DTAA is usually signed between two countries for lower tax jurisdiction and are based on the Organisation in Economic Cooperation and Development  model treaty. According to sources close to the development, it has sought views of the Reserve Bank of India [Get Quote] on the matter.

The tax treaty will enable a host of exemptions to foreign investors who could route their investment in India through Luxembourg.

"There needs to be checks and balances as there was a fear that unscrupulous entities in India could route their illegal funds through these countries by setting fictitious offices and establishments," a industry source said.

Going by the experience of Mauritius and with growing importance of the anti-money laundering laws and "Know Your Customer" norms, there should be proper monitoring of the kind of investments made in India, especially in equities, sources said.

In Mauritius, the treaty has made investment by foreign investors in China and India fairly easy. The treaty, which had led to growing emergence of Mauritius as the dominant channel for foreign direct investment into India, however, came under attack from Indian tax authorities in 2002 as a result of alleged abuses by Indian resident investors.

It was alleged that these companies owned by Indians and by merely being registered in Mauritius they should not given a tax holiday as their main business and income was from India. After a series of court cases, the status quo was restored.

The regulator is of the view that the DTA, if any, should promote direct investment in productive sectors and not only fuel speculative short-term debt creating inflows.

Countries such as Belgium, which have DTAA with Luxembourg, cover different categories of income dealt within the OECD model convention on income and capital.

One of the other areas which was being increasingly promoted related to issues of taxation on cross-border employment and self-employment.