How the Mauritius route works, why India wants to stop it, and why that may be easier said than done.

In the island paradise of Mauritius, apart from the pristine beaches, the main tourist attraction is Eureka, a 50-acre estate with its own waterfalls, a river and a grand colonial mansion with 109 doors. The estate is reputed to have been built by a fabulously rich Mauritian of French origin sometime in the 1830s. The history of Eureka is a tale of intrigue and immense wealth. No tourist can consider a trip to Mauritius complete without having visited this amazing estate.

Roughly 15 km from Eureka in the heart of the capital Port Louis is 1, Cathedral Square. This building is not any sort of tourist attraction. Rather, it is fast becoming a must-visit for global financial investors coming to this tiny state. The glass-and-chrome edifice houses several of the island’s ‘management companies’. These companies, in turn, control hundreds of ‘global business companies’, or GBCs, incorporated in Mauritius. Billions of dollars of business is transacted daily here in the tiny, neat cubicles inside the building. If Mauritius is fast earning a reputation as an important global financial centre, it is largely because of 1, Cathedral Square and a few similar buildings in the capital. In the process, it is crafting its own tale of great financial intrigue.

Over the past few years, the Indian government and its revenue wings have been getting increasingly worried about the way many of the Mauritian management companies and GBCs operate. What’s bothering them is the sudden emergence of Mauritius as India’s favourite offshore tax haven. The ‘double taxation avoidance treaty’ signed in 1983 — to make sure that businesses that operated in both countries didn’t get taxed twice — has turned out to be a Trojan horse. Mauritius has become the perfect conduit for anyone to bring in enormous sums of money to India — or even take it out — anonymously, and without paying any taxes. And it is not just global investors who are taking advantage of the favourable tax regime in Mauritius while investing in India. Officials in various arms of the government suspect that there are unscrupulous Indian businessmen who are sending out money through the hawala route, and then bringing it back as legal funds via Mauritius.

There are certainly impressive data to support some of these claims. Over the past few years, more money has come through the Mauritius route to India than through direct investments from almost any other country. In April-June this year, a total of Rs 4,165 crore came in through Mauritius to India — as against Rs 1,105 crore from the US. By the end of the year, the money flowing in from Mauritius to India could be as high as Rs 15,000 crore. In 2005-06, a total of Rs 11,441 crore came in through this route, more than double the Rs 5,141 crore in 2004-05, which in turn was almost double the Rs 2,609 crore that had come in in 2003-04. Compare that with the relatively piddly Rs 2,210 crore that came in through the US in 2005-06. Investment through Mauritius is over half the total FDI coming into India. Says a senior official: “It is evident more and more routing is taking place through Mauritius.”

Before we go any further, it is important to take note of a couple of points. First, Mauritius is hardly the only offshore tax haven in the world. In fact, the Isle of Man, the Cayman Islands, the Bahamas and the British Virgin Islands are all more famous, or notorious, depending on your point of view. The second important issue that needs to be stated is that Mauritius is not the only country with which India has a double taxation avoidance treaty. In fact, it has similar treaties with many other nations. What is peculiar to Mauritius — and the reason for this story — is that the combination of the treaty and some Mauritian laws passed years after the treaty was signed has turned this tiny country into the most favoured tax haven as far as India is concerned.

Indian finance ministry officials claim that it is not just global investors who are taking advantage of these laws. They say that Mauritius is increasingly being used by Indian businessmen as well to launder money, shore up their holdings in their own companies and to indulge in all manner of financial chicanery. And that is why the Indian government has been frantically pushing to get Mauritius to change the terms of the treaty — or at least, amend their own laws. Over the rest of the story, we will explain precisely how the system works, why the government is keen to change it, and why that may be easier said than actually done. The Mauritian authorities explain why it would be disastrous for their economy (which is going through its own share of troubles), if the Indian government takes a hard stand.

