The tax department is all set to tighten the noose around foreign investors who have been investing through shell companies in tax havens. CNBC-TV18 learns that the I-T dept will ask FIIs and foreign investors to file tax residency certificates if they are situated in a country with which India has a DTAA.
Legal experts say all forms of investment from Mauritius will now come under the scanner. Tax lawyers add that the taxman may eventually start going beyond just the tax residence certificate.
Moreover, the confusion over general anti-avoidance rules (GAAR) spooked the markets.
Mukesh Butani, chairman at BMR Advisors believes to some extent the SC verdict in Azadi Bachao Andolan case, which was rendered on the back of a government circular of 2000, gets diluted. He says now that applies to all forms of investment that comes from Mauritius, be it an FII or FDI route.
"If the participatory note is in relation to an underlined asset i.e. part of the investments into an Indian company and that would be taxed, then that's a far-fetched argument," he says.
Corporate tax lawyer HP Ranina says the fear is that the tax authorities will not go only by the Tax Residency Certificates issued by Mauritius and therefore they will go into what they call the "Commercial Substance".
"The company will be deemed to be resident in Mauritius only if it has commercial substance in that country. And not if it has just set up office in a lawyer's outfit with no employees and no other business activity. So, in that case, they will not apply the treaty and therefore the exemption which currently they enjoy from capital gains will not be applicable," he told CNBC-TV18 in an interview.
Market experts warn that unless there is clarity on the exact details of the GAAR guidelines, the markets may see more pain.
"This has been made very clear by the government as a general principle that India will not allow the use of tax havens - where this is used as a tax saving route or tax evasion route. So definitely harassment by tax department cannot be ruled out. The clarification given just now by the government that tax residency will be sufficient for claiming the exemption, that should suffice," investment analyst SP Tulsian told the channel. 
However, Ambareesh Baliga, COO of Way2Wealth Brokers feels, if it is very clear that it is only prospective, then this may not be too much of an issue.  "The fear of it being retrospective, then invest climate will get visited, and downtrend nervousness will continue for a while longer," he explained