:: Paranjoy Guha Thakurta

The end of tax havens?

By Paranjoy Guha Thakurta

Apr 05 : "We should endorse sharing information and bringing tax havens and non-cooperating jurisdictions under closer scrutiny". This is what Prime Minister Manmohan Singh said on Wednesday at a dinner meeting in London, on the eve of the meeting of the heads of state of the Group of 20 (G-20) countries (actually 21 countries and 9 international institutions).

Cut quickly to a new location. Mauritius is an incredibly pretty group of islands in the south-western part of the Indian Ocean off the coast of Africa. The now-extinct bird, dodo, was first sighted in Mauritius four centuries ago, around 1600, and became extinct barely eight decades later. The beautiful beaches of Mauritius attract tourists from all over the world. Mauritius is a preferred destination for another set of visitors who, while working, do not wear shorts and bikinis. Their preferred attire is a dark suit. They carry briefcases and are adept at arithmetic.

Mauritius, Libya and Seychelles are the only three African nation-states that are placed high on the Human Development Index compiled by the United Nations. Mauritius is home to more than 9,000 offshore corporate entities, many of them doing business with India. The population of Mauritius is 1.3 million; its national income barely $7 billion. Yet, investment in its banking sector is over $1 billion. Why? Mauritius is a tax haven.

What’s a tax haven? The Organisation of Economic Cooperation and Development (OECD) — a grouping of 30 of the world’s most affluent countries — states that a tax haven is characterised as a country in which the tax rates on individual incomes and profits earned by corporate entities is zero or close to zero and which encourages non-residents to escape paying taxes in their own countries. According to the OECD, there are 35 countries classified as tax havens, of which three (Andorra, Monaco and Lichtenstein) are currently described as "uncooperative" tax havens for their refusal to disclose the identities of persons and firms holding accounts in their banks or those engaged in businesses in their respective "national jurisdictions".

On Thursday, the G-20 issued a statement in London, a portion of which read: "The era of banking secrecy is over". It called for blacklisting those tax havens that did not adhere to the "international standard for exchange of information". That’s not all. British Prime Minister Gordon Brown explicitly stated rather dramatically: "This is the beginning of the end of tax havens".

Really? If we are to believe Mr Brown, will the well-heeled, number-crunching tourists stop visiting the sun-kissed islands of Mauritius in the not-too-distant future? As the ongoing worldwide economic crisis gathers momentum, devastating countries across the globe, there is a growing international consensus on the need to drastically curb — if not stop altogether — the practice in tax havens of allowing smart lawyers and accountants to set up "shelf" or "shell" companies that are essentially convenient conduits for laundering illegal money obtained by not just drug pushers and arms peddlers but by those who have committed fraud and evaded taxes.

Mauritius is not like any other tax haven. The country has had a special relationship with India. Its government is controlled by persons of Indian origin and it’s not really that far from our shores. Since August 1982, the governments of India and Mauritius have had a Double Taxation Avoidance Treaty (DTAT) that has allowed for "treaty shopping", a phrase which implies, among other things, that investors from third countries with relatively high rates of taxation on income earned from transactions in shares and other securities can get away without paying capital gains tax by routing their funds through Mauritius. To be fair, India has similar treaties with over 50 countries, including at least 16 treaties that are almost identical with the Mauritius DTAT.

Thanks to the absence of capital gains tax and the low incidence of taxation on corporate profits, these thousands of international companies have set up shop in the idyllic island nation. That is why we have a ridiculous situation at present: Mauritius is the single largest source of foreign investment in India although its economy is more than a 100 times smaller than ours! During the decade of the 1990s, investment inflows from Mauritius were the highest among all countries and a good 50 per cent above the inflow from the world’s largest economy, namely, the United States. The government of India’s department of industrial policy and promotion estimates the cumulative total inflow of FDI in the form of equity capital to be just under $100bn between August 1991 and September 2008 — $96.43bn to be precise — of which close to half or 44 per cent was routed through Mauritius.

Unscrupulous promoters of Indian companies have been known to use firms located in Mauritius to illegally ramp up the prices of their own shares through the use of "participatory notes" issued by international fund managers. The Securities and Exchange Board of India had submitted a detailed report in this regard to the Joint Parliamentary Committee that investigated the 2001 stock-market scandal involving brokers like Ketan Parekh.

There is a section within the country that has for long been unsuccessfully arguing that the Indian government should scrap the DTAT with Mauritius despite the "political and diplomatic implications" of offending a "friendly" country. There have been long drawn-out legal wrangles on the modalities of foreign companies, including foreign institutional investors, being exempted from payment of capital gains tax by using a certificate issued by the Mauritius government stating that such firms are "residents" of that country.

A powerful section of politicians and bureaucrats in India do not want to change the treaty with Mauritius. These are the people who shout the loudest about why the government of a friendly country should not be antagonised. They are probably also the same individuals who have parked their black money in Mauritius. If India truly wishes to assist the people of Mauritius and not just its politicians, lawyers and accountants, it would probably make better economic sense for this country to provide grants instead of allowing that country to be used as haven for a breed of money-launderers and financial sharp-shooters who are far from "dead as a dodo".

Paranjoy Guha Thakurta is an educator and commentator based in New Delhi