The modus operandi

MAURITIUS is the most favoured source for companies - Indian, NRI and foreign - for funnelling investments into India. Taxes on capital gains and dividends are low, and this makes the country attractive for investors making portfolio investments. Apart from this, it is also attractive for entities to make Foreign Direct Investment (FDI) because the island nation's legal regime is particularly suitable for setting up holding companies there, which in turn routes investments in India. Among the pioneers of this route was Enron, which used the Mauritius gateway to establish the controversial Dabhol Power Company in Maharashtra. This enables companies to avoid foreign exchange controls. More importantly, the device of setting up a paper company in Mauritius enables the intermediary based there to transfer funds to its parent overseas via Mauritius. It is important to recognise that much of this would not be possible without the Indo-Mauritius Double Taxation Avoidance Convention (DTAC).

According to a leading legal and tax consultancy, which helps clients to exploit the loopholes in the agreement, it has "become a rule of thumb to have a Mauritius entity between the investor and the Indian investee company. It warns potential clients that they must take care to "ensure that the Mauritius entity does not have a permanent establishment in India". What this means, in simple terms, is that the investing entity, in order to avoid paying capital gains tax, must ensure that its operations on Indian soil must not be traceable to a tangible Indian entity.

There are several "models" available to investors seeking to invest in India via Mauritius. An offshore structure is one in which a fund, based in Mauritius is the primary vehicle for routing investments into India. The fund, pooling investments from investors in third countries invests in India through an investment manager located in Mauritius. The manager makes investments in Indian markets through an India-based adviser. Tax consultants advise that the operations should be "structured extremely carefully so as to minimise the risk of the funds having a permanent establishment in India. Another "model", called a unified structure, enables the offshore fund to route investments through a trust registered in India.

The impetus for the rampant use of the Mauritius route rested on the permissive legal and tax regimes in Mauritius. The Mauritius Offshore Business Activities Act (MOBAA) of 1992 provided incentives to companies to establish offshore companies in Mauritius. Following the widespread criticism, notably the publication of a report, Harmful Tax Competition, by the Organisation of Economic Cooperation and Development (a body of the most advanced countries) in 1998, Mauritius was forced to make changes to its legal structure. In 2001, the Financial Services Development Act was enacted, repealing MOBAA. Asked whether this has made any difference, S.K. Jha, former Chief Commissioner of Income Tax, said: "Tax havens always pretend to make their systems more efficient and transparent, but in reality nothing changes." Observers have noted how the Mauritian authorities have systematically blocked SEBI's efforts to make inquiries about investments made from Mauritius.