Denis Healey, former UK Chancellor of the Exchequer said,“The difference between tax avoidance and tax evasion is the thickness of a prison wall.”
Public perception of wealthy Indian business oligarchs as being notorious tax dodgers stashing their ill-gotten money in tax havens gained ground with the sensational disclosures called the Swiss leaks. In a drama which unfolded with the nail biting suspense of a James Bond movie, a computer expert Hervé Falciani working with the HSBC bank leaked secret bank data accounts of 10,00,000 individuals and entities spanning 200 countries.
Among the prominent Indian business tycoons were Mukesh Ambani, Anil Ambani, Anand Chand Burman, Rajan Nanda, Yashovardhan Birla, Chandru Lachhmandas Raheja, Dattaraj Salgaocar, Bhadrashyam Kothari and Shravan Gupta.
How ‘Hawala’ Works
In their meticulously researched book ‘Thin Dividing Line’, Paranjoy Guha Thakurta and Shinzani Jain highlight the role that Mauritius plays in providing tax shelter for ultra rich Indians and the illicit financial flows in the global context. The authors point out,‘Tax havens, also known as low tax or no tax jurisdictions, enable wealthy individuals and corporate entities controlled by them to not pay taxes, legally and illegally.’
Central to the issue of tax evasion or tax avoidance is the so-called ‘Mauritius route’. According to the authors, what makes Mauritius an attractive destination for illicit global flows is the treaty for avoidance of double taxation and the secrecy laws that prevent exchange of information regarding the identity of persons or entities who own the illicit funds.
There is also the added advantage of cultural affinity: two thirds of the population of Mauritius is of Indian origin.
For a fee mail box, companies or shell companies (companies that have no real business) are created for the purpose for parking the tainted funds. Through hawala (a shadowy and parallel banking system) handlers for a commission or fee, deposit the illegal proceeds from bribes of politicians or earnings from drug running or arms smuggling into bank accounts of mail box companies located in Mauritius.
Why the Corrupt Love Mauritius
Now the stage is set for the ease of doing business in Mauritius. The authors reveal the astonishing fact that close to “40 percent of the total inflows of foreign money into India ( in the form of Foreign Direct Investments, as well as investments in stock, shares and other financial instruments) have been routed through this small clutch of islands in the Indian Ocean since the early 1990.”
Moreover, the extensive use of Participatory Notes (P-Notes), which is an opaque instrument to conceal the beneficial owners of the funds coming from Mauritius from the unwelcome scrutiny of tax and regulatory agencies.
In addition, any capital gains tax arising from transfer of capital assets in India is tax free in India as well as in Mauritius which has no tax at all. Truly, a win-win situation for the corrupt triad of politicians, businessmen and government officials who launder their illicit earnings and get a tax free income in the bargain!
The notorious Mauritius route attracted adverse publicity in the stock market scams which rocked the Bombay Stock Exchange (BSE), which was known as the Ketan Parekh Scandal. A joint parliamentary committee(JPC) found that Parekh borrowed Rs 120 crore from Global Trust Bank and Madhavpura Mercantile Cooperative Bank which was used to rig share prices of certain companies.
For this share-rigging scam, Ketan Parekh used the maze of 23 entities located in the tax haven of Mauritius. Another high voltage scandal that rocked the country was the scam of the popular cricket tournament (IPL). IPL Chief Lalit Modi was accused of tax evasion and laundering money through Mauritius based entities.
A Charade Called ‘Transfer Pricing’
Generally speaking, one of the compelling reasons for multi-national corporations (MNCs) to declare zero tax or pay low tax in countries where tax rates are more is the fact that more than 60 percent of world trade happens inside multinational corporations. Thus, shell companies or mailbox companies are established for the purpose of aggressive tax evasion.
In an elaborate charade called ‘transfer pricing’, corporations with their army of accountants and lawyers create a maze of shell companies (ie, companies which have no real business activity) in tax havens, which have secrecy laws concealing the ownership and the source of the funds. The tax strategy is fairly simple: book the profits in shell companies located in tax havens having low or nil rates of tax and show costs in countries which have higher rates of tax.
Take the case of Google — the giant tech company — which established a subsidiary in Ireland and with which the parent company entered into an agreement in 2003 giving the subsidiary the right to income arising out of search engines. From 2003 to 2009 the Irish subsidiary of Google earned USD 11 billion and the rate of tax in Ireland is 12.5 percent.
Not content to pay taxes of 12.5 percent in Ireland, it siphoned off its earnings as royalty payments to another offshore entity in Bermuda at zero rate of tax. Needless to say, if Google had booked its profits in USA it would have to pay (after available deductions) tax at 35 percent.
The success of the strategy is borne out of the fact that Google pays around 2 percent as taxes on its overseas income. If the offshore tax havens were to be knocked off, then Google loses a quarter of its earnings and a cool USD 100 dollars could be knocked off per share.
