Mauritius Treaty Network Creates Tax Avoidance Loopholes as a Conduit for Resource Flight
By
Everlyn Muendo
International Financial Centres (IFCs) were previously associated with major global cities such as London, Paris and New York or overseas territories such as the British Virgin Islands. However, this has changed, with the steady rise of IFCs in Africa.
Two IFCs are present in South Africa namely, Cape Town and Johannesburg, with another two being established in the East African Community (EAC) namely, the Nairobi International Financial Centre (NIFC) and the Kigali International Financial Centre (KIFC).
This is not to mention the Mauritius International Financial Centre (MIFC) whose (bad) reputation precedes itself.
Consequently, what are IFCs and how do they relate to Double Taxation Agreements (DTAs)?
The Problem of IFCs in Africa
IFCs may be described as ‘financial free zones’, or areas which are structured to provide financial services to foreigners or non-residents.
They are structured to attract foreign investment through tax incentives, 100% foreign ownership, laws that are distinct and more favourable to foreigners than the non IFC area, full repatriation of profits and a dispute resolution system that is predictable.
Aside from these incentives, IFCs make it very easy for foreigners to set up companies and other such entities, by offering a host of corporate solutions.
These include allowing for the setting up of holding and management companies as well as special purpose vehicles, in order to make procedures as simple as possible by reducing the bureaucracy that is normally involved.
Such characteristics of IFCs are expected to have a positive effect on the flow of foreign investment into a state, particularly if a country is in need of financing for development projects.
However, IFCs can be very harmful to a state’s economy in relation to its domestic revenue mobilisation (DRM) efforts.
This is because the lax regulations and tax incentives that IFCs provide are often used to channel capital out of states with no real intention of initiating real economic activity within countries.
Finances are then whisked away through the IFC for the purpose of avoiding taxes or some other regulation that may be present in capital importing countries or the final destination of the money.
DTAs Create Loopholes
DTAs on the other hand are agreements which are used to decide taxing rights between two states or more on cross border income.
They determine which of the two states will have: the right to tax an entity i.e. a person or company; the circumstances in which those rights apply; and, the extent they shall be able to tax them on an identified income.
Such treaties normally determine which state has the right to tax based on two things.
First is, whether the economic activity from which that income is derived has been carried out within a state or not. This relationship between where an income is generated and the state is known as the source taxation principle.
Second, is whether the income which is subject to tax has been derived from an entity i.e. an individual or company, residing within a state. This relationship between the entity/taxpayer and the state is known as the residence taxation principle.
DTAs are intended to encourage cross border trade and investment by reducing the risks of being taxed multiple times on the same income.
Nevertheless, there has been wide abuse of DTAs for the sole purpose of aggressively avoiding paying taxes on incomes by taking advantage of the loopholes therein.
This leads to significant loss of revenue for many governments, particularly in developing countries who often sign away most of their taxing rights to developed states in disproportionate DTAs.
A Tax Avoidance Ecosystem
The combination of IFCs and DTAs can be said to the main components of a tax avoidance ‘ecosystem’. IFCs will allow foreign entities to easily register themselves as commercial vehicles within a jurisdiction, enabling them to gain residency status.
As global multinational companies these entities will therefore be able to carry out activities within any state yet take advantage of the DTA facilitation and linkage to IFCs outside their jurisdictions.
While IFCs provide secrecy and DTAs offer lower taxation, an accurate description of cross-border activities needed in determining legitimate revenue gains to be accorded to government will be hidden away from authorities while the resources are whisked away from their reach.
The Mauritius Tax Conduit
Over a decade ago, the MIFC launched its global business sector allowing for the licensing of companies carrying out business outside Mauritius by foreign entities.
These authorizations referred to as global business license 1 (GBL 1) and global business license 2 (GBL 2) allowed companies that were carrying out economic activity outside the country to gain Mauritian residence.
Additionally, as residents they allowed holders of such licenses to derive treaty benefits from Mauritius’ wide DTA treaty network, which is well known for its vast reach, boosting the country’s reputation for being a gateway into Africa.
This dangerous treaty web of the MIFC and its DTA network has led to aggressive tax avoidance and the use of Mauritius as a conduit of Illicit Financial Flows (IFFs).
It has encouraged harmful tax practices such as treaty shopping and roundtripping as has been exposed in the Mauritius Leaks.
Local companies transfer their registration to Mauritius and wire back their capital investments to their respective countries as foreigners to avoid taxes such as capital gains tax and corporate income tax.
This has not gone unnoticed, considering how the MIFC has suffered continuous reputational damage, as seen in the latest Global Financial Centre Index of September 2020.
The index ranks IFCs in order of their competitiveness in five main areas. These include; reputation, business environment, human capital, infrastructure and financial sector development.
Yet again, Mauritius has been ranked among the bottom 15 countries with a poor reputation of an unscrupulous getaway jurisdiction thanks to its financial secrecy, and low taxes that serve as a conduit of resources by corporations dogging their revenue responsibilities.
This means that the overall qualitative character of the MIFC is more in question than its expected quantitative gains such as: the volume of capital it attracts, or its contribution to the economy in terms of GDP.
Developing countries are increasingly cautious of Mauritian DTAs due to the significant negative impact they are likely to have on their revenue collection.
Cosmetic Reform?
In 2018, due to the pressure of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS), the Mauritian government was forced to change the structure of their global business sector.
Further, Mauritian DTAs are being challenged. While its DTA with India was reviewed, in the case of Kenya, Tax Justice Network Africa (TJNA) – a civil society organization – petitioned the High Court claiming a violation of constitutional principles.
This resulted in the introduction of changes to the law governing the MIFC spearheaded by parliament leading to the abolition of the global business license 2 and strengthening of requirements of substance for holders of global business licenses who are therefore required to meet specified thresholds.
These include hiring a certain number of employees, carry out a specified amount of core income business activity and have their active management or control of an entity within Mauritius before they can be considered as residents worthy of receiving benefits of the country’s DTA network.
Need for Awareness
The Mauritius example, shows the need for greater awareness of the interaction between IFCs and DTAs in order to carefully scrutinise their impact.
With IFCs being set up in Kenya and Rwanda there is a need to carefully weigh their impact on internal DRM efforts and their trading partners. This is especially the case in relation to vulnerable states with whom they have concluded DTAs with.
As noted in the 2020 Global Financial Centre Index “We are worried about carefully constructed international taxation agreements designed to ensure fair receipts of tax based on location of earnings being undermined by nationalistic interests, and a naïve political drive simply to lower taxes to attract business…’’
The writer is a final year law student at the University of Nairobi. She can be reached at email: emuendo@taxjusticeafrica.net. Follow her on Twitter @EveKavenge