The Treaty And The Creation Of An Offshore Haven

In itself, the double taxation avoidance treaty is innocuous enough. Essentially, the treaty simply stipulates that a Mauritian firm investing into India will not be taxed in India — and vice versa. Among other things, therefore, a firm registered in Mauritius investing in the Indian markets does not have to pay any sort of capital gains tax — which can be as high as 40 per cent on short-term gains made on an unlisted company’s shares — when it decides to book its profits and repatriate the money. The implicit Indian assumption behind signing this treaty was that these profits and firms would be taxed in the country of origin anyway — and, therefore, it made little sense to tax them twice over.

Unfortunately, this was not how things actually worked out. Coinciding with the opening up of the Indian economy in 1991-92, Mauritius passed a law that allowed any foreign investor to set up a global business company (GBC-1) in the country provided they fulfiled some minimal conditions and paid a nominal fee to the Mauritian authority. These companies could operate in complete secrecy, would pay only a nominal tax (3 per cent net), have no real operations or assets within Mauritius, but enjoy all the privileges of the Double Taxation Avoidance Convention (DTAC). (See ‘Why It Pays To Route Money Through Mauritius’)

It took some time for global investors to figure out the precise implications of the new laws. Once they did though, there was a veritable rush to start setting up GBC-1s. This, in turn, led to a flourishing industry to provide all the necessary support for setting up these GBC-1s. Corporate lawyers and tax consultants helped global investors work out how to make the transactions perfectly legal — and yet tax free — by using the Mauritius route. Practically every global bank that had a presence in both India and Mauritius began offering their services to their corporate clients. With GBC-1s being set up at a rather rapid rate — there are over 7,000 GBC-1s in Mauritius today, of which about 2,000 are primarily transacting business with India — the demand for Mauritians employed by management companies to provide the back office services and nominee directors also has shot up. Directly or indirectly, over 2,500 people are engaged in this sector, which may seem a relatively small number to Indians, but is very big for the Mauritians.

It has been great for the Mauritian economy despite the low tax rates that apply to the GBC-1s. The sheer amount of money flowing through the country itself has given a massive boost to its economy, both directly and indirectly. Apart from the fees charged for setting up companies and the banking transaction fees, there are dozens of other ways Mauritius benefits if it is known as a good offshore tax haven.

Why India Wants A Change

As the money flows between the two countries increased, the Indian government started looking closely at the transactions. And as they investigated, a couple of points came into sharp focus. Firstly, the treaty, which had originally proposed to help Mauritian firms to invest in India and vice versa, was increasingly being used by global investors instead. The Indian view is that the GBC-1s can hardly be called true Mauritian companies. Sure, they have been incorporated in Mauritius, but they have no real operations there. In fact, the only purpose of their formation has been to avoid paying taxes in India. According to Indian officials, the GBC-1s are nothing more than shell companies — a view that Mauritius of course disputes.

To support their argument, the Indian side points to growing global concern on the emergence of tax havens as more and more countries find their tax base eroded on this count. The OECD’s model tax convention clearly states: “Abuse of a treaty occurs… if a person (whether or not a resident of a contracting state) acts through a legal entity created in a state essentially to obtain treaty benefits that would not be directly available.” Indian authorities say that the treaty with Mauritius is being routinely abused by this definition. They point out that the treaty was signed earlier and Mauritius, subsequently, modified its laws to allow for setting up of GBC-1s, encouraging investors to ‘treaty shop’.

Internationally, there has also been growing concern on the use of such conduit companies. “There is no proof of who owns these companies. The benefits go to people who are not genuine residents of Mauritius,” says a government official. Not knowing the origin of the real investors and the money is certainly worrying. In other tax havens, there has been evidence of money from drug and crime cartels being laundered thanks to the secrecy promised. That might not be the case in Mauritius, but then there is no real way of knowing because the data on the investors of these companies is not available to the Indian authorities.  Read More...