India-Mauritius Tax Treaty

Tit Bits

Even if the Indian government rolls back and clarifies some of the tax changes, there are legitimate concerns that the relevance and scope of the Mauritius-India investment route may still be permanently impaired…

By R. Chand

The radical taxation proposals contained in the recent Indian budget have raised considerable alarm about the ability of Mauritius to maintain its pre-eminent role as an offshore location for investments into India. In response, the Mauritian government has adopted a wait-and-see attitude, probably on the premise that the Indian government will backtrack on the proposed tax changes in the presentation of the Finance Bill in the Indian Parliament during the last week of April, under the mounting weight of harsh international criticism of the retroactive nature of the tax amendments and of the sweeping taxation powers accruing under the tax avoidance rules. 

Some cynical observers claim that treaty abuse by round-tripping of investments has closely involved the interests of Indian politicians, businessmen, bureaucrats, movie stars, and gurus alike — an influential constituency that will ensure that the tax proposals are rescinded or watered down despite the hue and cry from the Indian public for a crackdown on endemic corruption and black money. These observers, which include offshore operators, also point to the resilience of the tax treaty, in spite of the unending spate of financial scandals involving Mauritius over the years.

Opinions are nevertheless divided in the offshore industry on how to react to the impending changes. Not everyone is convinced that the Indian government will materially review the proposed changes in tax legislation to preserve our position as an investment base by virtue of a privileged relationship with India. Even a cursory reading of the finance bill raises fears that the special nature of this relationship may well have been blown to smithereens. Unlike what happened in 2000, Indian stock markets have not so far recorded any major drop to reflect foreign investor disapproval, although many international investors are warning of major capital outflows if the finance bill is not revised. The Indian minister of finance has only provided some vague reassurances of tax clarifications that nevertheless seem to have calmed stock markets. He emphatically stated that India is not a tax haven country, whatever that means. Indian finance officials have defended the retroactive nature of some tax changes, arguing that these were meant to clarify the legislation, and the minister also hinted that the retroactivity would not exceed 6 years.

Ironically, the British Chancellor of the Exchequer, who did not waste time in rushing to India to defend Vodafone’s interests, a British company affected by the retroactive provisions, had threatened a retroactive application of the law in his own March budget, in respect of a newly-introduced stamp duty on property transfers. Though the Indian government is pressed to strike a deal to leave Vodafone alone, it does not necessarily mean that others can heave a sigh of relief.

Even if the Indian government rolls back and clarifies some of the tax changes, there are legitimate concerns that the relevance and scope of the Mauritius-India investment route may still be permanently impaired, unless Mauritius can continue to demonstrate the strength of its unique relationship with India.

A good segment of the offshore sector is urging that Mauritius should urgently engage in a frank and open dialogue with India at the highest levels to preserve its special relationship in channelling investments into India, while providing more substance as an offshore location. Foreign investors need to see continuing evidence of this special relationship with India for basing their investments to India in Mauritius.

There is a need to impart a sense of urgency and muster leadership from the highest quarters in Government for this dialogue to happen. Not much time is left, and our bargaining strength with India will be drastically curtailed once the Finance Bill is approved by the Indian Parliament without a consequential review, by end April. If this initiative is to succeed, Mauritius must demonstrate its commitment to a new strategy that ensures tangible commercial substance, shows greater respect for India’s tax sovereignty, and promotes a mutual harnessing of the benefits from global capital flows.

A consensus for a fresh and active stance must also be established within the offshore industry, since many offshore management operators are dead against reaching any sort of deal with India to exhibit greater substance in offshore operations. Their clients are mostly smaller investors that cannot afford the cost of providing more substance, and will thus no longer go through Mauritius. Larger offshore management companies however have bigger clients, for whom the costs of substance do not matter much. Smaller operators feel they are unfairly paying the price for the past misdemeanours of others.To address the challenges confronting small offshore operators, Government should be prepared to provide support, through favourable tax treatment, and assistance on training, marketing and promotion. In this regard, it would be judicious to consider a resurrection of the Financial Services Promotion Agency, or setting up any kind of specialized institution for promoting the development of the financial sector, including offshore services.

