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Island hopping

10 April 2012 By Jeff Glekin

India’s offshore tax grab is bad news for Mauritius. Some investors on the island have responded to the country’s crackdown on tax avoidance by shifting their operations to Singapore. Yet while the city state is a better established financial centre, the very act of hopping islands may attract the interest of the authorities.

Mauritius owes its tax status to historic ties with India, which resulted in a treaty signed in 1983. It’s certainly been successful – over 40 percent of portfolio investment and more than 42 percent of foreign direct investment into India emanate from the tropical paradise. But the long, tax-free holiday may be coming to end.

New Delhi’s overhaul of its tax regime goes wider than just trying to claw back tax on Vodafone’s purchase of Hutchison Whampoa’s mobile business, which was controlled by an offshore entity based in the Cayman Islands. The government has also proposed general anti-avoidance rules which will over-ride existing treaties.

The new regulations, which look likely to come into law this month, place the onus on investors to prove they are not operating a business model that is explicitly structured to avoid tax. Most investments channelled via Mauritius will struggle to clear this hurdle: often the only connection to the island is the address of the investor’s law firm.

Hence the rush to Singapore, which also has a treaty with India that applies a zero tax rate on short-term capital gains. Investment managers will have less difficulty arguing that they have a substantive business operation in the financial centre.

But the anti-avoidance rule could be a trump card. Any fund which shifts its location from Port Louis to Orchard Road will struggle to argue it did so for any reason other than avoiding tax. Besides, if India’s objective is to close loopholes and increase revenue, then it’s not at all clear why it would crack down on Mauritius while leaving Singapore untouched.

The ambiguity means that funds will have to pass on the risk to their customers – or even pull out altogether. Though the Indian government is making moves to reassure investors, its track record is shot through. Even a favourable Supreme Court ruling wasn’t enough to protect Vodafone. If investors respond by simply turning to safer markets, then Mauritius, Singapore – and India – could all lose out.

 

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