Interview Rama Sithanen – ‘We have sacrificed a key pillar of our economy for only US$ 350. It’s simply mind-boggling’

‘We are in deep trouble. We are in a hole…
… and Bhadain keeps digging with conceited fury and arrogant zeal’

Following the signing of the revised Mauritius-India Double Tax Avoidance Agreement (DTAA) the mood among economic and financial players is definitely gloomy. The consequences for Mauritius as regards investment and our economic future are likely to be severe and impact several sectors negatively. Our guest is economist and former Minister of Finance Rama Sithanen, who gives our readers a no-holds barred view of the negotiations and the expected fallouts, in a semi-technical language that will make it accessible to the understanding of our readers.

Mauritius Times: Reactions to date to the revised Mauritius-India Double Tax Avoidance Agreement (DTAA) would suggest that the final blow has been hit to the Global Business sector of this country. What do you think went wrong in our negotiation strategy?

Rama Sithanen: The deadly mistake was made when the infamous protocol radically revising the 1983 DTAA treaty was finalised by Roshi Bhadain in Delhi in July 2015. After some of its contents were made public, I vehemently criticised it as it was against our economic interests. I was savagely attacked by him. He was so patently wrong but as he is totally new to the arduous game of negotiating tax treaties, completely inexperienced in handling sensitive economic issues, and lacking in domain-knowledge of the implications of the DTAA on Mauritius, he did not see the merits of my arguments even if it was from someone who has negotiated for almost ten years with three Indian Ministers of Finance, from Dr Manhoman Singh to Chidambaram to Pranab Mukherjee on this subject.

However, after my explanations sank in and sustained criticisms from many quarters persisted, Vishnu Lutchmeenaraidoo wrote to his Indian counterpart to reconsider some of the awful clauses. Then during a visit to India, our Prime Minister did the right thing by taking a different position and requested PM Modi to help the ‘little brother’ to cushion the adverse effects of that terrible protocol. Since then, Bhadain has been renegotiating the terms of a new protocol. We know the outcome since Tuesday last with the signature of a new text. Put simply, Mauritius has been awfully shortchanged.

Essentially because Bhadain has used the catastrophic July 2015 as a basis for the negotiation. As it was an egregious agreement, even some slight improvements means that it is still a deeply flawed document. Having made the initial blunder, it was near impossible to modify the agreement in our favour against the extremely seasoned Indian negotiators. We also made the strategic error of removing the chairpersonship of the technical committee from the very able Secretary for Foreign Affairs Usha Canabady-Dwarka. In so doing we lost the advantage of continuity in the tough discussion and the broadening of the negotiating remit to beyond simply a tax issue between the two Ministries of Finance.

* The Indian authorities had intimated in the past through their respective PMs that India would not propose any unilateral revision of the treaty for economic, political and diplomatic reasons. While the element of uncertainty was there, the DTAA had been saved thanks to the intervention at the highest political level in both countries. What is it that has changed now?

To be fair, our Prime Minister after realising that Bhadain had blundered did change position and asked PM Modi to reopen the negotiation so that the harm to our economic and financial interests could be mitigated. This gave hope to the industry that something good would come out from that review.

Unfortunately miracles do not happen. It was never going to be easy to get the mandarins at the Indian Ministry of Finance to give in on something that they have been trying extremely hard to obtain for almost 15 years. However thanks to the consistent, sustained and coherent stand taken by all Ministers of Finance since then including Paul Berenger, Pravind Jugnauth, Xavier Luc Duval and myself, we never gave in on a total transfer of taxing rights to India on capital gains.

What had changed was very simple. All Indian PMs were willing to help us even if it was difficult for them to go against the wishes of their Ministries of Finance. But the Indian Prime Ministers could arbitrate as long as Mauritius played its cards well. But once we committed the 2015 blunder by voluntarily and proudly surrendering the taxing rights, he could not become more ‘royaliste que le roi’ and instruct his Minister of Finance not to maintain a tough position.

