Fiscal sovereignty

So Mauritius commits to sign the Multilateral Convention to implement tax treaty related measures to prevent Base Erosion and Profit Shifting (BEPS). Once the parliament ratifies it, it will become legally binding on the country. This is a real game changer for our global business sector, which has hitherto thrived on bilateral tax treaties. The Convention deals a blow to Mauritius tax regime as it includes measures to prevent abuse of such treaties, without recognising the transitional costs associated with changing the tax arrangements, and without providing for grandfathering clauses.

The ministry of Finance reassures that “for those Double Taxation Avoidance Agreements that will not be covered by the Multilateral Convention, discussions will be held on a bilateral basis with the concerned countries to ensure our compliance with the BEPS recommendations while safeguarding the legitimate interest of Mauritius”. If there is still some room for manoeuvre, it cannot be in the interest of an independent country to renounce its sovereign rights over its tax policy, in favour of an organisation of which it is not even a member.

The Organisation for Economic Co-operation and Development (OECD) has a point though: taxes should be paid by a company in the countries in which it is operating. An international financial centre is not worth the name if it woos foreign investors without requiring economic substance. But this is not a reason to restrict innovation in tax policy design and impose instead a uniform tax model on the world, thereby causing a huge loss in investment and in job opportunities especially in developing economies like Mauritius.

Tax competition

The OECD bureaucrats, who themselves enjoy tax-free salaries, recognise the benefits of tax competition for a country, but strive to emasculate it in such a way that it does not do harm to others. In fact, tax competition is healthy as it sets up a market for governments, who are forced to be more efficient in attracting businesses. With different countries providing different levels of taxation and of government activity to suit different preferences, tax competition has the same effects on governments as competition in goods has on enterprises. By preventing diversity of choice, the OECD is actually pushing for a tax cartel.

Tax competition encourages tax planning, which is to use existing rules to optimise tax obligations, but the OECD deliberately confuses it with tax evasion, which is to circumvent the rules to dodge taxes. In particular, multinationals are suspected of shifting profits away from the jurisdictions where they operate in order to reduce their taxable profits, hence the concerns of OECD about alleged erosion of the corporate tax base. Thus, the OECD action plan to tackle BEPS aims to stamp out tax avoidance by reforming international tax frameworks and improving coordination between tax jurisdictions.

Obviously, the real motive of the BEPS initiative is to help European governments extract more tax from successful businesses, for the project includes limits on interest deductibility, restrictions on royalty payments and measures to disallow legitimate expenses for tax purposes. Yet, no one can get away from the fact that high taxes deter investors. It is a natural business activity pattern that global firms locate more plant and employment in low-tax countries, and less in high-tax jurisdictions.

A lot of hypocrisy

On that count there is a lot of hypocrisy on the part of rich countries. Tax havens are found within Europe (Switzerland, Liechtenstein, San Marino, Monaco and Andorra), among the various “dependent or associated territories” of EU members (the Channel Islands, Isle of Man, the Dutch Antilles and Aruba) and in the United Kingdom’s dependencies in the Caribbean. With its zero per cent corporate tax on non-distributed profit, Estonia is known to be the most tax-competitive country in the OECD.

Tellingly, the United States are not a signatory to the Multilateral Convention on BEPS. As The Economist wrote on 7 April 2016, “the strongest secrecy is, arguably, to be found onshore, in the United States, where the agents who incorporate firms aren’t even required to collect information on the identity of the ultimate “beneficial” owner (the person to whom the company really belongs, as opposed to the registered holder, who can be a nominee or even another company)”. Legislative competition in this country, as a result of the absence of a federal corporate law, allows free choice of incorporation. It turns out that one half of the largest industrial firms are incorporated in Delaware because of the legal certainty which lowers transaction costs.

“The OECD package adds to regulatory uncertainty, let alone tax complexity”.

Conversely, the OECD package adds to regulatory uncertainty, let alone tax complexity, which hinders international investment and discourages firms to expand to new markets. The measures proposed are couched in a vague language and are open to interpretation. It is not sure whether national tax authorities have the means and expertise to implement them, the more so as implementation requires time and resources.

Mauritius can therefore take a “wait and see” approach, allowing time for debate on BEPS rules, rather than proceeding hastily with the OECD plan. The government should analyse the effectiveness of the Mauritian tax legislation, bearing in mind that the island has to be competitive as a foreign investor destination. It should give thoughtful consideration to the costs of complying with the BEPS standards compared to the benefits, and to the impact on ease of doing business in Mauritius. Any BEPS solution should be assessed from the Mauritian perspective, taking account of the country’s specific circumstances.

Between Mauritius and OECD, there must be a discussion from first principles. The country could adopt BEPS rules in so far as they adhere to the four principles of a good tax system: certainty, efficiency, equity and simplicity. Certainty means low compliance costs of the tax system. Efficiency entails minimum distortion in allocation of resources. Equity requires that a country’s tax laws are fair and impartial. Simplicity implies that they are not complex.

Having a very good treaty network with African countries (28 out of the 43 Double Taxation Avoidance Agreements signed), Mauritius should not jeopardise the achievement of its strategic goals of export diversification. As a developing country, it is overwhelmingly reliant on foreign direct investment to sustain its economic growth. Since it needs international firms to develop new economic activities, it cannot afford to raise their operating costs here.

Mauritius must retain its fiscal sovereignty and be free to adopt tax policies that increase its global competitiveness and its attractiveness as a viable investment centre. A surrender of fiscal power to the OECD would be at odds with the Mauritian victory on Chagos at the United Nations General Assembly.