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New Reform Strategy in the Civil Service

Senior officials of government and trade unions met this week to discuss the findings of a Draft Technical Overview Note prepared by the World Bank on the new reform strategy in the Civil Service. The Report notes that the transition within the public sector from management based on inputs to one based on results — that is, from administration to management –, will have to be supported by appropriate reforms. Addressing some of the significant capacity and human resource constraints will go a long way towards smoothening this transition process. Some of these reforms are easily implementable like the lengthy recruitment process. However, for a meaningful number of reforms proposed in the draft note, we strongly believe these will have to be properly sequenced to ensure progress in improving the efficiency and effectiveness of the public sector. The appropriate preconditions will have to be fulfilled before such reforms are initiated. These are some of the comments we have gathered from some key stakeholders.

Accountability — Performance Contracts and Performance Management System: The Programme Based Budgeting process (PBB) is still at its early stages and we are still up the learning curve. At the moment, the output specifications, costing, reporting and monitoring tasks are in the early stages and are not sufficiently developed to provide assurances about accountability for performance.. Another area that needs attention is ensuring that ministries and other budgetary bodies have ownership of their Programmes and that there is sufficient internal management capability to support increased flexibilities including sound budgeting and that well-developed processes for costing, performance specification, reporting, monitoring, proper internal audit and audit committees are in place.

Uncertainty about authority: An organisational structure that is aligned to the programme structure is desirable for accountability and reporting purposes. It is critical that there exists a clear and unique relationship between the budget programme structure and the organisational structure, so that programme implementation and service delivery can be monitored and the appropriate unit of organisation can be held accountable. If programmes are falsely imposed on an old organisational structure, the result is PBB in form but not in substance. Recognising that changing organisational structure is not easy, this is an objective to be achieved over the medium to long term.

Decentralisation and Ownership: Significant progress can be made through a logical sequence of steps while building ownership, managerial capacity, confidence, and experience. Before the performance agreements take root, it should be possible for the Ministry of Finance to ease the regulations by giving line ministries’ managers broader discretion in operating their programs. Line ministries must be able to control inputs before they are called upon to control outputs; they must be able to account for cash before they are asked to account for cost; they must abide by uniform rules before they are authorized to make their own rules. Obtaining the strong support of the organisational leadership and managers can be facilitated by giving them the necessary flexibility to achieve goals. Without this flexibility, managers will have the responsibility for achieving targets without the ability to deliver, and no one wants to be held accountable for targets that are not within his/her control.

A full-fledged Ministry of Economic Planning (MEP): The report notes that the introduction of the Performance Based Budget (PBB) in Mauritius has progressed in the absence of a comprehensive strategic planning exercise at the national and ministerial levels — “The merger of the Ministry of Economic Planning and Development, which used to develop the National Strategic Plan for 5 years, with the Ministry of Finance in 2003 resulted in a loss of strategic planning capacity within the Government at the national level. This has created a challenge for Ministries in developing their strategic plans – as the link between sectoral and national objectives is not explicit. Sector planning capacity needs to be developed in order for the proper costing and evaluation of policy options to occur.”

The setting up of Planning Cells in line ministries does not solve our problem; it had been tried in the past and it has proved, as in the case of the present Planning Implementation Units (PIUs), to have very little value addition. We need a full-fledged Ministry of Economic Planning to develop a holistic approach to policy formulation in critical areas of human and economic development, in sectors which require coordination and synthesis like health, water, energy, education and environment protection that have yet to be subjected to coordinated policy formulation. An integrated approach can lead to better results at much lower costs. Presently, we are operating in a fragmented and dispersed manner giving rise to a lot of inconsistencies, incoherence and confusion. A Ministry of Economic Planning and Development will provide an integrated planning framework and will be a driver of policy reforms. Unlike other ministries, it does not have a vested interest and so can be expected to think out of the box and present an unbiased opinion. It will thus provide the catalyst to the economy to enhance overall economic efficiency and improved growth.

