The Paradise Papers leak has once again forced us to come forward with our usual defensive and repetitive repartees about the substance of our jurisdiction and the relevance of the work done by the Mauritius International Financial Centre.
However, facts and arguments are often drowned in the deluge of articles attacking the system in an international press that is always attempting to take some high ethical stance to sell their contents. This sensationalistic distinctiveness seemingly dispenses the uninformed reader of the need to have a fair and balanced point of view of the role of International Financial Centres (IFCs) in the world economy. The problem is compounded by the fact that a proper understanding of tax havens and international tax governance issues requires a thorough understanding of the economics of tax competition, a good grasp of international law, the Vienna Convention on Law of Treaties and international tax principles notwithstanding overarching geopolitical issues.
Over the years, this persistent bashing of International Financial Centres has sadly convinced part of our own population to equate an IFC with a tax haven. The Panama Papers, the Paradise Papers leak, the crackdown by the OECD and the EU, and the re-negotiation of our DTAA with India have all fueled this wrong perception.
Therefore, it is imperative and critical for us to conduct out a genuine probe of our financial services industry and its role in both the domestic and the global economy before moving forward in our national development agenda.
The main concern today is to dispel the muddling waves of sensationalism created by the media. Accordingly, it is important that we have a clear and levelheaded understanding of the functions of international financial centres in the global economy.
For far too long IFCs have been associated with shady business deals and overpaid “banksters” robbing poor people from poor economies of their dues. The approach has almost always pried into the misgivings of onlookers who have been forced to believe the malevolent aspect of the activities which, admittedly in some cases, are shrouded in secrecy. NGOs like Oxfam and the Tax Justice Network have been quite vocal about social injustice and poverty, and it is fair game. However, the response of IFCs, at least that of the genuine ones, has so far not been compellingly articulated.
Defining an International Financial Centre (IFC)
The International Monetary Fund defines International Financial Centres as “international full-service centers with advanced settlement and payments systems, supporting large domestic economies, with deep and liquid markets where both the sources and uses of funds are diverse, and where legal and regulatory frameworks are adequate to safeguard the integrity of principal-agent relationships and supervisory functions.”
This definition is a far cry from the portrayal of such jurisdictions as launderettes or subterfuges ingeniously devised for tax evasion. The emphasis is rather placed on the security, stability and the promise of aboveboard quality service through intermediaries of choice for businesses.
London, for instance, is the gateway to Europe with around 37% of global foreign exchange trading with more US dollars traded in London than in the US, 70% of world’s secondary bond market and 39% of the world’s derivatives market. In 2015, FDI flows through London were estimated at just under USD 400 billion. World FDI flows were roughly USD 1.5 trillion.
Hong Kong, on the other hand, is the traditional gateway to China, although, in recent times, major organisations have been using Singapore as an entry point into the Chinese market as well. Singapore is the platform of choice for investment for western organIsations into Asia. In 2015, around USD 70 billion were channelled via Singapore into Asia. Hong Kong remains, however, the major RMB centre in the world and channelled around USD 200 billion into China in 2015.
These leading IFCs, however, are seldom referred to tax havens. They have taken the time to build their reputation and now they offer unparalleled advantages to MNCs willing to find certainty and concision in the management of their portfolios, with adequate infrastructure and manpower to service operations across the globe.
What is often befuddling is that these more ‘advanced economies’ are overlooked in NGOs’ scrutiny and attacks and they remain unscathed in spite of the fact that the overwhelming bulk of global transactions are channelled through them. Instead, it is small-island jurisdictions like Mauritius that are most unfairly taken for targets despite the tangible benefits that they bring to the regional and global economy. The world’s most important providers of financial services which supply a shroud of secrecy to misappropriated or flatly robbed assets and embezzlements are not necessarily small IFCs as unwittingly supposed by profane observers, but rather some of the world’s biggest and wealthiest countries.
Small-island jurisdictions have in fact focused on the development and implementation of efficient and business-friendly regulatory frameworks. To offset their limited resources, they have crafted innovative and dynamic solutions to respond to the requirements of the global market. Their offerings are perfectly adaptable to consumers of financial services in a wide range of complex products.