* What will be, according to you, the immediate, medium-term and long-term consequences of the revised DTAA in terms of business, employment and job creation?

The size, composition and architecture of the global business pillar will be considerably altered. As India starts taxing capital gains in April 2017, there will be both an output and a substitution effect.

First, as the costs of investment in India rises with the new tax, India will lose some foreign direct and portfolio investments. As Mauritius has around 40% of that market, we stand to lose.

Second, there will be a strong substitution effect. There are three distinct possibilities. Firstly, some investors may go directly to India without using an international financial centre like Mauritius. This is in fact the strategy of India. It has lowered capital gains tax on disposal of shares over the years and introduced low interest debts to encourage such equity and debt investments directly into India. We will lose out if this happens as we are an important provider of FDI/FPI into India.

Next, global investors will shift some of their transactions to other financial centres that compete with Mauritius. And there are many such competitive locations from Singapore, Cyprus, and the Netherlands. Without the benefits of the tax incentives, we could lose a sizeable chunk of the equity investment businesses that go to India.

And last, we hope that some investment will continue to use Mauritius for other than fiscal reasons

* So the equity side of the business will be affected . But we have obtained a grandfathering clause to protect existing transactions and this should certainly help?

It is a good thing that existing equity investments by companies and loans by banks are protected. However, I need to clarify three points. First, it was already agreed during the negotiation last year that whatever agreement is ultimately signed by the two states existing structures will be safeguarded. However our delegation made the mistake of inserting the grandfathering clause in the wrong clause. I pointed this out to the delegation when it came back to Mauritius. There was a disconnect between what was agreed and what found its way in the text. Now the rectification of this error is being hailed as a victory.

Second, it is established practice to grant grandfathering protection to existing transactions as taxes should be prospective and not retroactive. Two expert panels in India have recommended such grandfathering so as not to tarnish India’s reputation vis-a-vis global investors who do not like retroactive taxation.

Third, even the very strict GAAR to be introduced in India in April 2017 makes ample provision for grandfathering all investment and structures prior to 1st April 2017. It is therefore not a concession. However we are interested in the future of our global business and as from April 2017, capital gains on share disposal will be taxed by India and this will affect our financial centre.

* There is also a transitional period of two years to give time to Mauritius to adapt. This must be a good point…

While the transitional period is certainly welcome, I must point out that the conditions attached to it may be very difficult to meet. To begin with, the period of 2 years from 2017 to 2019 is too short for private equity and long term funds to benefit from. They will have to raise funds, invest in various projects in India and dispose of those investments before March 2019. The life cycle is generally about 5 to 7 years. Also investment holding companies and SPV’s that invest as from April 2017 and do not exit before March 2019 will not gain anything. There may be an opportunity for foreign portfolio funds that operate on a shorter time frame.

Next is that these companies must satisfy a bona fide business and main purpose test and a substance test. While the substance test is explicitly spelt out at around US$ 42000 that must be incurred on annual operational expenses in Mauritius, the subjective bona fide and main purpose tests are not clearly stated.

Then, there is a 50% reduction on applicable taxes on capital gains. It means that these investments will be subject to a tax while this is not the case today. It is difficult to anticipate the reaction of short term players.

Finally, it will also depend on what happens to the tax treaties which India has with other countries. If the other treaty partners of India have better tax provisions, then investment will migrate to those centres. Will Singapore structures prior to April 2017 be grandfathered like for Mauritius? Will Singapore insist on the same terms as Mauritius with respect to both the transitional provision and the 7.5% withholding tax on bank and other interests? What will be the terms and conditions of the new treaty between India and Singapore?

All these remain unclear. Hence my proposal to Bhadain that we should have asked for a Most Favoured Nation clause to prevent discrimination against Mauritius. Will Cyprus remain black-listed?

