A second reason why India wants some changes is that it suspects that Mauritius is providing an easy way for some less scrupulous Indian businesses to ‘round trip’ their money and bring it back into India through this route. Round tripping occurs when capital that originates in one country, say, India, goes through another country, usually an offshore tax haven, and then re-enters the first country (India) as ‘foreign’ investment. A senior investigation wing official explains the possible modus operandi of this round tripping. “Money leaves India through inflation of exports or imports or for some other ostensible business purpose or through the hawala route. It goes to another country and comes back into India through the Mauritius route. It is not easy to track down the money trail.”

There is no real evidence of this, but it has been alleged time and again by the authorities that insider trading is also carried out through this route, with promoters of companies buying shares of their own companies through a Mauritian GBC-1 and then selling it to make profits. The profits moreover, are free of capital gains tax due to the treaty. Since none of the Indian authorities — neither the finance ministry, the RBI or Sebi — know who the real owner of the GBC-1 is, there is no way of knowing who is up to what. “There has been evidence of misuse and these we feel are increasing,” says a senior government official. Many leading Indian companies have been receiving — in some cases, fairly large investments through the Mauritian route (see ‘Mauritian Money Flows Into Some Large Indian Firms’). Of course, there is nothing illegal in this. But the authorities allege that it is hard to believe that the promoters of these companies don’t know who is holding such substantial investments in their company.

The Left Front led by Rajya Sabha member Tapan Sen has been putting increasing pressure on the government to look into the misuse of the treaty. In letters dated 25 May and 4 August 2006 to finance minister P. Chidambaram, Sen argues that the National Common Minimum Programme (NCMP) commits the government to stop misuse of double taxation treaties. He argues that the NCMP stipulates that the “vulnerability of the financial system to the flow of speculative capital will be reduced”. He points to a CAG audit which says that income of FIIs and their sub accounts engaged in the business of investment in stock markets was being erroneously categorised as capital gains and being exempted from tax by routinely invoking DTA agreements.

The entire Mauritian DTAC was questioned some years ago in what was known as the ‘Azadi Bachao Andolan’. The matter was taken to court but the Supreme Court had upheld the treaty and its validity. From 1993 and in the JPC report in 2002, questions of misuse of the treaty have been raised time and again, but despite lots of loud noises no concrete steps have been taken by the various governments in power to check misuse.

Finally, there is the question of revenue loss to India. As the volume of transactions through Mauritius increases exponentially, the revenue loss is also turning out to be substantial because of the taxes being avoided. It has been estimated by the Indian side that the notional tax loss on the profits of just 20 such companies is Rs 140 crore in one year. “Now multiply this by the number of companies and every year and the quantum jumps dramatically,” says an official. He argues that since more and more money is now being routed through Mauritius, this loss is rising. According to Indian finance ministry sources, the total gain to Mauritius on account of the treaty works to only Rs 100 crore a year in terms of licence fees, renewal fees and so on, and only around 1,000 people are employed directly in the management companies. “It is evident that the loss of revenue on account of just 20 companies is more for India than the total gain to the Mauritian economy,” says a source. That alone, they argue, is grounds enough for India to ask for substantive modification.

Of course, Mauritius’ problem with that argument is that even the amount gained by its economy through licence fees and other transactions is substantial revenue for a tiny country like it. But more than the actual financial gain, it would mean losing a carefully built up new sector at a time, when its staple money earners — sugar and textiles — are on a shaky wicket

Easier Said Than Done

Modifying the treaty on the lines that the Indian government may want is easier said than done, simply because the resistance to change isn’t just from the Mauritian side. Besides, the economic, political and diplomatic relationship between India and Mauritius, there is a ‘small army’ of people within India which has a great interest in seeing that the treaty is not tampered with. “To start with, the Indian corporate sector benefits hugely from this loophole,” explains a finance ministry official. All examples of what they call misuse — though it’s not illegal — involve well known Indian business houses. Virtually all the leading foreign banks are custodians of the funds that flow in and out of the country, the volume of which is rising every year. Data collected from just four custodian foreign banks shows that there was a total inflow of $38,260 million during a two-year period (April 2004-March 2006) and a total outflow of $27,992 million.

Most of the top consultancy firms (E&Y, KPMG, PWC), for instance, advise their foreign clients who look at investing into India to come through the Mauritius route. There are several law firms in India, who advise the clients on all legal aspects. “When a client wants to come into India, depending on the nature of the investment, he is advised to come through Mauritius as that will be to his best tax advantage. The entire design and structuring of the company is done keeping this in mind,” explains a source in one of the legal firms. “There will be many more companies and individuals lobbying against any changes to the treaty in India than there will be in Mauritius,” says an executive in one of the top consultancy firms in India. He argues that substantive changes to the treaty will impact the Indian stockmarket adversely.
Supporters of the treaty argue that India needs to clean up its own act — either make it easier for investors to invest directly or routes like this one will persist. Says a partner in one of the top consultancy firms in India: “The government must make it easier to invest directly to discourage people from using these routes.” His point is that if it is not Mauritius, it will be Cyprus or somewhere else. For instance, he points out, the high dividend tax (33 per cent) on money repatriated makes it very unattractive for Indian businesses to repatriate dividends into India. “The companies simply park it overseas for other global business,” he says.