The genesis of International Financial Centres
IFCs’ operations are embedded in bilateral tax treaties and Investment Protection and Promotion Agreements (IPPAs) which minimize the need for international surveillance of national tax legislation. In turn, these are governed by the Vienna Convention on the Law of Treaties. This protocol precludes substantial differences among jurisdictions.
The practical implication is that States are not at liberty to abide solely by dometic tax rules they consider expedient, but they rather operate in the context of an international taxation regime which evolves in the same way as international law undergoes changes over time.
Thus, unilateral action is not an option and States have to abide by the basic stipulations that underlie the international tax regime. These stipulations comprise the single tax principle (i.e. that income should be taxed once – not more and not less) and the benefits principle (i.e. that active business income should be taxed primarily at source and passive investment income primarily at the place of domiciliation). Similarly many tax treaties provide that capital gains from the alienation of immovable property or property that is connected to a PE are to be taxed in the source country. Other capital gains are taxable in the country of residence. Even in the absence of bilateral tax treaties, the above fundamental principles are so entrenched that they have become bedrock doctrines of international taxation.
Apart from the single tax and the benefits principles, tax and investment treaties also take into account the reality of financing and structuring foreign investment activities that are often channelled through multi-layered structures in several jurisdictions.
In particular, investment treaties usually cover shareholdings in companies as part of their definition of investment, including not only majority shareholdings, but also minority non-controlling shareholdings. In addition, the notion of investor is often understood broadly as covering shareholders on multiple levels within corporate structures.
Therefore it is not, as it is often widely believed, the Bank of England which created the concept of International Financial Centres when it took the decision that transactions that were conducted in the City between two parties residing outside the UK were not subject to UK financial regulation, nor are IFCs the result of the pressures of globalization.
It is really the combination of the above-mentioned three principles of single tax, benefits principle and the official recognition of corporate structuring which coalesced in the creation of the international legal framework for tax neutral platforms to emerge as International Financial Centres. In other words, these three principles have endogenously created IFCs just as innovations in information technology and telecommunications have allowed the emergence of the Business Process Outsourcing.
The Roles of IFCs
IFCs’ efficiency as well as the commercial certainty that they provide reduces the cost of intermediation and lowers capital and risk mitigation. Financial intermediation through IFCs is synonymous with efficient cross-border capital flows which enable pooling of funds into an efficient collective investment for redirection to major countries, facilitating the management of pension assets and promoting consumer choice, reducing costs and enhancing returns, allowing companies to manage sudden and unforeseeable risks like foreign exchange fluctuations, provide insurance and reinsurance facilities for onshore risks and provide liquidity to markets. These cost savings release more capital for innovation, entrepreneurship and job creation.
Apart from providing tax neutral platforms for global business and investment, thereby stimulating trade and contributing to capital market liquidity and job creation in the global economy, many of these IFCs also provide other advantages like political and social stability with fairly high levels of education and an enviable high quality of life. They also ensure the rule of law and low levels of corruption together with relatively high levels of economic freedom, particularly with regard to international trade and capital flows.
The effects on neighbouring countries are very beneficial. Blanco and Rogers (2010) suggest that IFCs have had what they call a “neighbourhood effect” on FDI inflows to LDCs during the 1990-2006 period. They found that increases in FDI in the nearest IFC will lead to greater FDI inflows for those LDCs in its immediate proximity. This finding is relevant since it defuses the popular argument that tax-haven activity is likely to be particularly damaging to LDCs.
Desai, Foley and Hines (2004) have also shown through empirical studies that, for instance, investors in hedge funds domiciled in offshore jurisdictions achieved higher returns. They also found that smaller IFCs can stimulate growth in neighbouring larger IFCs by 0.5% to 0.7%.
Sometimes the impact is unanticipated. In 2007, during a speech before the Committee on Finance at the US Senate, it was stated that an average of 22% of American universities endowment portfolios are invested in hedge funds, the returns on which allow ivy-league universities to offer more scholarships to high-performing students from a poor economic background!
IFCs have thus amply justified their existence and crucial role in the global business system. However, it should be conceded that there are instances where IFCs are being misused. Nevertheless, these cases do not warrant a systematic scrapping of IFCs. Rather, lessons must be learnt, and corrective actions should be implemented without delay.
