An imposing 12-storey building opposite the cathedral in the heart of Port Louis, the capital of Mauritius, is best known as the home of its stock exchange and several government offices reports the Financial times
But a few years ago, the block received attention in the Indian press for another reason. It was identified as the address of a surprising number of companies and funds that together were responsible for billions of dollars of cross-border investment.
The questions over the seemingly insubstantial companies with an outsize bearing on the Indian economy were a sign of growing tensions over the role of Mauritius as a tax-efficient conduit for investment into India. A third of all investment in India this century has come from Mauritius, according to the Indian government.
But in May, Mauritius and India agreed a far-reaching revision of their tax treaty, which is expected to halt much of the investment from Mauritius.
The tax treaty was originally agreed in 1982 — a time when Indira Gandhi was India’s prime minister and her government was keen to buttress ties with a strategically important state with which it shared heritage and culture.
The India-Mauritius tax treaty exempted investors from Indian capital gains tax on the sale of Indian securities, which could otherwise range from 10 per cent to 40 per cent. Investors made the most of its favourable terms, funnelling nearly $96bn of investment into India in the 16 years to March.
But over the past decade India has become increasingly irritated by the scale of tax avoidance that was permitted by the treaty. When it announced the treaty revision in May, it said it would “tackle the long pending issues of treaty abuse”.
It said the changes would also prevent “round-tripping”, a tax avoidance ruse by which individuals and companies sent funds abroad and then returned them via Mauritius-based companies.
The changes under the terms of the revised treaty will be made in phases starting with a 50 per cent reduction in capital gains tax between April 2017 and April 2019, after which the full rate will apply. The relief will apply only to companies that spend more than $40,000 in Mauritius in the 12 months before the sale. This clause is designed to stop “shell” companies reaping the benefits.
Indian tax experts say the change will have a big impact on the behaviour of investors. Gautam Mehra, a partner at professional services firm PwC in India, says that inflows from Mauritius could drop significantly from March 2017. “The advantage of using Mauritius for capital gains tax protection on shares will no longer survive. Its use will be far reduced,” he says.
But for private equity investors, there might be administrative advantages from continuing to use Mauritius as a hub. Mr Mehra adds: “Some categories of alternative investment may continue to use Mauritius, such as private equity funds, which pool investors from anywhere in the world. This would not require the investors to go through Indian tax compliance, although the amount of tax they paid [would be] ultimately the same.”
Another reason some equity investors might continue to use Mauritius is its network of “bilateral investment protection treaties” with more than two dozen countries around the world including India, Egypt and Tanzania. These accords are perceived to lower the risk of investments.
In a recent report, Moody’s, the credit rating agency, said the fall in investment flows could deteriorate Mauritius’s balance of payments, which would put pressure on the country’s foreign reserves.
Ramesh Basant Roi, governor of the Bank of Mauritius, is sanguine about the change, saying it “eliminated uncertainty that plagued the industry for years”. He says that nearly all the 22 banks operating in Mauritius have “drastically reduced” their exposure to liquidity risks that arose from the revised agreement. “The domestic foreign exchange market has remained flush with foreign currencies,” he adds.
Moreover, he points to a potential silver lining in the revised treaty for Mauritius. It has lowered the withholding tax on interest payments — which was as high as 40 per cent — to 7.5 per cent. That is lower than rival jurisdictions, raising the possibility that Mauritius could become an attractive base for investing in Indian debt securities.
The financial services industry is therefore eyeing the debt market, which is potentially four times as large as the market for India-focused equity investment. Rama Sithanen, a former finance minister and now chairman of International Financial Services, says Mauritius could become the centre for debt financing going into India.
India needs $100bn of foreign direct investment a year, not all of which will be in the form of equity, says Mr Sithanen. “There are a lot of opportunities there for us to leverage.”