Indian PSU and government officials in Mauritius say that cases of misuse have, in fact, reduced. “In the 1990s, it was much, much easier to set up the GBC-1s and very less information was required by the regulatory authorities. It is far more stringent now,” says an Indian PSU official in Port Louis. Couldip Lala, director of IFS, one of the biggest management companies in Mauritius, argues that much of the talk that none of these companies have much Mauritian presence is untrue. Sure, there are Mauritian directors who serve in hundreds of GBC-1s, but then there is no reason why a person should not sit on the board of several companies if the nature of the companies allows him to handle many companies simultaneously.

“It is the time you invest not the numbers that are relevant. If it is a passive single investment with 2-3 board meetings in a year, it is not onerous. It is different from being on the board of a large manufacturing company,” he argues. Lala’s company has four directors and all the GBC-1s (around 500 are live) are divided among the four. Since two directors are required for each company’s board, each director is on the board of 250 companies. According to certain sources in Mauritius, one of the big management companies in Mauritius (these are owned and run by local Mauritians in most cases) provided directorships to 1,205 GBC-1s and one director served on the board of 776 GBC-1s! The fact that this is in contradiction to the established global norms of corporate governance doesn’t bother Lala or anyone else in Mauritius in particular, because as they see it, the very nature of the companies differs.

Lala also argues that “substance” depends on the type of operations a company undertakes. “Take an Indian example. A Tata Motors and a Tata Holding will have very different infrastructure, staff, etc. The holding company, which decides where to invest how much may not need much more than just a board and some secretarial services, whereas the manufacturing company will have huge infrastructure and staff. The nature of the business conducted by many of the GBC-1s do not require them to have this kind of staff or infrastructure,” Lala explains. His point is that one can’t have employees, offices and a set-up when it is not needed.

Lala says that many Indian companies are investing through Mauritius in other countries. The Mahindra group, according to him, is investing into China through Mauritius as the treaty between India and China is less favourable than the one between Mauritius and China. “Treaty shopping is certainly not illegal and investors all over the world choose the best jurisdiction to invest through. The idea is to structure your investment in such a way that you maximise your returns and that is legitimate. The only question one can ask is whether treaty shopping is fair,” he says.

Mauritian management company officials say that some other countries make it even easier to set up offshore companies. “There is no regulation or equivalent of the FSC in many other countries with whom India has such treaties,” points out Anil R. Ballah, advisor, Abacus Management Solutions, who has worked closely with many management companies in Mauritius. He argues that Mauritius has checks and balances which ensure that the money coming in is not drug or terrorism funds, something that many other tax havens don’t bother with. Their point is that management companies, FSC and banks in Mauritius do their best to verify the ownership and source of funds, but that may not be possible in cases where there is malafide intent.

While that may be true, the Indian government says it is trying to plug all such legal loopholes, so that whether there is malafide intent or not, the system becomes more transparent. A joint working group has been set up between India and Mauritius to resolve this problem and, by the end of the year, some specific proposals may be on the table. Though political considerations and hectic lobbying by interests in India are likely to prevail over revenue and other considerations, any radical changes to the treaty will be like a small tsunami for this beautiful island nation.

Post-box Companies

It has no office, no staff, not even a nameplate. If you try and locate the companies that are investing millions of dollars into the Indian stockmarket through Mauritius, you simply can’t find them. That’s because the GBC-1 companies exist only in the files of the management companies, who provide them all services after they help them start operations.

These management companies provide secretaries, staff, chartered accountants and ‘nominee directors’ to the GBC-1, the last being a pre-requisite for setting up such companies. These directors lend their name as they are ‘supposedly’ participating in board meetings of hundreds of companies. The board meetings are held telephonically with only the Mauritian directors present. In effect, all investment decisions are taken by individuals, who are not resident in Mauritius. Says a senior Indian government source: “If that’s not shell, what is? It’s evident that these companies are a conduit for routing investments from all over the world.”

Setting up these companies in Mauritius is fairly easy. All it needs is one shareholder and one director. The companies aren’t allowed to hold immovable property, cannot invest in securities listed on the stock exchange of Mauritius and cannot transact with the residents either, unless authorised to do so. It can open and maintain a bank account in foreign currency only. “The companies are there for one purpose and one purpose alone,” says an official. Moreover, under the Mauritius income tax law, such a company has to pay no tax on capital gains and interest income.

Mauritian authorities argue that these companies are not shell. “We have done everything to ensure substance. We can look at ways of increasing substance”, says FSC chairman Milan J. Meetarbhan (see interview on page 38)). His argument is that what Mauritius offers is way better than many of the other tax havens provide and several jurisdictions are very lax with their laws. But the Indian government doesn’t buy this argument. Their point is that either there is substance or there isn’t. “How can one increase substance? Either there is substance or there is no substance. There is no question of increasing substance,” says an official.