* How will the new protocol affect the activities of international banks in Mauritius?

We need the presence of global players for the brand, image and repute of our financial centre. Some international banks have come to Mauritius because there is no withholding tax on bank interests on loans made to Indian companies.

Now with the introduction of a 7.5% tax on bank interests by India as from April 2017, it is clear that the competitive landscape will change. And if we add the 3% tax paid by these banks on their profits in Mauritius, the total tax will be 10.5%.

Some banks may be tempted to move to another centre and serve the Indian market from there. It will also depend on what Singapore obtains in its negotiation with India on tax on bank interests.

* You do not seem not to find a single positive provision in that protocol? There must be something good in it, isn’t it?

I have told you the ‘acquis’ that we have lost – what we have built painstakingly over 22 years of good work by all governments since 1992 and what we are likely to lose from the new protocol. While diversification is certainly important, we should not forget about consolidation of what we have achieved. This is my concern. We have sharpened our competitiveness and acquired experience and expertise in two key areas of activities with India. The equity side of the business and the bank loans aspects of the supply chain. This represents around 90% of our activities with India and both will be acutely affected.

Of course we can develop new areas based on what exists in the 1983 treaty and what has been obtained in the new protocol. First there may be an opportunity with respect to Article 13 on investments that are not shares and equity. In the current 1983 treaty, Mauritius has the exclusive right to tax capital gains on instruments other than shares. These will apply to instruments linked to derivatives, PE notes and debt related products. There may also be prospects to develop a niche in debt instruments other than bank loans through Article 11. Non-bank debt will be levied at 7.5% similar to the tax on bank interests as from April 2017.

To tap into these opportunities will require a different set of skills and strategy than Mauritius has embraced up to now. There are also other competing financial centres that have first mover advantages in those two niches. We will have no choice than to probe further into these two areas to understand how our country can benefit from them. You are asking a football player to become a rugby player. May be we will have to swiftly make this transition to survive.

* Our Global Business sector will probably be weakened due to the revised DTAA, but we will have gained Rs 12.7 billion grant from the Indian government that will be used for the Heritage City and to build a new financial city. Isn’t that not good enough?

It is plain that waiting for GAAR was much better than this egregious protocol. Most analysts believe Bhadain signed because of the US$ 350 m and his obsession to find funds for his pet Heritage project and a new financial city.

In 2007 we were offered a compensation of US$ 200 m in exchange for giving up our taxing rights on capital gains. At that time there was no question of a 7.5% tax on bank interests. I turned it down as Minister of Finance simply because the contribution of global business in terms of growth, employment, government revenues, foreign exchange earning, balance of payment, economic diversification, innovation and skills development was considerable. And that it would be utterly irresponsible to sacrifice such a key driver of the economy for US$ 200 m. The US$ 350 m is not far if we adjust for the nine years that have elapsed and to the additional loss of the zero tax on bank interests.

In 2007 we did a quick study to find out the economic value of the global business sector based on the four key parametres of economic growth, jobs, government revenue and balance of payment, and reached a figure of around US$ 4 b to US$ 5 b. This included the direct, indirect, induced and catalytic effects of the industry. If adjusted for growth for the last nine years, the worth would be around US$ 6.5 b to US$ 8 b in 2016.

To sacrifice such a massive contribution for only US$ 350 is simply mind-boggling. We have auctioned a key pillar of our economy for 5% of its economic consideration.

* Besides allegations of shell companies, lack of substance and round-tripping, that have served as grist to the mill of the anti-DTAA militants in India, are you convinced that the authorities in Mauritius have done whatever is possible and necessary to appreciate the concerns of the Indian authorities and to allay their apprehensions?

Let us look at the evidence. All Governments have responded to demands of India on exchange of information whenever there have been requests to cooperate to fight money laundering and other financial malfeasance. We have upgraded our exchange of information with India and have offered to graduate to an automatic exchange of information which is the latest standard in the industry.

