#dnaEdit: What does new taxation protocol signed between India and Mauritius mean?

While economic analysts and politicians have always revelled in the increasing foreign direct investment (FDI),  foreign institutional investments (FIIs) and foreign portfolio investments (FPIs), a closer look at the data showed a distorted picture with a big chunk of the foreign investment coming from tax havens like Mauritius. The arrangement with Mauritius, whatever its loopholes, was based on the 1983 Double Taxation Avoidance Treaty, enabling the Indian Ocean island-country to be the top source of FDI, FII and FPI. It accounted for one-third of the foreign investment inflows. Interestingly, of late Singapore has been competing with Mauritius for the top slot for investments. Singapore has slipped into the second position for 2014-15 after getting to the top in the previous year. In 2014-15, the inflow from Mauritius was US$9.03 b, while that from Singapore was US$6.74 b, out of a total of US$30.93 b for the same period.

The new protocol signed between India and Mauritius on Tuesday in the Mauritian capital of Port Louis will not come into effect immediately. The present exemption on capital gains tax from Mauritius will continue this financial year. From April 1, 2017 to 2019 there will be a 50 per cent tax on capital gains on investments from Mauritius. 

There has been concern for nearly a decade that the foreign fund inflows from Mauritius was round-tripping of Indian tax evaders taking the money out of the country and bringing it back into the domestic market through Mauritius, taking advantage of the capital gains tax exemption. Of course, this remains a mere hunch and no exact study has been made whether Indian black money is travelling home via Mauritius. It is but right that this loophole should be plugged because it gives an unfair advantage to those ducking the system compared to others doing the business according to law. There is also the speculation that perhaps wily investors will now look to other tax havens like Cyprus to route their funds. It is also not yet clear as to what will be the increase in tax collection because of the change in the treaty between India and Mauritius.

What should be of interest to analysts is whether a substantial part of India’s foreign funds inflows is really Indian money making its way home through a detour, and that Indians are investing in their own growth though in a roundabout way. If that is indeed the case, the rational thing to do would be to reconsider the capital tax gains on investments as such, whatever be their source. If finance minister Arun Jaitley believes in what he says about lower taxation and higher growth, then investment-friendly tax rules must be put in place. This would prove to be a positive disincentive to those who are engaged in the circuitous way of routing their funds.

The more substantial case against the avoidance of double taxation treaty with Mauritius is that it gives undue advantage to Mauritius over other countries, and that to encourage investments from all countries, there is a need to create a level playing field as it were. India has of course double taxation avoidance treaties with many other countries as well. However, unlike in Mauritius, these countries do not have near-zero domestic taxation rates on investments. 

It can be argued that investment imperatives made it necessary for India to accept the lax tax rates of Mauritius, and that this has not harmed India greatly. The new thinking that tax collections could be increased by tapping this source either betrays anxiety about increasing tax collections, or it shows the confidence that India is receiving foreign investment and it does not have to offer incentives to attract fund inflows.