“It is almost inevitable that the [Mauritius] treaty will be renegotiated and amended in some way or form. As a result, it is likely that the requirements for tax residency in Mauritius are going to be broadened and made more detailed.”
- Craig Fulton, Conyers Dill & Pearman
“By not making positive statements, the Indian government is only confusing the investors and everybody seems to be (a) little nervous.”
- Mohit Saraf, Luthra & Luthra
India and Mauritius have long squabbled over their double tax avoidance treaty, which allows third country investors to claim tax exemption in India. With billions of dollars flowing through Mauritius every year, New Delhi wants the treaty amended and Port Louis may finally relent, reports Raghavendra Verma
"We believe that we can find a mutually satisfactory solution and a win-win package that would address [India’s] concern about the alleged misuse of the Double Taxation Avoidance Agreement," said Mauritius Prime Minister Navinchandra Ramgoolam during his India visit in February this year.
The contentious provision in the treaty has been the exemption to all Mauritius-based companies – even those with 100 percent foreign funding and no physical structure in Mauritius – from paying capital gains tax in India. Mauritius does not levy any tax on capital gains, and companies there are required to pay only 3 percent effective income tax, making it an attractive offshore financial centre for Indian investments.
According to the Mauritius government, more than $62 billion foreign investment has come to India through the island nation in the last twelve years. Mauritius accounts for 42 percent of India’s foreign direct investment, and a substantial amount of foreign institutional investment in Indian stock markets.
The intended 10 percent tax on the capital gains made on these funds could be a substantial amount and, therefore, New Delhi is keen to plug this loophole.
On the other hand, Port Louis fears that if the particular treaty clause is removed and the Indian investments stop flowing through Mauritius, its financial sector may get affected seriously.
Conduits
“An important section of Mauritius’ financial sector is dependent on the offshore investment business,” says Shefali Goradia, partner, corporate tax practice at BMR Advisors in Mumbai, “there are lawyers, company secretaries, bookkeepers and administrators providing their services to these companies,” she says.
In June 2011, there were 593 financial intermediation companies in Mauritius, with 45 new ones created in the preceding one year. According to Mohit Saraf, senior partner at Luthra & Luthra Law Offices in New Delhi, these firms providing financial advice and corporate management services are often managed by only 10 people. “They are just conduits,” he says, adding that: “one company is formed on one file, for which they charge between $5,000 to $10,000 annually.”
“These offshore service providers also help in compliance with corporate governance and other annual filing requirements,” says Sunil Jain, partner at New Delhi-based law firm J. Sagar Associates. “There are also many quality and efficient full service providers,” he says.
To contain the revenue loss due to the investments directed through these firms, the Indian government has a couple of options. One is to insert an anti-treaty shopping clause in the Mauritius treaty that prohibits residents of third countries from taking advantage of the liberal tax provisions. This would, however, require Mauritius’ consent, getting which has turned out to be a difficult task. The two countries have been involved in negotiation over the issue since 2006.
General anti-avoidance rule
The other option is to introduce a General Anti-Avoidance Rule (GAAR) in its domestic law, which could override the provisions of the Mauritius tax treaty. According to Goradia, India can amend its own laws to say that this benefit will not be granted to the shell companies.
A step has already been taken in this direction though the proposed Direct Taxes Code in India, which provides that any structure, which lacks in commercial substance and exists solely for obtaining tax benefits, may be denied to avail such benefits.
However, Goradia warns that any attempt to limit tax benefits through GAAR will be open to litigation and would create an uncertain businesses environment. She says that litigation is even more likely after the recent Supreme Court judgment in the Vodafone case.
In January this year, the Supreme Court held that Vodafone’s offshore transaction, in which Hutchison International sold its Cayman Islands-based company CGP to Vodafone International, is outside the jurisdiction of Indian tax authorities and is, therefore, not taxable in India. In the $11.2 billion deal executed in May 2007, Vodafone had acquired 67 percent stake in Hutchison-Essar Ltd from Hong Kong-based Hutchison Group through companies based in Netherlands and the Cayman Islands. The Indian income tax department had then contended that since the capital gains were made in India through the deal, Vodafone was liable to pay a tax of $2 billion to Indian taxation authorities.
Foreign investors
Invoking GAAR will also make India a less attractive destination for foreign investors, says Daksha Bakshi, executive director of Mumbai-based law firm Khaitan and Co. “The government has to calculate as how much investment it wants to bring in, and how much tax revenue it can let go (of),” she says.
An outcome of such a calculation would depend upon the level of the Indian government’s assessment of its economic strength and future growth projections, both of which seem to be positive. According to Jain, “for the last 20 years, India has relied heavily on foreign capital [to fuel its economic growth]. But now, its growth story is becoming quite compelling and it, therefore, believes that even if the treaty rules are changed, investors would still be flocking.”
However, Mauritius is not the only country with whom India’s double taxation treaty contains such a provision. India’s tax treaties with Singapore and Cyprus also allow companies based in those countries to claim exemption from paying capital gains tax. Singapore is also the source of the second-largest foreign direct investment into India, though at 9 percent, it is much less than Mauritius.
Interestingly in 2005, the India-Singapore double tax treaty was amended to include a provision which states that as long as the beneficial treatment for capital gains tax remains in the India-Mauritius treaty, it will continue to apply under the Singapore treaty as well.
