India’s biggest source of FDI is India itself, money departing on a short holiday to a tax haven and then routed back as FDI. Will the government muster up the political will to clamp down on the tax-allergic business elite?


This could be a bumper year for the ever-lucrative tax avoidance industry. The 2015 final reports of the Organisation for Economic Co-operation and Development (OECD)-led project on Base Erosion and Profit Shifting (BEPS) — which refer to the erosion of a nation’s tax base due to the accounting tricks of Multinational Enterprises (MNEs) and the legal but abusive shifting out of profits to low-tax jurisdictions respectively — lays out 15 action points to curb abusive tax avoidance by MNEs. As a participant of this project, India is expected to implement at least some of these measures. But can it? More pertinently, does it have the political will?
The BEPS project is no doubt a positive development for tax justice. If India’s recent economic history tells us anything, it is that economic growth without public investment in social infrastructure such as health care and education can do very little to better the life conditions of the majority. Which is why curbing tax evasion to boost public finance is part of the United Nations’ Sustainable Development Goals (SDGs).
However, notwithstanding the BEPS project, MNEs and their dedicated army of highly paid accountants are not about to roll over and comply. Again, if past history is any indication, the cat-and-mouse game between accountants and taxmen will continue, with new loopholes being unearthed in new tax rules.
Empowering tax dodgers

The primary cause of concern here is the quality of India’s political leadership, which has consistently betrayed its own taxmen. All it takes — regardless of the party in power — is for the stock market to sneeze, and the Indian state swoons. We’ve seen it happen time and again: the postponement of the enforcement of General Anti-Avoidance Rules (GAAR) to 2017, and more spectacularly, on the issue of participatory notes, or P-notes.
Last year, the Special Investigation Team (SIT) on black money had recommended mandatory disclosure to the regulator, as per Know Your Customer (KYC) norms, of the identity of the final owner of P-notes. It was a sane suggestion because the bulk of P-note investments in the Indian stock market were from tax havens such as Cayman Islands. But the markets threw a fit, with the Sensex crashing by 500 points in a day. The National Democratic Alliance (NDA) government, which had come to power promising to fight black money, promptly issued a statement assuring investors that it was in no hurry to implement the SIT recommendations. Given such a patchy record, what are the realistic chances of India actually clamping down on tax dodging?
Let’s take, for instance, Action No. 6 of the OECD’s BEPS report: it urges nations to curb treaty abuse by amending their Double Taxation Avoidance Agreements (DTAA) suitably. The obvious litmus test of India’s seriousness on BEPS is its DTAA with Mauritius. By way of background, Mauritius accounted for 34 per cent of India’s FDI equity inflows from 2000 to 2015. It’s been India’s single-largest source of FDI for nearly 15 years. Now, is it possible that there are so many rich businessmen in this tiny island nation with a population of just 1.2 million, all with a touching faith in India as an investment destination? If not, how do we explain an island economy with a GDP less than one-hundredth of India’s GDP supplying more than one-third of India’s FDI?
We all know the answer: Mauritius is a tax haven. While not in the same league as Cayman Islands or Bermuda, Mauritius is a rising star, thanks in no small measure to India’s patriotic but tragically tax-allergic business elite. In Treasure Islands: Tax Havens and the Men Who Stole the World, financial journalist Nicholas Shaxson notes how Mauritius is a popular hub for what is known as “round-tripping”. He writes, “A wealthy Indian, say, will send his money to Mauritius, where it is dressed up in a secrecy structure, then disguised as foreign investment, before being returned to India. The sender of the money can avoid Indian tax on local earnings.”
In other words, it appears that India’s biggest source of FDI is India itself. Indian money departs on a short holiday to Mauritius, before returning home as FDI. Perhaps not all the FDI streaming in from Mauritius is round-tripped capital — maybe a part of it is ‘genuine’ FDI originating in Europe or the U.S. But it still denotes a massive loss of tax revenue, part of the $1.2 trillion stolen from developing countries every year.
What makes this theft of tax revenue not just possible but also legal is India’s DTAA with Mauritius. It’s a textbook example of ‘treaty shopping’ — a government-sponsored loophole for MNEs to avoid tax by channelling investments and profits through an offshore jurisdiction.
For instance, as per this DTAA, capital gains are taxable only in Mauritius, not in India. But here’s the thing: Mauritius does not tax capital gains. India, like any sensible country, does. What would any sensible businessman do? Set up a company in Mauritius, and route all Indian investments through it.
India signed this DTAA with Mauritius in 1983, but apparently ‘woke up’ only in 2000. India has spent much of 2015 ‘trying’ to renegotiate this treaty. But with our Indian-made foreign investors lobbying furiously, the talks have so far yielded nothing. Meanwhile, China, which too had the same problem with Mauritius, has already renegotiated its DTAA, and it can force investors to pay 10 per cent capital gains tax in China.
Changing profile of tax havens

