Yesterday a new protocol was signed between Mauritius and India to amend the 1983 Double Taxation Avoidance Agreement (DTAA) and a joint communique was issued by the two parties. The three main provisions of the communique deal with:

1. Source-based taxation of capital gains on disposal of assets. India obtains and Mauritius loses the extremely important taxation rights on capital gains from the alienation of shares as from 1st April 2017;
2. Sourced-based taxation of interests of banks. India imposes a 7.5% withholding tax on banks’ interests on loans made after 31st March 2017;
3. Limitation of benefits clause to be eligible for a 50% reduction on capital gains tax in India during the transitional period of 1st April 2017 to 31st March 2019.

In addition there are grandfathering rights to protect investment in shares acquired before 1st April 2017 and interest income in respect of debt claims existing on or before 31st March 2017.

Mauritius has made an extremely poor strategic choice. As a direct result of the disastrous protocol negotiated in July 2015, the country has agreed to a very slightly improved but still very shocking revised treaty. It had the better option of refraining to sign any agreement and wait for General Anti-Avoidance Rules (GAAR) to be implemented in India.

A. Why have we thrown the baby away with the bathwater?

We all know that we had no choice than to share taxing rights with India as the days when all such rights rest with the resident country are numbered. However there is a huge difference between a sharing of taxing rights and giving away of all these rights to the partner country. Sadly this is what has happened in the new protocol signed yesterday by Mauritius.

Against all odds and expectations, Mauritius agreed last year to transfer the taxing rights on capital gains to India. It also accepted a new 7.5 % withholding tax levied on bank interests. The country took a totally different stand from the consistent, coherent and sustained stance adopted by all Ministers of Finance including Paul Bérenger, Pravind Jugnauth and Xavier Duval.

Four fundamental faux pas were made in July 2015 when Mauritius radically shifted its position:

1. it surrendered completely the taxing rights on capital gains to India instead of seeking a sharing of those rights with a limitation of benefits (LOB) clause;
2. it allowed the imposition of a 7.5 % withholding tax on bank interests by India;
3. it did not seek a most favoured nation (MFN) clause to ensure that our country is not discriminated against in favour of India’s other treaty partners such as Singapore, Cyprus and the Netherlands;
4. it included a grandfathering provision but it was embedded in the wrong paragraph;

Everybody was flabbergasted when the news of this dramatic change reached our shores. When the industry and well-informed specialists demonstrated the adverse consequences of the protocol, the then Minister of Finance wrote to his Indian counterpart to reconsider some of the clauses of the revised agreement. Since then it has been an uphill struggle at damage control by Govt. There has been some slight improvements in the awful protocol signed last year and this is being hailed as a great victory.

However the three major issues that impinge on the future of global business have not changed at all and as a result, the industry will face disastrous consequences. These relate to:

1. The transfer of taxing right on capital gains from Mauritius to India. This is confirmed in the new protocol and it takes effect as from 1st April 2017, less than one year from now;
2. The introduction of a 7.5 % withholding tax on bank interests by India. Again this is embedded in the new protocol and will be effective as from 1st April 2017;
3. The absence of a most favoured nation (MFN) clause to protect us against discriminatory practices. Again there is no such clause in the protocol signed yesterday and Mauritius is open to discriminatory practices as other treaty partners of India currently have much better provisions.

B. Whither capital gains tax, banks’ interest tax and a MFN clause in the new agreement?

We have surrendered completely our taxing rights on capital gains to India. Equally the confirmation of a 7.5 % tax on banks’ interests will severely impact international banks operating in our jurisdiction. And we currently have a major disadvantage compared to other treaty partners of India which have better provisions in their treaty than us. Until such time that their treaties are revisited, if at all.

Instead of this deeply one-sided protocol, I had proposed a more balanced text around the following points:

1. A more stringent exchange of information clause as per the Organisation for Economic Co-operation and Development (OECD) model with the possibility to graduate to an automatic exchange of information to better fight money laundering and other financial crimes;
2. A new clause on assistance in the collection of taxes;
3. A strengthened provision to further curb alleged round tripping;
4. A new taxing right to India on fees for technical services;
5. A new taxing right to India on other income;
6. A refined definition of permanent establishment;
7. A reinforced governance and transparency provision to ensure more business purpose and economic substance;
8. A bona fide and main purpose test clause for article 11 that deals with bank interests. This will guarantee more substance in Mauritius while preventing international banks from using the jurisdiction to simply book transactions on their balance sheet;
9. A sharing of taxing right on capital gains through an LOB clause to ensure economic substance. Companies that meet the LOB clause would be taxed on capital gains in Mauritius while those that do not satisfy the LOB provision would be charged capital gains in India on disposal of shares and assets.

A well-structured LOB would also allow Mauritius to meet the bona fide and the main purpose test as contained in the GAAR provision. The guiding principle has always been to strike a balance between the absolute necessity to protect, as far as possible, our vital economic and financial interests and the overriding need to meet some of the requirements of the Indian side. Negotiation is always about a balanced outcome where both parties obtain and/ or retain some benefits.

C. Grandfathering clause : no big deal and nothing given away by India

The protocol grand-fathers investment made before 1st April 2017 from capital gains tax and interest income on debt claims before 31st March 2017 from withholding tax in India. It was always understood that whatever agreement is finally concluded between the two countries, there would be a clause to safeguard existing investments and structures. This is grounded on the principle that taxation must apply prospectively and not retrospectively. Unfortunately even this clause was poorly drafted in the July 2015 protocol. There was a huge gap between what was agreed between the two par- ties and what found its way into the signed text. The rectification of this slip in the new protocol should not be heralded as a major concession by India. Even the very strict GAAR makes ample provision for grandfathering existing transactions. This was confirmed by Minister of Finance Jaitley in his budget last year. In addition, both the expert committee chaired by Dr Shome and the Parliamentary Standing Committee on GAAR have recommended that existing investments and transaction should be protected so that the image of India is not tarnished by the global community because of retroactive taxation. No great deal.