We have at the request of India changed the condition for the renewal of the tax residency certificate that grants treaty access. We are the first country to have agreed that India posts a tax officer at its High Commission in Port Louis to strengthen the collaboration between the two tax authorities.

I am not aware of any proven case of round tripping in spite of constant allegations in the Indian press. Substance is clearly defined in our legislations and regulations and we have recently enhanced the substance criteria to add more economic value in our country. The treaty has been defended by India in court cases and the treaty has been upheld in many landmark judgements. Of course time has changed and we had no choice than to revise the agreement. However we made a strategic mistake in surrendering all our taxing rights to India rather than opt for a sharing of those rights.

* Not signing the new revised treaty was not an option, according to the Minister of Good Governance, since India’s General Anti-Avoidance Rules (GAAR) would have caught up with us in 2017 anyway. Isn’t he right?

He is wrong again. The Minister wanted my views on two key points. Whether what he was going to sign is good and whether it is better to sign now or wait for GAAR. You know my views on the first point. Based on what he told me he would sign, I advised him not to go ahead and to instead wait for GAAR.

The rationale for this is very simple. By signing today, we give up the most important taxing right. GAAR thus become immaterial as the taxing rights on capital gains will be with India. However if we had waited for GAAR, we would have kept the taxing rights and it would have been the onus of the tax authority of India to prove that Mauritian structures do not pass the bona fide business and main purpose test to be eligible for treaty benefits. Probably all the funds that are domiciled here would have passed the twin tests and be entitled to treaty benefits.

Secondly, GAAR also allows for grandfathering provisions. It is obvious to the naked eyes that he has signed because of the honey pot of US$ 350 m. This is sheer economic recklessness.

* Have we been building up alternative substantial markets for our global business sector? What are the options available to our Global Business operators now that things have come to the crunch? Does Africa look like an attractive option to you? The Global Business sector will surely survive, will it not?

The size, composition and architecture of global business will change. This is an extremely competitive sector. There are more than 70 jurisdictions that are promoting global business in one shape or another. Frankly, we have no choice than to diversify in terms of products, services, and geography and create significantly more integration between the global business and the domestic economy.

We need to think out of the box to come up with innovative solutions. The challenges would be enormous. India represents around 75 % of the value of investment and contribution in the global business sector while Africa is at around 4%. It will therefore take a very long time to replace what India is for us. This is very well articulated in the latest Article IV report of the IMF on Mauritius. It explains in a very cogent way the importance of the treaty with India and the significant risks to the country if it is profoundly modified.

We have to consider the two opportunities that may arise for business with India in terms of debt structuring in Article 11 and instruments other than shares such as derivatives in Article 13. We must encourage regional headquarters to set up here. Of course Africa and the China corridor represent opportunities for diversification. We have no choice than to step up our engagement with Africa. While it is good to be upbeat, we need to understand the challenges and not live in a dream world.

Africa is 54 or so very diverse states as opposed to India which is one country. There is hot competition to have a slice of the Africa cake. On the back of the revised treaty with India, countries in Africa may seek a review of their DTAA with us on the same basis. This would put us at a competitive disadvantage. The value of the deals are still low compared to the high value add from India. We have made another mistake by reviewing the treaty with South Africa. Since the revised text, there has not been much traction of investment into South Africa using Mauritius.

Also Africa has entered a new phase with the end of the commodity supercycle and the drastic fall in its export prices. We have to be innovative and inventive. But we should also be realistic and not sell dreams to people.

* With the Global Business sector now likely to be weakened and the billions that would probably have to be forked out should arbitration go in favour of Betamax and BAI, the future does not look particularly bright on the economic front. It would appear that the worst is yet to come, isn’t it?

