Mauritius may have got the rough end of the stick

Moneycontrol BureauTwo weeks ago, India changed its 34-year-old tax treaty with Mauritius. For a long time, the Double Taxation Avoidance Agreement (DTAA) had been an irritant for India. The pact was used as a cover by foreign investors to route their investments through the island nation back into India and give the slip to taxmen in both countries. To be sure, the agreement needed tweaks -- and for a reason. Mauritius accounted for a whopping USD 93.66 billion (or 33.7 percent) of the total foreign direct investment of USD 278 billion. With so much money in transit, the amended treaty received a lot of hurrahs from industry.

But thanks to the new treaty, Mauritius' coffers will also be under stress, finds a Moody’s report. Its balance of payments will take a knock, says the note. Net inflows that poured into Mauritius had helped the central bank of that country to tote up foreign-exchange reserves of almost USD 4 billion (as of March 2016). Six years ago, it was USD 2 billion.

Companies which use the DTAA in Mauritius operate under a special licence. These companies have 0 percent capital gains tax. Their corporate taxes are also low.

By the end of 2014, Mauritian companies with this special licence held USD 200 billion in Indian assets, according to the Financial Sector Commission of Mauritius. They constituted 38 percent of their USD 520 billion total assets held worldwide, including in Mauritius, says the report.

Companies with the special licence in Mauritius have 'historically' contributed 15 percent of gross domestic market annually in net inflows (i.e., net foreign earnings). This could take a hit, thanks to the treaty.

The contribution to Mauritius largely comes from company revenues that averaged 3 percent of GDP for five years to 2015, says the note. A lion's share of bank deposits in Mauritius are from these companies which don't pay a penny on capital gains. Such bank deposits add up to USD 10 billion. Although this figure might be small when you compare it to the size of their cumulative asset portfolio of USD 520 million, it is still large (almost 40 percent) compared with the banking system’s deposits.

About two-thirds of total net financial inflows in Mauritius have been related to investment in India. “As such, we estimate that changes to investor sentiment could curtail net financial flows by 1 percent-2 percent of GDP annually. In an unlikely scenario in which investors no longer leverage Mauritius for new investments in India, a sudden stop in investment flows would cause a stronger deterioration in the Mauritian balance of payments," said Moody's report.