Jain says that if the Indian government succeeds in convincing Mauritius to delete the capital gains tax provision from their treaty, then the next target could be Singapore. For this reason he says that “it is false to believe that in future the investments will be routed through Singapore, in place or in preference to Mauritius.”
Furthermore, the India-Singapore treaty has an additional substance requirement due to which it has not been the first choice for third country investors. It demands that a company must spend $200,000 per year for at least two years in Singapore before it is eligible for any capital gains tax exemption. Goradia says that including a similar provision in the India-Mauritius treaty could be an alternative agreeable solution for the two countries.
Craig Fulton, head of the Conyers Dill & Pearman Mauritius office, agrees that there is a possibility of a solution similar to that of the Singapore treaty. “It is almost inevitable that the [Mauritius] treaty will be renegotiated and amended in some way or form,” he says. “As a result, it is likely that the requirements for tax residency in Mauritius are going to be broadened and made more detailed,” he adds.
Fulton says that an amended treaty is going to be a positive development even for Mauritius, as “it would promote the formation of more complicated corporate structures like joint ventures and investment funds in the country, rather than just using it as a gateway.” These sophisticated transactions, he says, may also increase the amount of money brought in, and the number of jobs created in the country. Mauritius already has a diversified financial services industry, which also targets investment into African countries.
Regarding the impact of any possible change on the smaller financial management firms, Fulton says that “they would need to deal with more complicated tax residency requirements, and be in a position to offer more sophisticated products to their clients”. However, he says that their business model may still remain stable.
Malcolm Moller, managing partner of the Mauritius and Seychelles jurisdictions of offshore legal, fiduciary and administration services provider Appleby, agrees that any change in legal provisions would force financial service providers to reconsider the ways they structure their future deals. However, he says that he is not convinced about the treaty getting amended soon. “At the moment, it is all speculation,” he says.
Saraf of Luthra & Luthra also says that the favourable provisions of India’s double taxation treaties benefiting foreign investors are going to stays. “By not making positive statements, the Indian government is only confusing the investors and everybody seems to be [a] little nervous,” he says.
Illegal transactions
Positive statements on the Mauritian financial service industry seldom originate from New Delhi’s corridors of power. This can be attributed to the deep rooted suspicion about the nature of financial business done there, especially after its involvement in major corruption scandals in India.
In 2008, for example, 15 Mauritius-based companies were found to be highly involved in India’s 2G mobile spectrum allocation fraud, where gross undervaluation of the resource led to a loss of $ 39 billion to the national exchequer. Ten of these newly created companies were registered at the same address in Port Louis.
Round tripping
Furthermore, Indian authorities suspect that the huge foreign investment from Mauritius also contains a portion of the secretly held foreign funds of wealthy Indians. Recently, the director of India’s Central Bureau of Investigation, an agency for criminal investigation and the collection of economic crimes related intelligence, said that Indians have illegal money worth $500 billion stashed away in foreign bank accounts.
While international investors try to earn higher returns from the fast progressing Indian economy, there are compelling reasons for Indians with slush funds in foreign bank accounts to maximise their earnings in the same way. It is widely believed that some of these individuals channel their wealth through neatly disguised and multilayered shell companies in Mauritius to invest in India.
Such a practice also allows Indian investors to maintain anonymity, avoid paying the capital gains tax, and retain the flexibility of withdrawing the money out of the country without having to worry about India’s strict exchange control regulations.
However, a senior official at the State Bank of Mauritius in Port Louis, who is not authorised to speak to the media, rejects the charge of dealing in ill-gotten wealth. He says that “we do a thorough check on the ultimate beneficiary owner of every transaction.” According to him, allegations that Mauritius is being used for rerouting or round tripping of Indian money are based on a wrong perception that has not being sufficiently countered by the Mauritius government. However, he agrees that “some dubious money has gone through Mauritius, but this has happened in very high-profile cases like the 2G scam, and so can’t be generalised.”
According to the bank official, Mauritius provides its full support to the Indian government for holding inquiries and investigations. “Now, an Indian revenue officer is permanently based in the High Commission in Port Louis specifically to track slush funds. Not many countries can provide that comfort to Indian investigating agencies,” he says.
Goradia of BMR Advisors agrees that Mauritius follows strict Know Your Customer (KYC) norms, especially with Indian investors. “They also try to understand if any of the Indian exchange control restrictions for investing in Mauritius have been violated.”
Saraf of Luthra & Luthra also blames Indian agencies for not being able to identify the Indian tax defaulters with foreign-held funds. “In India, the enforcement of law is not proper as our enforcement agencies don’t have the required manpower and technology,” he says.
Ancestral bonding
Combating money laundering and ensuring financial transparency can be easily dealt with by the two countries at an official level. But the issue of tax exemption has to be tackled at the highest political level; and for good reason. Irrespective of tone and tenure of demands being made by various Indian authorities, Mauritius remains confident of favourable treatment in New Delhi due to strong political and historical ties.
The majority of the 1.2 million Mauritians population is of Indian origin; people whose ancestors were brought into the country for sugarcane farming in the 18th century by the British colonial power.
Furthermore, at any international forum, Mauritius remains the strongest supporter of the Indian government. There is little doubt that Prime Minister Ramgoolam was very confident after his recent New Delhi visit, when he said that he has been reassured that nothing would be done to hurt Mauritius’ economic interests. ALB