Financial Daily from THE HINDU group of publications
Tuesday, Dec 14, 2004
Treaty shopping Plugging the Mauritius loophole
Paranjoy Guha Thakurta
If New Delhi decides to renegotiate some of the more controversial provisions of the India-Mauritius Double Taxation Avoidance Treaty (DTAT) also called a convention or an agreement as is expected, the idyllic island-state in the Indian Ocean will no longer be able to count `financial services' as its most important economic activity after tourism. What is also likely to happen in the future is that foreign companies may choose such countries as Cyprus instead of Mauritius to route their investments to India.
The Common Minimum Programme (CMP) drawn up on May 27 by the ruling United Progressive Alliance coalition and its supporters from the Left parties had stated that the misuse' of DTATs would be stopped without making a specific reference to the India-Mauritius treaty. The Finance Minister, Mr P. Chidambaram, has said the commitment made in the CMP was aimed at errant domestic companies and not at foreign institutional investors (FIIs).
The UPA Government had constituted a joint study group on the Comprehensive Economic Cooperation Agreement with Mauritius that suggested changes in the existing DTAT. The Finance Ministry has also formulated a model double taxation avoidance agreement and wants all future agreements including the ones currently being negotiated with nations such as Chile and Bosnia to adhere to this model. Since the Mauritius DTAT differs from the model agreement, "we would therefore like to revisit the treaty," Mr Chidambaram told the Lok Sabha on December 10.
Since a bilateral treaty can be renegotiated only if the governments of both countries agree to do so, the Finance Minister was quick to add that there had not been any formal talks so far between the Governments of India and Mauritius to revise the current DTAT that was signed in August 1982 ostensibly to boost the economies of both countries it was renewed ten years later.
On reworking the DTAT with Mauritius, Mr Chidambaram told Parliament: "This is not a purely economic issue. There are political and diplomatic implications. We are in consultation with the Ministry of External Affairs and can proceed on this cautiously having regard to our good relations with Mauritius... "
New Delhi has signed more than 50 DTATs with governments of different countries, including at least 16 treaties that are virtually identical to the one signed with Mauritius. In the latter category are treaties signed with the governments of Cyprus, Indonesia, Malta, Tanzania, Thailand, Syria, United Arab Emirates and Zambia. If the Mauritius treaty is renegotiated, there is a possibility that some of these treaties will also be reopened.
Since India has DTATs with other countries that are identical to the Mauritius treaty, why indeed is Mauritius so popular as the preferred route for investments coming to India? First, Mauritius is geographically relatively close to India. It helps that persons of Indian origin control the Mauritius government. Moreover, Mauritius has many lawyers and accountants who assure complete secrecy to foreign investors (as the Swiss banks once used to do).
Companies are quickly incorporated in that country (within a fortnight) and the currency of Mauritius can be fully convertible. The icing on the cake comes in the form of a salubrious climate and golden beaches.
Mr Chidambaram stated: "We have no plans to extend the identical provisions of this treaty (with Mauritius) to any other country. New treaties are being negotiated on the lines of the model DTAT. But it is possible that in future treaties with some countries, some elements of the Mauritius treaty or treaties with other countries could get reflected. That will depend on our current assessment of our trade with that country and investment opportunities with that country."
At the core of the controversial DTAT between India and Mauritius is the incidence of what is euphemistically referred to as `treaty shopping'. In essence, this means that foreign investors in third countries with relatively high rates of taxation on income/profits earned by companies and/or capital gains accruing from transactions in shares and securities are using the Mauritius route to bring investments to India by taking advantage of the DTAT.
The Mauritius Government does not levy any tax on capital gains. Foreign firms, including institutional investors, operate out of Mauritius simply because they do not have to pay any tax on profits earned by transacting in shares in India. Mr Chidambaram told the Lok Sabha that "much of the advantage of routing investments through Mauritius has been taken away with the abolition of long-term capital gains tax (in his July Budget for 2004-05) ... even for Indian investors."
The long-term capital gains tax earlier used to be 10 per cent, a rate of taxation that is now levied on short-term capital gains (that is, if the income from securities transactions is repatriated is less than one year) that used to earlier attract a tax rate that was twice as high. Nevertheless, because of the levy of a 10 per cent tax on short-term capital gains, the Mauritius loophole has not been entirely plugged.
Though Mr Chidambaram denied there was "hard evidence" of Indian money being routed through Mauritius with the help of shell/shelf companies, there have innumerable reports to the effect that Mauritius has been the preferred destination for substantial sums of black money generated in India, including slush funds stashed by corrupt politicians, bureaucrats and businesspersons.
In 2001, the Securities and Exchange Board of India had submitted detailed reports to the Joint Parliamentary Committee investigating the scandal involving brokers like Mr Ketan Parekh about how certain Mauritius-based FIIs were issuing participatory notes to unidentified individuals and firms to undertake major transactions in the Indian stock market.
The same day Mr Chidambaram made his statements on the Mauritius DTAT in Parliament, that is, December 10, the Finance Ministry tabled a progress report in the Lok Sabha on the scandal in which it was stated that investigations into the activities of 18 companies "are at a very advanced stage".
The probe pertains to the nexus between brokers and corporate bodies to manipulate stock prices.
The report stated that the government had issued show-cause notices to eight companies in this connection. Though the Mauritius Government has taken some steps to check misuse of the DTAT, such as stopping the registration of companies with parents in India, these are clearly perceived to be inadequate.
New Delhi reportedly wants three key changes in the DTAT with Mauritius to check tax evasion and ensure that the island nation is not used as a conduit to launder illegal funds.
The first would be to change the basis of taxation from the `residence' of the firm to the `source' of the funds. Companies use a certificate of residency from the Mauritius Government to seek exemption from payment of capital gains tax.
Second, the model DTAT of the Indian government seeks to include a `limitation of benefit' so that the benefits of the DTAT are confined to `genuine' residents of Mauritius. Third, the Indian authorities want to rework the rates of withholding tax.
Will the Mauritius Government agree to these changes in the DTAT? There is speculation that the Finance Ministry would adopt a `carrot-and-stick' policy with Mauritius,by offering a $100-million credit facility through the Export-Import Bank of India while putting pressure on the Mauritius Government to review specific provisions in the DTAT with India.
It has also been reported that if the Mauritius Government refuses to play ball, New Delhi could `threaten' it by offering comparable tax benefits to countries in the Association of South-East Asian Nations (Asean) such as Singapore. Time alone will tell whether such so-called threats will work.
(The author, a senior journalist, is Director, School of Convergence. He can be contacted at email@example.com.)
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