Tax gateways to India

By David Cay Johnston
August 9, 2011

By David Cay Johnston
The author is a Reuters columnist. The opinions expressed are his own.

The equatorial island nations of Mauritius and Singapore are competing for the role of preferred gateway for foreign investments into India and other Asian countries.

Think of it as a triangle, not of love, but of lucre.

Companies and rich investors use gateway countries so they can earn profits in such places as India, China and Indonesia.  Favorable tax treaties let them send dividends and other payments to such places as Mauritius and Singapore while paying little or no tax. The United States can even provide such benefits under some of its tax treaties.

These treaties are sold to the public as vital to avoiding double taxation of the same money and thus encouraging cross-border investments. Countries with tax treaties that enable lightly taxed or tax-free profits can benefit if their rules require local work by accountants, bankers, executives, investment bankers and lawyers, who earn high pay and require little in government services.

But just as tax laws can be drafted to fashion loopholes, so too can tax treaties.

One of the biggest loopholes involves what is commonly known as “black money” and a circular movement of capital known as “round tripping.”

Black money refers to capital that is being hidden, sometimes from the tax authorities and sometimes from partners, litigants, estranged spouses or even criminals such as loan sharks or drug dealers.

ROUND TRIPPING

Round tripping involves getting the money out of one country, say India, sending it to a place like Mauritius and then, dressed up to look like foreign capital, sending it back home to earn tax-favored profits.

The problem for the home country is that native profits escape taxation this way. And instead of foreign capital flowing into the country, local capital just gets a free ride.

While the principles are simple, the mechanics of getting black money to a favored tax treaty partner can be the financial equivalent of a Rube Goldberg machine, only this is no complex contraption that ultimately turns on a toaster or opens a door. Instead, cash moves out of the country in seemingly nonsensical ways designed to throw off auditors or anyone else trying to follow the money. Once the cash is safely out of the mother country, it’s easy to place it in a jurisdiction with a favorable tax treaty and to use a shell company to send the money back home so profits become tax-free or taxed at very low rates.

Under a tax treaty signed 28 years ago, Mauritius has been the gateway country of choice for foreign investment in India. Companies like Caterpillar, the maker of earth-moving equipment, as well as Bank of America, Citigroup and Wells Fargo invest in India via subsidiaries in Mauritius.

As the Indian economy has begun to take off — thanks to a mixture of high tech, manufacturing and call centers — seemingly foreign money has been pouring into India. Since the turn of the millennium about US$55 billion has come via shell companies set up in Mauritius. This is more than 40 percent of the direct foreign investment in India.

Tax authorities in New Delhi believe a lot of that investment was black money from India making a roundtrip to Mauritius. Overall the Indian Finance Ministry estimates faux foreign direct investments from Mauritius are costing it $600 million in taxes annually.

SUSPICIONS

India is not alone in its suspicions. Indonesia terminated its tax treaty with Mauritius in 2005, convinced that its government treasury, or fisc, was under assault from round tripping of Indonesian black money.

In India, a series of scandals, tax audits and investigations by the Central Bureau of Investigation, India’s anti-corruption agency, have strained the once intimate financial relationship with Mauritius.

And just as the two partners were sparring, along came Singapore, eager to show it can be a more faithful partner by acting as a tax-favored conduit for real foreign investment in India and not round tripping.

Singapore boasts that it does not allow shell companies, but rather wants a real economic presence. It puts the standard for that at S$200,000 a year spent running a Singapore office. That is a mere drop in a bucket of money, but as with perfume and love triangles, a drop may be all it takes to turn an already disaffected partner’s head.

While India has a reputation for letting legal issues drag on for years, it started talking publicly about a tax treaty with
Singapore last year and the two signed an agreement in June. Whether the treaty will actually deter round tripping remains to be seen, but on paper it looks better for India than the Mauritius treaty.

Mauritius has for several years dallied on negotiating a new tax treaty with India. But the speed with which India moved to embrace Singapore clearly motivated Mauritius to pay more attention to its longtime partner.

This past week officials in Port Louis and Delhi spoke of a new agreement being almost at hand. But then that is often how it goes in triangles, when one party is unsure of whether to stick it out with the old partner or move on to a new one.

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