An analogy can be drawn with the Mauritius Freeport to demonstrate how a new business sector with substance was created by leveraging fiscal incentives.
The Mauritius Freeport was created in 1992 by the then Government to boost international trade and diversify the economic base of the country. As such, a new regulatory framework was devised, and an attractive fiscal package was elaborated.
Nevertheless, it would be fallacious to say that the longevity of the Mauritius Freeport is merely the result of the generous package of fiscal incentives including zero corporate tax. The Government in collaboration with the private sector invested heavily in core logistics infrastructure. Just like the Jebel Ali Freezone, it was world-class logistics infrastructure in full compliance with international norms and streamlined customs procedures that gave the Freeport its competitive edge.
Admittedly, there are perceptions that such tax-free zones are not compliant with WTO Agreement on Subsidies and Countervailing Measures, for instance subsidies on export requirements, or even some of the OECD’s requirements against harmful tax practices.
However, what could be perceived as a suspected non-compliance with the WTO Agreement on Subsidies and Countervailing Measures is but the affirmative expression of fiscal sovereignty. Companies domiciled in the Freeport zones may not be subject to corporate taxes, but they are nevertheless “taxed” by other means since the Freeport companies pay substantial fees and other port dues for their use of port logistics and warehousing infrastructure.
International law is founded on the principles of sovereignty and sovereign equality. In the light of these principles, Mauritius as a sovereign State has the right to enforce its own domestic laws and implement its own fiscal policies, including tax laws and regulations, within its own territory. The world system will contain as many variants of tax and regulatory regimes as there are States.
From a broader perspective, Preferential Tax Regimes (PTRs) are all susceptible to be misused by unscrupulous businesses. However, there has never been an outcry for a ban on Freeport structures. Rightly so, because today we cannot but acknowledge the positive contributions of the Mauritius Freeport logistics platform to the regional economy through its integration in the Eastern and Southern African supply chains.
The same strategic thinking has undergirded the development of IFCs.
The Mauritian IFC
These principles have guided the crafting of the identity of the Mauritian economy. Media reports erred lamentably when they said Mauritius was a haven shrouded in secrecy. But in addition to that inaccuracy, they missed one essential point: Mauritius is a country with diversified economic activities, a real economy with substance, with global business activities contributing only 5.6 % to our GDP, far behind manufacturing, commerce, ICT or even tourism.
On the contrary, tax havens are jurisdictions that have laws and features that deliberately encourage the evasion of taxes legally due in other jurisdictions. Tax havens are built on the central features of tax liability minimization and secrecy.
Whereas Mauritius, on the other hand, stood the test of scrutiny of tight investigation and to this day proudly remains on the OECD’s white list.
A multiplicity of statements and communiqués have been issued over the years pertaining to our adherence to international best practices and agreements, including eight (8) Tax Information and Exchange Agreements (TIEAs), the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting and the FATCA, amongst others. We are also member of the Eastern and Southern Africa Anti-Money Laundering Group (ESAAMLG). Our laws such as the Companies Act and the Securities Act are inspired on New Zealand legislation, and they are enforced openly and consistently with absolutely no ‘secret rulings’ or negotiated tax rates.
This is all solidly documented. However, what is missing from our justifications is the fact that investors do not choose Mauritius only for fiscal incentives. Our infrastructure, our workforce, our geostrategic location and the ease-of-doing-business environment constitute a magnetic and an irresistible package.
Furthermore, there are other controls internally, first and foremost of which are our well-regulated and trustworthy institutions. This is an aspect that is far too often overlooked in the debate. There are many domestic regulations, independent institutions with sometimes overlapping functions as well as agencies that have the capacity to pre-empt the entry of illicit flows of capital into Mauritius.
High net worth individuals, tycoons and magnates or, for that matter, even top companies should be able to establish, beyond the least suspicion, their financial trail and the source of their funds before they elect Mauritius and decide to invest in whatever activity they would wish to, be it real estate, financial services or agriculture.
These safeguards rest on the strength, integrity and independence of our institutions. It unfortunately happens that institutions are sometimes subject to pressure, be it from a promoter brandishing threats of prosecution or seeking support at higher levels, or agents using their most often inexistent political clout, in an attempt to materialise projects that would not be approved by international rule.