Busting Myths About ‘Benefits’ from Tax Havens
Or take the case of Starbucks — the coffeehouse chain, which is headquartered in Seattle, US. If the trademark of, let us say, a Frappuccino vests with an entity registered in Netherlands which has 1-2 percent tax on intellectual property rights, then part of the income on its sales of the coffee drink is booked in Netherlands at low tax while lower earnings are booked in a higher tax country like the US.
An important takeaway from the book Thin Dividing Line is exploding the myth that unregulated and illicit capital flows emanating from tax havens is good for the economy. There are compelling reasons that such illicit flows are more of a curse than a blessing.
Firstly, the unregulated financial flows from tax havens erodes the tax base of the host country where transaction occur but profits not shown but booked in low or zero tax havens. Falling tax revenues force the state to abandon welfare measures such as affordable education and health care for the needy and elderly. The case in point is India where a sizable proportion of the population is trapped in poverty. Spending towards public health is an abysmal 1.2 percent of the GDP.
Black Money from Abroad Yet to Come Back to India
Secondly, offshore global finance aids and abets in the investment of earnings from serious criminal activities and thus, offer incentives for the global spread of such activities.
And lastly, tax havens, as the authors starkly observe, “have been used by the rich and the powerful to benefit themselves at the expense of the poor and the underprivileged, thereby widening inequalities within countries and on occasion, across nation states as well.”
The astounding figures from Oxfam Inequality Report tells its own story: In India 57 billionaires possess as much wealth as the poorest 70 percent of the population.
In the high decibel election campaign of 2014, Modi took advantage of the helplessness of the Congress government in bringing back black money stashed abroad, and promised the people of India that not only would he get the black money back but also put 15,00,000 ( fifteen lakhs) in every account of the common people.
While the BJP stormed to power exploiting the anger of the people against the Congress, it has yet to get any black money from abroad. The campaign promise of depositing Rs 15 lakhs in every Indian family’s account proved to be a mere jumla (empty election promise).
The Demonetisation Blitzkrieg
In April 2016, there was another bombshell in the form of the Panama Papers which revealed that 500 Indian nationals formed offshore companies which in reality were shell or mailbox companies formed by the Panama head quartered Law firm Mossack Fonseca, for the sole purpose of keeping secret the illicit hoarding, from the prying eyes of the Indian Tax authorities.
The prominent casualty of the Panama Papers exposé was Nawaz Sharif, the then Prime of Pakistan who was barred from holding public office for a decade by the Supreme Court of his country.
The other heads that rolled were that of the Prime Minister of Iceland, Sigmundur David Gunnlaugsson and the Spanish Industry Minister Jose Manuel Soria. The relatives and associates of Russian President Putin and China’s President Xi Jinping also cropped up. The Indians who figured in the Panama Papers were Amitabh Bacchan, Aishwarya Rai, Vinod Adani among others.
In India, there were no ripples and it was business as usual for the Modi government. At the end of 2016, the demonetisation blitzkrieg which was ostensibly executed for the purpose of flushing out black money, only served to send the most poor and deprived members of the society to greater destitution as currency was sucked out of the banking system.
Deviating from the ‘Mauritius Route’
The tide is turning against the Modi Government and he is facing anger for his unfulfilled promises of getting back black money stashed in tax havens. With his eyes on the 2019 polls, policy measures have been tweaked to make the ‘Mauritius route’ a less lucrative one.
Now a new provision has been added which gives India the right to tax capital gains arising from the transfer of shares in Indian companies after 1 April 2017. For short term capital gains (shares within one year), one will have to pay only 50 percent of the tax applicable between the period April 2017 and March 2019.
Thereafter, the regular rate of 15 percent will be applicable. This new rule would be applicable to those who invest at least Rs 27,00,000 in a year. Further, the tax on interest income earned by Mauritian companies would be limited to 7.5 percent.
But global finance like water finds weak spots and flows through. Now reports suggest that the illicit finances would flow through Netherlands which has no tax on short term capital gains. Moreover, derivatives which account for about 90 percent of equity trading in India are also exempt from capital gains tax.
The Battle of David and Goliath
The global push back against tax havens by Automatic Information Exchange (which reduces secrecy and curbs the evasion of tax) is an important measure to reign in rogue capital. So is the General Anti-Avoidance Rules. But the battle is a one sided one: we have the Goliath of global finance on the one hand, and on the other David — the ordinary citizens of the globe facing austerity measures on account of profit shifting and tax erosion. The battle appears to be hopeless.
But engage we must, in the battle against ‘Goliath’. Failure to do so would mean that the rest of us would slide permanently into inequality while a tiny few would have their boots washed in champagne.
The price of indifference is an onerous one.
(The writer is a lawyer from Bengaluru, he writes for the Economic and Political Weekly and has contributed to websites with alternative views. His writings are available at sapientpen.blogspot.in and can be reached @sapientpen. This is a personal blog and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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