As someone who has followed the development agenda of my country for almost 40 years, I am very concerned about the current outlook and near term prospects. All informed analysts and many of my fellow citizens I meet share this growing anxiety. We will simply not grow by more than 5% per annum, we will not be able to generate 15000, let alone 25,000 jobs per year. The share of manufacturing to GDP will not reach 25%. It has in fact declined to 17% last year. The share of investment and savings to GDP are simply too low to produce such outcomes.

We require bold structural reforms and economic adjustments in many critical areas to raise productivity, sharpen competitiveness, enhance skills and talents and remove bottlenecks so as to uplift the quality of life of our citizens.

Unfortunately confetti economics will not address the deep structural deficiencies of our economy. It will simply kick the can down the road to the next set of policy makers.

I was recently invited to share my views on the economic prospects of Mauritius to the top management of a highly respected institution. I simplified my perspective by stating that our economic destiny depends broadly on three sets of factors in the following proportion. And all three are not in good shape.

(i) – Around 60% depends on what happens in the global economy as we are an open economy;

(ii) – 25% is driven by the right policies. Policies matter considerably for success;

(iii) – 15% relies on the economic management capacity and credentials of the policy makers driving the national agenda.

* What is your honest assessment of the three factors?

The global environment is very tough at the moment. Growth in most countries is low, weak and uneven. The world is still battling to emerge from the throes of the economic recession and financial meltdown of 2008. Debts are very high, deficits enormous and fiscal and monetary space very small. Today interest rates are negative in some countries while many are actively pursuing very unconventional monetary policy to prop up economies. After quantitative easing, they will probably throw away money from the helicopter to stimulate consumption and investment. It is certainly not good news from the 60% except for tourism.

On the policy front, the consensus is that we have lost almost 18 months looking at the rear window and settling political scores instead of focusing on the key social and economic challenges. The economy is worst than on automatic pilot. It is in reverse gear. One can only hope that the new budget will represent a much-needed oxygen and confidence booster and a game changer to address the fundamental problems that beset our economy. If we do not embrace the right policies it will be difficult to have robust, sustained and shared growth. And we will remain stuck for longer in the middle income trap.

As to the economic management capacity and credential of the policy makers, it seems to me that the population has drawn its conclusion. Suffice it for me to comment on the performance of the two alleged economic stars.

Lutchmeenaraidoo returned to office on the back of a good track record in the 80s. But he became so cut off from realities that he turned out to be a calamity at Finance. Instead of focusing on economic data, financial statistics and trade figures to lead a paradigm shift, he was mostly driven by instinct, intuition and extra-terrestrial solicitation. The PM has rightly stated that he was very unhappy with his Minister of Finance and he has since lost his portfolio.

Bhadain is the brazen and presumptuous rising star even if he came to the job without much traction. I am deeply intrigued by what he thinks is good economics and great finance. A modicum of economic knowledge and a paucity of financial intelligence is enough to know that it is impossible for captive insurance to generate 10,000 jobs in our country. If we deliver one twentieth of that figure, we should go to pilgrimage to a holy site and say thank you.

I am simply amazed how he prides himself at having successfully renegotiated the tax treaty with South Africa. Since then there has been hardly any structure that uses our jurisdiction to invest in South Africa. Investments have dried out completely. And now he thinks that he has accomplished a marvel in the revised tax protocol with India. Whereas everybody who has some commonsense knows fully well that the exact contrary is true. And unashamedly and pompously he stated that he has achieved in one week – to revise the treaty with India — what Berenger, Sithanen, Jugnauth and Duval combined could not do in 15 years.

His sense of economic right and financial wrong is frankly at severe odds with most if not all people. May be he should tell us where he acquired such talent so that our children can avoid such places for their education and training.

With such economic credentials, no wonder we are in deep trouble. We are in a hole and Bhadain keeps digging with conceited fury and arrogant zeal. For the sake of the country I hope that the Prime Minister reverses the trend quickly with his budget and put us back on the path of strong, sustained and shared growth and prosperity.

* Published in print edition on 13 May 2016

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