Taxation treaties: Anxious to keep a place in the sun

Taxation treaties: Anxious to keep a place in the sun

By Wheatly Aycock

Published: March 11 2008 19:41 | Last updated: March 11 2008 19:41

Mauritius worked hard to earn its special status, and the country might have to work harder to keep it. Its advantages as an offshore investment centre are being whittled away year by year, as the developing economies on which it relies revisit their taxation treaties with the island. For more than 20 years, favourable tax treaties with India and China have formed the backbone of Mauritius’s financial sector, which is the biggest contributor to its gross domestic product.

In 2004, India, China and Indonesia together received 78 per cent of the nearly $60bn – the vast bulk of it to India – in foreign investment that flowed through Mauritius. International investors reaped huge tax benefits by putting their money into Mauritius-based companies that used the tax treaties to invest in third countries.

Tax authorities in India, China, and Indonesia, however, have lately joined more developed countries in scrutinising offshore investment structures. The Indonesian government unilaterally allowed its treaty with the island to lapse in 2005, citing “round-tripping” abuse. Indonesian companies, in other words, were putting money into Mauritius-based companies, only to reinvest that money at lower tax rates in Indonesia. India too is concerned about revenue lost to round-tripping, and may seek to renegotiate its treaty. This poses a threat to the island’s most lucrative symbiotic relationship.

Mauritius-based companies have accounted for more than 44 per cent of all foreign direct investment into India over the past seven years, and the bilateral tax treaty is seen as the foundation of Mauritius’s success as a financial centre.

“There is now no possibility of round-tripping,” says Rama Sithanen, the finance minister, echoing the government’s increasing sensitivity to the concerns of its treaty partners. “We have strengthened the regulatory framework and monitoring.”

Mauritius has also tightened up its residency requirements, meaning that companies must have much more than a post box on the island to avail themselves of bilateral tax advantages. Doubts remain, however, that the authorities can eliminate round tripping. While they can identify the origin of the investment, the nationality of individual investors may not be known.

As the Indian and Chinese economies mature and their risk profiles lower, there is also less of a sense that wholesale incentives for investment are necessary to attract capital. Savvier regulators from India, China, and other emerging markets are starting to make investors pay more dearly for stakes in their markets.

China, for instance, implemented a withholding tax on dividends in January, meaning that distributions from Chinese companies to their Mauritius investors – or any investors – will first be taxed in China, resulting in diminished income streams to investors. South Africa is expected to do the same in the next couple years.

Scrutiny of investment structures comes amid a global crackdown on tax abuse and avoidance. While Mauritius is not a tax haven such as Liechtenstein – where a tax-evasion furore erupted in February – the global taxation climate is changing for offshore investment, as more countries impose anti-abuse laws and reduce the number of exemptions.

What distinguishes Mauritius from most tax havens is that it does not have strict confidentiality laws that attract investors to the Cayman Islands and Liechtenstein for example. It is thus seen to guard to an extent against tax evasion.

China, which received more than $1bn through Mauritius last year, reviewed its 21-year-old treaty in January 2007, expanding the conditions under which capital gains tax would be levied on sales of Chinese holdings. It has also imposed a domestic anti-abuse law aimed at offshore investment. It may be this latter change that proves most significant for Mauritius. Reputation is crucial to the country’s success; the island must walk a line between offering investment incentives and ensuring commercial probity. “We want to sell Mauritius as a credible, strong financial centre in this part of the world, which is why we aren’t going to take any risks as far as our reputation is concerned,” says Mr Sithanen.

To compete with other tax havens in the stricter global tax environment, Mauritius might need to market itself anew. Enjoying the lowest withholding tax rate – 5 per cent – that China applies to any country, the island is still attracting plenty of China-bound money.

But Hong Kong and Singapore are becoming more attractive too, both for their proximity to China and for their incorporation of China’s anti-abuse law into their treaties with Beijing.

For the time being, however, Mauritius continues to offer tax advantages to offshore investors and to maintain 33 treaties. Mr Sithanen says the country can adapt as needs be. “We do what most countries do,” he says. “We try to keep abreast of what is going on in the world.”

Wheatly Aycock is an international transactional lawyer working in southern Africa