Amidst panic in the stock market over double tax avoidance treaty with Mauritius, the government on Monday said India "cannot impose arbitrarily" capital gains tax on investment routed through the island nation.

"How can you do that? There has to be some agreement on that. Right now, it is not there in the agreement. You cannot impose it arbitrarily," finance secretary Sunil Mitra told PTI.

However, he said the two nations are likely to hold discussions on revision of the double tax avoidance treaty, which has been used for routing third country investment into India for availing of tax exemptions.

The BSE benchmark Sensex plunged by over 556 points in intra-day trade today on widespread panic selling by funds as well as retail investors, triggered by reports that the government may impose capital gains tax on investments through Mauritius.

There was a recovery in the market in the afternoon, but the Sensex was trading 336 points lower 1450 hours.

Asked to comment on the market fall, Mitra said," that is up to the market. What can I say".

The finance secretary said the process of renegotiation of the tax treaty with the island nation began in 2006 through a joint working group, but got stalled in 2008.

New Delhi has suggested dates in July and August for resumption of talks. "They have to give their consent," he said.

Under the present treaty, only Mauritius has the right to tax capital gains on investment which is routed through it in India. But it does not levy any tax as per its domestic policies giving advantage to the investors.

Most of the foreign direct investment as also the inflows in the stock market are round-tripped through Mauritius.