Markets & the M word: Why Mauritius is a red herring

The Mauritius scare of Monday was not the real thing. The Bombay Stock Exchange Sensex, which crashed by over 500 points on hearing the M word on Monday, rallied on Tuesday even though the finance ministry has confirmed that talks with Mauritius to revisit the Double Taxation Avoidance Agreement (DTAA) are being resumed.

The big fear in the markets has always been that any tinkering with the DTAA will reduce foreign inflows into stocks. Most foreign institutional investors (FIIs) are registered in Mauritius since that country levies no tax on capital gains. Under DTAA, if you are registered for taxation in one country, you don't pay in the other. Mauritius-registered FIIs thus pay zero tax.

While there is no doubt that Mauritius stacks high up on the ladder of foreign inflows, its scare value is ephemeral. Photo by AlanCleaver/Flickr

But Tuesday's rebound in the markets shows that Monday's crash was meant to happen anyway, Mauritius or no Mauritius. Market insiders believe that the indices are heading down anyway and are looking for excuses to drop share prices. The M word came in useful for a day.

While there is no doubt that Mauritius stacks high up on the ladder of foreign inflows, its scare value is ephemeral. Of the $81 billion that has been invested in India since FIIs were shown the welcome mat in the 1990s, $35 billion has been routed through Mauritius. But a revision of the DTAA is not so worrisome anymore for three reasons:

One, most of the money coming in from Mauritius is in the form offoreign direct investment (FDI), which is long term in nature. As India does not impose any tax on long-term capital gains, most of the profit booked will anyway be non-taxable even in India.

Two, the government cannot tax the investment on a retrospective basis. So, investments made till date will not be affected. What might take a hit will be future investments from Mauritius.But India has DTAAs with 79 countries, which means money can find its way into the country through other routes.

Three, it takes two to tango. Or change the DTAA. Mauritius will probably take its time agreeing to changes, and even if it does, it may leave enough loopholes for investors to squeeze through. In any event, since a lot of the Mauritius money is suspected to be Indian money routed back through tax havens, there will be pressure domestically to go easy on this.

The DTAA clearly specifies the rates of taxes and jurisdiction on specified types of incomes arising out of a country and moving to a tax resident of another country. There are two provisions - sections 90 and 91 - under the Indian Income Tax Act, 1961, which provide for specific relief for taxpayers to save them from double taxation.

Section 90 is for taxpayers who have paid tax to a country with which India has signed a DTAA while Section 91 gives relief for those who have paid tax to a country which has not signed any DTAA with India.

While FIIs investing from tax havens are exempt from capital gains tax, those operating from the US and the UK claim their gains as business income which makes them liable to tax in their home country.

With so many options open for investors to route the money in the country without paying tax, why is the government reviewing the treaty? One plausible reason is that the government wants to show it is acting on closing down black money routes in the light of the pressure it is facing from civil society and the Opposition.

But the faceless tax evader still has other doors to come in with hisinvestment and exit without paying taxes.

For more enlightenment on the Mauritius DTAA and what many people are suggesting should be done with it, read this, and this (chapter 9), and this (page 29).

Published Date: Jun 21, 2011 03:10 pm | Updated Date: Dec 20, 2014 01:44 pm