Why it is important to tread carefully
It has been announced that the Mauritius-India double tax avoidance treaty is up for re-negotiation in coming December. This re-negotiation is apparently taking place against the backdrop of misgivings on the Indian side regarding abuse of treaty provisions. This is a serious matter which should not be taken lightly if only in consideration of the impact it may have on the future good running of Mauritius’ financial sector which accounts for over 10% of GDP and makes a significant contribution to total high value-added employment.
But we may first take a look at the nature of bilateral double tax treaties.
The philosophy underlying the signing of double tax avoidance treaties between countries is simple. Individuals and companies who are resident in one country can make taxable incomes/gains in another country. Not unusually, laws of the country in which those persons are resident require them to pay local taxes on them; however, the country where the incomes/gains were made may also require them to pay taxes thereon. In such a case, the incomes/gains are taxed twice, once in the country of residence and again in the country where the money was made. This is inequitable and can act as a deterrent to the undertaking of cross-border business activities. Countries therefore agree bilaterally among themselves as to where specifically the incomes/gains should be taxed, preferably in a single jurisdiction to avoid the inequity referred to earlier. Usually, it is in the country of residence that the tax is applied. When two countries reach an agreement to this effect, they sign a double tax avoidance treaty (DTAT) between them to enshrine, amongst others, the taxation principle and the exchange of information they contemplate between themselves to avoid tax evasion.
As of date, Mauritius has 42 bilateral DTATs with so many countries, of which three are yet to be ratified by the authorities of the two countries. The DTAT with India was ratified by the two countries in 1983. For much of the time up to the late 1980s, this treaty was in a dormant state. Two events precipitated its acceleration as from then. First, the Mauritian government was keen to explore offshore financial activity as an economic undertaking in its own rights in the manner of several other countries in other parts of the world that had been thriving on it for several decades past. Enabling laws were thus introduced to clearly define the scope of offshore financing in Mauritius and to demarcate it from other domestic activities which were subject to all sorts of internal controls. Offshore activity brooks no such administrative hassles.
Second, in 1991, India, which had heretofore been subjected to a policy of obstructionist administrative micromanagement, decided to liberalize the economy. This immense shift of policy was a clear invitation to investors worldwide which, coupled with the fact that international capital flows had been liberalised since the early 1980s in most of the West, created the opportunity for Mauritius to intermediate the flow of capital to India.
Everything started falling neatly into place. We gradually built up our reputation as a rule-of-law common/civil law jurisdiction. We had a trained workforce of legal and financial professionals, i.e., the skills to handle international transactions in an accountable and professional framework. The Indian diaspora and other major institutional investors, in their quest for investing into India, built up trust in our capacity to do at least as well as they could have done it through other jurisdictions. On top of all this, the DTAT with India conferred sufficient tax incentives for international capital investment activity to choose Mauritius as a route for channelling investments to an India which was in great need of capital to raise its infrastructure in particular from the levels in which they found themselves in those days.
There is nothing unusual to the role that befell upon Mauritius in the context with regard to India. Typically, international investors are in search of the finest advantages they can obtain, be it from a tax minimisation angle, from having access to as wide a variety of professional services as possible in a jurisdiction with good international credentials and from putting in place smart structures through which to route their investments profitably and internationally. This is why Jersey, Guernsey, the Isle of Man and such others enhance the role of London as an offshore financial centre acting even more finely than we, given the support they have from numerous specialised law and accounting firms operating from those places. Similarly, the enduring economic success of big American corporates and of New York as an offshore financial centre par excellence has been built upon the support of offshore financial centres like Delaware, the Bahamas, the Caymans and the Caribbean. Singapore, Hong Kong and Labuan have acted in an identical manner to propel the growth of, say, China. They still do the same and are busy trying to diversify their target client base.
The Mauritius-India DTAT has drawn attention to itself from several angles. Some stakeholders in India have shown concern that more than a third of total FDI flowing annually into India has come from entities resident in Mauritius over several years. Not that India does not need that much of FDI. It may need even more given its appetite for capital projects. Some have raised their eyebrows as to how Mauritius could account for such a large share of the FDI into India. They suspect that part of the money coming in as FDI to India through Mauritius would actually be money somehow deviously moved out of India at some time or other from some sort of a parallel economy operating in India. This is a legitimate concern and much bad blood could be avoided by increasing cooperation between the two countries to sort out how much of this is substantial. Mutually supportive effort will go a long way to sort out such concerns, the more so as emotions are running high in India about political corruption and the jury is still out about whom to scapegoat for all the mess.
It would also stand to Mauritius’ credit and sustained good international standing not to condone or aid and abet in the commission of financial crime in India or any other country for that matter. By definition, a parallel economy escapes the normal scrutiny that one could apply to otherwise legitimate transactions. It is tougher to identify the source of trouble in such cases. There is much point however in the view that an emotional surcharge on the side of the presumed victims in dealing with the problem in such cases may run the risk of creating a situation whereby the baby may be thrown out with the bathwater purely on grounds of speculative rumour. If the burden of collaboration in sifting the wheat from the chaff is fairly shared between the two state parties, there would be no need to put the treaty itself under scrutiny or call its bona fide into question, short of finding a solution to a side issue.
One needs therefore to do the careful manoeuvring of issues so as not to unnecessarily undermine the attractiveness of the treaty itself to international investors wanting to invest in India. No one knowingly loses a whole ship for a half penny worth of tar. Moreover, it has served nobody’s long term interest to cast doubt on an economically performing instrument from time to time rather than doing all that is possible to maintain confidence in it at the highest level between the two friendly countries.
There are barely 20 years between the time India opened up to the world and the Mauritius-India DTAT came in handy for helping push up India’s renewed business agenda in the bigger world. This is too short a cycle to do away with an instrument by withdrawing or neutralising the essential features on which it has thrived and served India’s interests so well this far. It may be miscalculated to impair the working of a system which has paid off so well to both states and has potential to keep contributing to economic growth.
Issues like “round-tripping” (flow back of funds originating from India back to it as investment from abroad) and “treaty-shopping” (companies routing investments through a preferred treaty channel to secure tax advantages) can always be tackled through the good intentions and cooperation of the two parties but the bigger picture should not be lost sight of.
History has demonstrated time and again that risk-taking and opening up have contributed much more than introducing different sorts of controls on systems which deliver. Global economic liberalisation from the 1980s has enabled more poor people to be taken out of poverty than over the several decades since decolonization when the world was operating on constant fears that tomorrow might be darker than yesterday. When horizons are opened up instead, even better than before, not only economic growth is accelerated. These situations also help the Exchequer collect much higher revenues than before and eventually afford to widen incentives that economic agents usually look for within the scope of DTATs. It is worth pondering whether this positive direction is not worth fighting for on both sides rather than putting in jeopardy, under political pressure, advantages that have been secured in a globally highly competitive world by dint of hard work over several years giving the Mauritius-India DTAT the unique mission it has been able to accord to itself. To the mutual benefit of the two countries. With proven results.
In view of the key importance the DTAT has achieved in delivering tangible results to the two treaty partners so far and the potential it still has to deliver further more despite the clouds gathering on the international economic front, the December discussions should, in our view, be constructive and carried through with mutual respect. The unique flavour this treaty has conferred upon all parties, were it to stay, would send signals to all concerned that backtracking on principles is not on the agenda but that repairs to prevent the treaty from being abused are the shared concerns of the two treaty partners. It is never all black or white; there are shades of grey as well and this is the negotiating ground.
* Published in print edition on 18 November 2011