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Capital inflows and appreciation of the rupee

If we restrict ourselves to facts, we will have to acquiesce that the capital inflows accounted for a large part of the appreciation in our real effective exchange rate (REER). These are supported by successive IMF reports. Mauritius: 2008 Article IV Consultation — Staff Report notes that large capital inflows have added to demand pressures, compounded by supply-side constraints and inefficiencies.
The real effective exchange rate appreciated sharply — by 17% in the 12 months ending February 2008 from an overly depreciated level in 2005-06. The same report indicates: “Large foreign investment inflows, projected to rise to about US$1 billion per year (12 percent of 2007/08 GDP), risk overheating the economy, especially if the fiscal deficit is not reduced further and structural reforms are not pursued to improve the supply response. Should large capital inflows persist as projected, the REER would be expected to appreciate over the medium term, preferably through an appreciation of the nominal rate. The impact of appreciation could be offset by further fiscal consolidation and the implementation of structural reforms aimed at improving the supply response and reducing inflationary pressures.”

In Mauritius: 2011 Article IV Consultation-Staff Report, it is clrealy pointed out that “a part of the appreciation is attributable to the real appreciation of the actual exchange rate, which is likely related to the record FDI inflows and large government external borrowings.” It is true that the imports for 2011 might have reversed some of the steady appreciation of the rupee. But in the medium-term these imports, which are not capital imports, are not boosting our productivity or our export potential and thus will not bridge the gap between the REER and its equilibrium value. Hence, the misalignment of the REER will tend to accentuate because imports will be increasing more than exports (because of IRS) and the Current Account Balance of the Balance of Payments will continue to widen and if this is not accompanied by still higher FDI, we will be left with no choice but to devalue the overvaluated REER.

Such FDI is not sustainable in the future and it is not boosting our export competitiveness in any meaningful way. Mauritius: 2012 Article IV Consultation-Staff Report, besides highlighting that with the relatively quick rebound from the world economic crisis, FDI and other investment flows returned to pre-crisis levels in 2010–11, which translated into a slight real appreciation over that period, reports that the authorities are concerned about the impact of a real exchange rate appreciation on export competitiveness. The Staff Report recommended that “the authorities monitor real exchange rate developments in relation with its fundamentals going forward. Further real appreciation not warranted by fundamentals might be resisted through sterilized interventions, but such policies should also be supported by fiscal adjustment and productivity increasing reforms to facilitate external adjustment.”

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A University for the Mediocre

Universities are all over the place; a university for the poor, a university for the elite. We would not mind a university for the mediocre — those that have not gone through the elitist CPE system, which churns super rats for a rat race instead of nurturing excellence and creativity, and that does not allow students to think, question and reason rather then regurgitate rote lessons and compete for irrelevant percentages. Those that have successfully come through our present system are assumed to be achievers having scored high grades; the others are the mediocre ones. We want to work with the mediocre ones for we want to reduce the importance of results in selecting applicants and apply greater weight to activities such as sports and the arts. We want to work with mediocre ones who have not had their brains burnt out by rote memorization and there is still some space to assimilate practical applications and instill some creativity.

We do not want to overlook bright kids who would make good citizens that would perceive things better, be ready to work in a world where jobs are rarely for life and where adaptability is as prized as knowledge and creativity and be good entrepreneurs. Our mediocre ones are however guaranteed not to be misfits as compared to the achievers when they get out into the real world. Our university for the mediocre will cultivate the strong traditions of freedom of spirit and inquiry that have been the hallmark of great universities throughout the ages, will develop a national appreciation for discovery, entrepreneurship and the creative process.

Our university will the apogee of extreme education in bringing out students’ talent and potential and inspire them to life-long learning. It will be learning-oriented rather than teaching-oriented. That’s the only way our mediocres will beat the odds, as long as a dysfunctional educational system is a fact of life.

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* Published in print edition on 6 April 2012

Tags:British Chancellor of the Exchequer, CPE System, Draft Technical Overview, India-Mauritius Tax Treaty, Indian Parliament, New Reform Strategy, Performance Contracts, Performance Management System, R. Chand, Vodafone, World Bank