or business operations.
[2] Shell companies are entities that exist on paper with no significant asset or active business operations but are legally incorporated.
[3] chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.indiacode.nic.in/bitstream/123456789/1988/1/A1999_42.pdf
[4] https://www.rbi.org.in/scripts/BS_FemaNotifications.aspx?Id=2126
[5] https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12381#Para19
[6] chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.indiacode.nic.in/bitstream/123456789/15402/1/moneylaunderingact2002.pdf
[7] (2012) 6 SCC 613
[8] (2015) 2 SCC 212
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