Tax havens such as Mauritius thrive parasitically, feeding on substantive economies like India. Back in 2000, the OECD had identified 41 jurisdictions as tax havens. Today, as it humbly seeks their cooperation to combat tax avoidance, it calls them by a different name, so as not to offend them.
The same list is now called — and this is not a joke — ‘Jurisdictions Committed to Improving Transparency and Establishing Effective Exchange of Information in Tax Matters’. Distinguished members of this club include Cayman Islands, Bermuda, Bahamas, Cyprus, and of course, Mauritius.
Today the function of tax havens in the global economy has evolved way beyond that of offering a low-tax jurisdiction. Mr. Shaxson describes three major elements that make tax havens tick. First, tax havens are not necessarily about geography; they are simply someplace else — a place where a country’s normal tax rules don’t apply. So, for instance, country A can serve as a tax haven for residents of country B, and vice versa. The U.S. is a classic example. It has stringent tax laws, and is energetic in prosecuting tax evasion by its citizens around the world. But it is equally keen to attract tax-evading capital from other countries, and does so through generous sops and helpful pieces of legislation which have effectively turned the U.S. into a tax haven for non-residents.
Second, more than the nominally low taxes, the bigger attraction of tax havens is secrecy. Secrecy is important for two reasons: to be able to avoid tax, you need to hide your real income; and to hide your real income, you need to hide your identity, so that the booty stashed away in a tax haven cannot be traced back to you by the taxmen at home. So, even a country whose taxes are not too low can function as a tax haven by offering a combination of exemptions and iron-clad secrecy — which is the formula adopted by the likes of Luxembourg and the Netherlands.
Third, the extreme combination of low taxes and high secrecy brought about a new mutation of tax havens in the 1960s: they turned themselves into offshore financial centres (OFCs). The economist Ronen Palan defines OFCs as “markets in which financial operators are permitted to raise funds from non-residents and invest or lend the money to other non-residents free from most regulations and taxes”. It is estimated that OFCs are recipients of 30 per cent of the world’s FDI, and are, in turn, the source of a similar quantum of FDI.
Such being the case, all India needs to do to attract FDI is to become an OFC, or create an OFC on its territory — bring offshore onshore, so to speak. That’s precisely what the U.S. did — it set up International Banking Facilities (IBFs), “to offer deposit and loan services to foreign residents and institutions free of… reserve requirements”. Japan set up the Japanese Offshore Market (JOM). Singapore has the Asian Currency Market (ACU), Thailand has the Bangkok International Banking Facility (BIBF), Malaysia has an OFC in Labuan island, and other countries have similar facilities. OFCs, as Ronen Palan puts it, are less tax havens than regulatory havens, which means that financial capital can do here what it cannot do ‘onshore’. So every major hedge fund operates out of an OFC. Given the volume of unregulated financial transactions that OFCs host, it is no surprise that they were at the heart of the 2008 financial crisis.
Apart from accumulating illicit capital (in the tax haven role), channelling this capital back onshore dressed up as FDI (in investment hub role), and deploying it to engage in destructive financial speculation (in OFC role), these strongholds of finance capital also serve a political function: they undermine democracy by enabling financial capture of the political levers of democratic states.
It is well known that political parties in most democracies are amply funded by slush funds that would not have accumulated in the first place had taxes been paid. But today, not least in the Anglophone world, global finance’s capture of the state appears more like the norm.
A lone exception seems to be Iceland, which began the new year on a rousing note — by sentencing 26 corrupt bankers to a combined 74 years in jail. Meanwhile in India, we continue to parrot long discredited clichés about the need for more financial deregulation and a weird logic that mandates a smaller and more limited role for public finance.