May 2010

Indian companies are routing tens of billions of dollars through Mauritius each year in a giant tax avoidance scheme



India is changing its tax laws in a bid to introduce greater transparency into its financial transactions with Mauritius. The aim is to stem ‘round-tripping’ of funds by politicians, businessmen and criminal syndicates, and assuage concerns about the unregulated and ‘hot’ money which transits through the Mauritian economy and into India. The licit and illicit financial flows from Mauritius account for as much as 90%, or tens of billions of dollars, of foreign direct investment in India each year.

Round-tripping via Mauritius involves the use of the 1983 Double Tax Avoidance Agreement (DTAA), a tax holiday advantage provided by Mauritius and other tax havens, to re-route money transferred illegally out of India. The illicit funds are then transferred back to India as legitimate foreign investment in the Mumbai stock market via participatory notes. These ‘P-Notes’ are used by overseas investors not registered with Indian regulators, allowing them to acquire shares anonymously, which triggers allegations of widespread money laundering. Much of the money invested through P-Notes is legal and comes from sources like hedge funds, which seek to benefit from the non-taxation of capital gains on Indian stocks bought in Mauritius, but Indian officials worry because they cannot separate the good money from the bad.

Questions over financial flows are hotly debated in Indian politics. The opposition Hindu nationalist Bharatiya Janata Party claims that over $1.5 trillion – enough to wipe out India’s external debt – has been parked around the world in tax havens like Mauritius and ‘significant sums’ are routinely round-tripped back into India, especially via the P-Notes conduit. These funds have been particular targets of BJP members of Parliament Lal Krishna Advani and Bhartruhari Mahtab, who told the press that ‘dirty money’ was coming into the bourses through the back door.

Tax authorities are obviously concerned about the massive loss of revenue to the state on the huge sums of money that transit through Mauritius. Federal revenue intelligence officials told Africa-Asia Confidential that billions of dollars are transferred daily from India to locations around the world via the informal but highly-organised hawala system. Hawala is based on a global network of money handlers. It again came into the spotlight when linked to a failed truck bomb in Times Square, New York City, on 1 May. The officials say that a ‘large proportion’ of Indian hawala money ends up in Mauritius ready for laundering.

In defence of Port Louis

Market analysts say that most of the money that annually flows into India from Mauritius as foreign direct investment enters the largely bullish Mumbai stock market. Indian investors, they said, preferred dealing with Mauritius not only because of its geographical proximity but also because nearly 70% of its residents are ethnic Indians. Earlier this year, Mauritius tried to defend the DTAA. Milan Meetarbhan, the Chief Executive of Mauritius’s Financial Services Commission (FSC), argued that Mauritius was not a tax haven, denied the prevalence of round-tripping of funds to India and said that his government was ready to address Indian concerns about the DTAA. With hedge funds and others able to set up in jurisdictions like Singapore and the Cayman Islands, officials in Port Louis have worked hard to maintain the tax treaty with Delhi.

A squabble between India’s cricket organisers has shed new light on the financial flows from Mauritius (see Box). Without the 1983 DTAA and corporate tax rates as low at 3%, the financial services sector in Mauritius would collapse. The cricket controversy comes at a crucial time because the draft 2009 Direct Tax Code, which is now under debate and due to come into force in 2011, would abolish the benefits enshrined in the DTAA. In that sense, the DTC would strengthen the Indian domestic financial sector by increasing the tax-take but India’s private sector complains that such measures will deter investors.

First introduced in 2009 by the Indian National Congress-led coalition government, the draft DTC was a minor revolution in that it would allow the DTC to trump all of India’s 80-odd international tax treaties. The move was criticised by consultancies like KPMG, which said it had ‘shaken the faith of foreign investors’.

The revised tax code was open for debate in the early part of 2010, but powerful business and political lobbies support the status quo, which lets unregulated money flow in from Mauritius. Analysts said that the government was preparing to drop the clause that would allow the DTC to override India’s tax treaties. According to India’s Department of Industrial Policy and Promotion, around 43% or $35.2 bn. of the cumulative foreign fund flow of $81 bn. into India between April 2000 and May 2009 was routed via Mauritius. This is despite India having similar DTAAs with nearly 77 countries, including Britain, France and Germany. Foreign direct investment to India for the same nine-year period was $7.6 bn. from the United States, $7.7 bn. from Britain and $2.1 bn. from Germany.

‘This potential hot money from Mauritius accounts for a little more than half the FDI inflow into India each year which can not only influence stocks but also take flight swiftly in turbulent times,’ says financial journalist Virendra Kapoor. Despite talk of regulatory moves, no Indian government has taken serious moves to reform the tax arrangement with Mauritius since it is considered necessary to keep the stock market indices high. Consequently, a booming stock market also facilitated the corporate sector in raising funds locally for expansion through initial public offerings, effectively spreading the ‘feel-good factor’, Kapoor said.

During the last decade, financial scandals have repeatedly arisen. Under pressure from the opposition, successive Indian governments have all declared their intent to re-jig DTAAs, particularly that with Mauritius. However, a group of powerful businessmen, politicians and financiers in both India and Mauritius have always managed to stall it. The Mauritius link is a sophisticated and well-oiled mechanism which no one in government is willing to seriously investigate or alter.

The cricket controversy relates to the secretive ownership via Mauritius of at least one of the eight teams in the Indian Premier League, which plays a truncated version of the traditional game with the competing sides playing for 20 overs each. Intelligence sources say that high-profile politicians and leading businessmen are involved in the IPL controversy and it was ‘highly unlikely’ that anything concrete or ‘actionable’ would emerge.

Opposition politicians argue that the Indian economy would not have been hit as hard by the global recession had it not been for the P-Notes. ‘The P-Notes, which were “hot money”, were then [after the US financial crisis surfaced] just shipped out of India without any hindrance – to the tune of $60 bn. – in October 2008-January 2009, causing a stock market crash domestically,’ former Commerce Minister Subramanian Swamy said. ‘It is this that caused the financial crisis in India and not the US sub-prime loan defaults or exports drying up.’ In late March, the Securities and Exchange Board of India reported that money from P-Notes had reached an all-time low – only 13% of assets under management by foreign institutional investors, down from 55% in June 2007.

After a series of Indian securities scams in 2000-2001 which exploited the Mauritian tax rules, the FSC agreed to cooperate with the Securities and Exchange Board. High-profile trials were conducted, but Mauritian promises of help were not kept and business continued as usual. Talk of modifying the DTAA arose again in 2006 and Mauritius said it would reform tax residence rules. With the ongoing tax reform debate and the cricket controversy making headlines, there is pressure for change but – like previous scandals – that too will pass.