India cracks down on a major tax evasion route
A guest blog by Abdul Muheet Chowdhary
My award winning essay, written for a competition jointly held by the Tax Justice Network and Oxfam International, focused on how India is unable to meet its child rights obligations as it loses a huge amount of tax revenue because of some policy decisions taken by the government. These decisions enable tax abuse, and as is being increasingly understood, tax abuse is a human rights issue.
One of these decisions is the Double Taxation Avoidance Agreement (DTAA) with Mauritius, a favourite tax haven for Indians. Under this, Mauritius based companies selling shares of Indian companies are effectively exempt from capital gains tax. This encouraged tax evaders to route investments into India through Mauritius based shell companies, leading to lots of tax revenue foregone. Official data states that over the 15 year period from 2000-2015, the highest amount (34%) of total FDI into India was from Mauritius, valued at US$ 93.6 billion.
What Basically Happened
This treaty has now been amended after years of negotiations between the two countries. From 2017, Mauritian investors will be taxed on capital gains at half the Indian rate (meaning 7.5%) till 2019, after which the full rate will apply. This basically removes the incentive for tax evaders to route funds through Mauritius as they will be taxed anyway. In that sense it plugs a major loophole. It is also one of the remedies sought in my essay and it is a stroke of good fortune that action on the issue has been taken so quickly.
Shell companies are exempt from the half rate during the two year transition period. If a Mauritian resident company has spent less than 1.5 million Mauritian Rupees on operations in the preceding year, it will be deemed a shell company. This is a rigorous definition and will include almost all shell companies.
The government has announced that it will now rework (on similar lines) its DTAA with Singapore, another major tax haven and the second biggest source of FDI after Mauritius.
- A major loophole has been plugged, so the amount of tax revenue lost through the ‘Mauritius route’ should decrease.
- This will provide more resources to the government to carry out developmental activities such as building more schools.
- Other governments around the world can take inspiration/warning. A historic litigation is unfolding in Kenya, where the government is being taken to court for its tax-abuse-enabling DTAA with…Mauritius.
- It’s also a victory for the ‘source-based’ principle of taxation, which states that tax should be levied where the money is made, as opposed to where the company is based (which is what the ‘residence-based’ principle states). The residence-based principle works to the advantage of rich countries, where most large corporations are headquartered, to deprive poor countries of their fair share of taxes.
- It seems that other securities – mutual funds, exchange-traded derivatives and convertible or non-convertible debentures, to name a few – will be exempt. Thus other options for investing illicit cash remain. All eyes will now be on the contents of the long-pending General Anti-Avoidance Rules.
- Its application is prospective, not retrospective – meaning farewell to the money lost so far.
- Mauritius (and Singapore) are the biggies, but by no means the only ones. Evaders will likely shift to other havens, such as the Netherlands or British Virgin Islands.
Despite these drawbacks, this is a big step forward and certainly a boost to the global effort on tax havens. An intergovernmental tax commission in the UN is needed now more than ever to catalyse these individual efforts and enable globally coordinated and consistent action against tax havens.