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Not all black and white

The renegotiation of the Indo-Mauritius tax treaty is really aimed at flushing out illegal wealth.

india Updated: Nov 20, 2011 11:53 IST

The stock market has taken fright over talk that India is renegotiating a tax treaty with Mauritius to bring profits of portfolio investors into the fold.

The current jitters are over a misreading of statements emanating from various levels of the Indian government that the treaty is being reworked to plug the tax loophole. On the contrary, India and Mauritius are talking only about sharing information, not about changing the way they go about taxing their citizens.

This is part of a global crackdown on black money after the 2008 financial meltdown that has led India to review its treaties with 79 countries, including tax havens. The talks with Mauritius have been on since 2006 but were stalled in 2008 as elections at home and on the island nation came in the way. The negotiators are meeting now at a time when black money is high on the Indian public agenda and talk of plugging tax giveaways acquires traction without much basis in fact.

India had indeed proposed in 2007 a source-based capital gains tax on alienation of shares, but Mauritius refused to even entertain the notion. Around 13% of its national income comes through “offshore financial services”, essentially letter-box companies that set up shop on the island to route financial investments into India and repatriate the profits where they face a zero capital gains tax. India reckons it loses $600 million in taxes on this account, small change for a country of its size. New Delhi is more interested in cracking down on “round-tripping”, whereby black money flows out of the country and returns laundered from Mauritius as portfolio investment. This is a legitimate concern, and enhanced information-sharing can help to address it. The attempt is not to scare away all portfolio investors, merely those that are using funny money.

The costs are high for Mauritius if it chooses to tell. Western hedge funds that use the island as a launch-pad into the Indian equity market do so to escape scrutiny in their respective countries that would rob them of their edge in generating superior returns for their investors by foraying into riskier assets and markets, including emerging ones. A move by the Indian market watchdog to get hedge funds registered with it has met an understandably tepid response.

This is a situation we can live with because we need foreign capital to meet our growing investments in infrastructure and industrial capacity. Swimming in a tide of black money, on the other hand, is becoming politically untenable. The government would have done better to have pitched the revival of talks with Mauritius as part of its efforts to flush out dark pools of unaccounted wealth. Instead what emerged from statements by tax officials and bureaucrats has been twisted out of context.

Finally finance minister Pranab Mukherjee has had to step in and calm a jangle of frayed nerves.