It is necessary for the full functioning of the economy that the right balance is found and that strict conditions are put in place to ensure that our jurisdiction’s reputation is safeguarded. Bold decisions to build in specific requirements can per se suffice to repel adventurous financial rodents and rapacious rogues helplessly battling against invasive trail and looking for refuge.
The Mauritius IFC has the backing of its robust institutions and possesses fair but unbendable distinctive regulations that give them their identity and constitute the protective net against potential machinations.
Founded on such credentials, our financial services sector has not only allowed young professionals to find high quality jobs, but it has equally contributed to the development of the region.
It is noteworthy that international investors have used the Mauritian IFC platform to invest in Africa. Investments from Mauritius have flowed into a number of sectors, including telecommunications, international chains of consumer goods, mining, healthcare, banking, insurance, education, agriculture, manufacturing, energy and other infrastructure projects. Some of the most active Development Finance Institutions as well as philanthropic foundations have elected Mauritius as their home for their developmental investments targeting Africa as well.
What our IFC has done is that it has reversed the perception of inefficiency, thereby becoming instrumental for the solution of some of the problems that have for too long hindered the development of a good part of the African continent. It is now set to continue to fulfill this role through its competitive advantage and offerings.
The way forward
It is recognized that opaque and unregulated IFCs are the least successful ones. They might have for a while succeeded in some instances to attract money laundering activities or money raised from embezzlement. But these IFCs have rarely been successful in positioning themselves as respectable financial hubs.
What Mauritius needs to do now is to further improve its offerings, as constant remodelling is the key to ensure success. This nurturing process is under way with the elaboration of the blueprint for the financial services sector as well as the Regulatory Sandbox License which is attracting innovative companies into the Fintech segment.
More importantly, however, we need to ensure that the image that we project and our marketing strategies and missions emphasize all these positive aspects and systematically challenge any malicious attempt to smear our hard-earned reputation on the international level.
The Mauritius Financial Services Centre, let it be boldly affirmed, will not tolerate tax evaders, money launderers, racketeers, bribe takers for they are a bane for any country trying to consolidate its position as a regional financial centre.
In its latest report entitled “Blacklist or whitewash”, Oxfam is already putting pressure on the EU which is expected to publish its blacklist of tax havens. While Oxfam has welcomed the decision, it has again pointed out the problems associated with the process of coming up with the subjective-type tax-haven lists of the EU, most important of which is the opacity and absence of measurable and objective criteria to judge them and to give credibility to the EU blacklist. Their qualm has been, and justifiably so, that the EU tends to turn a blind eye on the activities of some of its own members, thereby seriously weakening the thrust and credibility of its assessments.
Perhaps it is high time that Mauritius gave more consideration to scientific based methodologies. For instance, competing in the Doing Business Index of the World Bank or the Global Competitiveness Index of the World Economic Forum has allowed us to identify shortcomings and promptly remedy them.
Similarly, for IFCs, there are indices that we rely on to identify lacunas in our ecosystem. One such index is the Financial Secrecy Index (FSI) , which is a ranking of jurisdictions based on fifteen secrecy indicators encompassing, inter alia, banking secrecy, ownership, standards, tax practices, treaties and exchange of information.
Such indices, despite their flaws, put everyone on the same footing by comparing particular sub-indicators for different countries. They go a long way in dispelling all suspicions of bias and remove prejudices while assessing IFCs. A less secretive method by the EU, for instance, would not sound the alarm bells of Oxfam, for instance.
More importantly, the use of the Financial Secrecy Index will allow all IFCs to benchmark best practices and allow IFCs to compare their offerings with that of their peers. In addition, the Financial Secrecy Index will help track the performance of the IFC over the years, thereby making continual improvement and progress possible.
IFCs are vital and very powerful platforms that enable the functioning of our global economies. However, the wrong use of IFCs can certainly be irreversibly damaging. A very relevant quote which illustrates the current predicament would be “fire is good servant but a bad master”.
Mauritius has and will continue to implement required safeguards to promote stringent ethical principles and a most efficient eco-system as a trustworthy International Financial Centre at the service of a global market.