 “By signing the protocol today, we have unilaterally and completely surrendered our taxing rights on capital gains.”

D. The worthless two year transitional provision on capital gains tax

The protocol mentions a transition period when investment made in India as from 1st April 2017 will be limited to 50% of the domestic applicable tax on capital gains tax in that state if the disposal of these assets occur by latest on 31st March 2019. It essentially gives entities a two year period to raise funds, to invest and to exit. It is also conditional on the tax-resident entity meeting an LOB clause based on a threshold of expenditure on operations which should be at least Mru 1,500,000 in Mauritius in the immediately preceding period of 12 months from the date the gains arise.

As I explained to the Minister during our meeting, private equity funds typically have a life cycle of between 5 to 7 years. It takes them a minimum of 1 year to raise their funds and another year or two to invest in a pipeline of projects. They start disposing only after another three to four years. The transitional provision thus becomes a useless proposal as no private equity fund would be able to meet these conditions. It would be difficult even for capital market funds to satisfy this tough requirement. At least, we could have protected the investment made during that window rather than restrict the exit to a given time frame of two years only. I also cautioned the Minister that most funds would choose another jurisdiction where these two constraints do not exist. There are still other countries where there is no limit on the time to exit and no capital gains tax imposed in India on such investments and structures. At least until such time that their treaty is revised. Hence the importance of a MFN clause.

E. Better to have waited for GAAR than signed a bad agreement now

Our country was completely ill-advised to sign this new protocol. We have given up our taxing rights on Article 13 on capital gains with regard to investments and have accepted the imposition of a 7.5 % withholding tax on bank interests as from 1st April 2017. And there is no MFN safeguard to prevent discrimination against us. The game is simply not worth the candle. Put differently, as the disastrous clauses of the protocol of July 2015 are unchanged with respect to capital gains and bank interests on future transactions, we should not have signed any agreement. Instead we should have waited for GAAR to come into force as we would have been better off.

The basis for such a choice is very compelling

1. By signing the protocol today, we have unilaterally and completely surrendered our taxing rights on capital gains. It is game, set and match over for Mauritius as a jurisdiction to facilitate investment into India. GAAR would simply become irrelevant as we would have given up the most important taxing right;
2. ii) If we had not signed up today, we would be subject to the bona fide business and main purpose tests of GAAR when it is introduced in April 2017. However we would have retained the taxing rights on capital gains. It is plain that structures and arrangements that pass these two tests would not be classified as impermissible transactions and would thus be eligible for exemption from capital gains tax in India as per the treaty. There are many funds that would meet these twin criteria. Why on earth have we killed all these structures which could easily cross the GAAR hurdles?
3. iii) There is provision for grandfathering in GAAR. This was recommended by both the Shome Committee and the Parliamentary Standing Committee on GAAR. And it was specifically mentioned by Minister of Finance Jaitley in his 2015-2016 budget speech ;
4. iv) There are deep constitutional issues at play on whether GAAR will override bilateral treaties between sovereign nations. There are many legal experts in India who would probably take the matter to the highest judicial body to seek an interpretation.

F. The economic importance of the India treaty

It would be extremely difficult to build a strong, robust and sustainable international financial centre without the India traction. The critical mass of activities would simply be missing. This is plain from the official figures issued by the FSC and the IMF in terms of outward foreign investments, portfolio investments and private equity funds. The treaty with India accounts for almost 75% of the value addition of global business. For the high income generating funds (essentially private equity and real estate funds), India represents 73% of total investment while Africa generates only 4% of that amount. We ought to make the distinction between the number of structures set up and the quantum of investments and their value add. Africa will help for diversification but there is no comparison in terms of investments, value addition, economic substance and employment generated in what India contributes. Especially at a time when there is strong headwind against Africa with the end of the commodity super-cycle and the plummeting of its export prices. While India will be the fastest growing economy in the world. It is so clear that we have cut the branch of the tree on which we are sitting. This is similar to building a sustainable tourism industry without Europe, Réunion, and South Africa!

G. Concluding remark

We needed a balanced outcome that would have somewhat protected the economic interests of Mauritius while accepting some of the demands made by India. Undoubtedly the sector would have been affected by any review that includes a LOB and a bona fide and main purpose test. The industry had no choice than to accept that there will be some loss of business going forward. What worries the industry and is a major cause of concern for the country is the scale of the losses that will occur and the damage inflicted with this new protocol. It is the difference between a tremor and an earthquake.

In the absence of such balanced outcome, our country would have been much better off not to sign the new text and to wait for GAAR for the simple reason that we would have retained the taxing rights on capital gains and many funds and investments would be eligible for treaty benefits.

The global business sector has become the sacrificial lamb on the altar of a cynical collateral agenda. Putting at risks such a vital pillar of our development agenda for what could turn out to be very expensive and highly speculative real estate dead ducks is the height of economic irresponsibility. I categorically turned down a grant of US$ 200 m in 2007 as compensation for surrendering our taxing rights on capital gains as I firmly believed that the global business sector is worth significantly more in terms of growth, diversification, economic linkages and spin offs, quality jobs for our youth, human and skills development, tax receipts, foreign exchange earnings, innovation, efficiency and productivity. Little did I realise then that the fire sale would take place 9 years on with some adjustments for inflation in the pay-off.