Special Report - Treasure Island or Banana Republic?

Mauritius faces tough choices about legitimacy and development

Mauritius has been pursuing the path of legitimacy, but the way forward for the island nation will be far from straightforward.

To some campaigners, it is an established truth that small tropical islands without natural resources must be willing to turn a blind eye to global illicit financial flows.

Mauritius, a country of less than two million people situated off the East African coast, is often lumped with so-called tax havens in the Caribbean, as well as its neighbour the Seychelles. But its situation is more complicated than the stereotype.

Financial services are a pivotal element of Mauritius’ development story—one in which a new chapter has recently begun. Renewed political will among leading economies to crack down on the multi-trillion-dollar global offshore secrecy industry, combined with a thickening of global regulatory regimes, has presented many jurisdictions with a stark choice between full legitimacy and an increasingly public stance of non-compliance. Mauritius has been pursuing the path of legitimacy, but the way forward for the island nation will be far from straightforward.

Background: a regional leader in political and economic development

Mauritius has been defying the world’s expectations for nearly five decades. A flourishing parliamentary democracy, it has consistently topped governance quality rankings (like the Mo Ibrahim Index for good governance in Africa) despite its profound ethnic, cultural and linguistic diversity.

Political stability has been accompanied by steadily increasing prosperity. Mauritius has diversified from near-total dependence on sugar to using tourism, textiles, financial services and information technology as means to economic development. The resultant growth has lifted gross national income to $19,290 per capita (as of 2015). It is now the second richest country in Africa, and one of just six upper middle income countries rated as highly likely to become high-income by the World Bank.

Mauritius has also been consistently rated as the African continent’s most business-friendly jurisdiction. It maintains a bevy of investment promotion and double taxation agreements, as well as preferential market access to Europe, Africa and the USA. Its trusted legal system and attractive corporate tax code (tax-free dividends with personal and corporate income tax harmonized at 15%) have attracted dozens of foreign banks, including heavyweights like HSBC, and the introduction of Islamic banking has allowed petro-dollars to flow through the economy.

A mixed record on financial crime, with tentative signs of progress

The label ‘tax haven’ is at best a blunt instrument. It is used to imply a collection of quite distinct behaviours: laundering the proceeds of criminal activity (including corruption and organised crime), illegally evading tax on legitimately earned funds, and legal (if creative) international profit shifting without meaningful economic residency. The two latter practices both contribute to the problem of global tax base erosion, which implies a certain set of social costs but does not necessarily involve or facilitate vicious criminality.

Mauritius’ good governance credentials looks most patchy when it comes to financial crimes like money laundering, but there are distinct signs of improvement.

Euan Grant, a consultant on money laundering issues and former Strategic Intelligence Analyst for UK Customs and Excise, told KYC360 that Mauritius is, like many similar jurisdictions, still largely vulnerable to money laundering. It has experienced less scrutiny from authorities in the U.S., the U.K. and Europe compared to offshore finance hubs in the Caribbean. In recent years, this relative obscurity has made it a more attractive destination for money from Europe, the Middle East, India and sub-Saharan Africa. Grant also points to ‘schmoozing’ relationships between regulators and white collar finance professionals in Mauritius, the Seychelles and Caribbean islands. He argues that formal legislative limits may not be fully reflected in practice.

“When it comes to company formation, offshore centres are much less likely to allow the sorts of dangerous practices that facilitate money laundering, corruption, and the financing of terrorism than onshore centres.” – Dr Jason Sharman

However, there are some optimistic signs. Cutting edge research into anti-money-laundering compliance now uses randomized field experiments to compare different jurisdictions. The results of a comprehensive 2013 study suggest that, contrary to conventional wisdom, international Know Your Customer standards are applied more effectively in Mauritius than in the average International Financial Centre, and far more effectively than in OECD jurisdictions.

In the study in question, Mauritius received a score of 28 compared to the United States’ 10.9 on the Dodgy Shopping Count, which represents the number of companies a client would have to approach, on average, to find one which would create a shell company without demanding proper identification. As one of the study’s authors, Dr Jason Sharman, writes, “when it comes to company formation, offshore centres are much less likely to allow the sorts of dangerous practices that facilitate money laundering, corruption, and the financing of terrorism than onshore centres.”

Euan Grant comments that while this level of formal compliance represents progress, there is no guarantee that these KYC processes will identify the ultimate beneficial owner in complex, multi-jurisdictional chains of ownership. However, if true, this is a problem with international efforts rather than a failure of Mauritian regulators.

In addition to besting OECD nations on some measures, Mauritius is also light years ahead of its nearest analogue, its neighbour the Seychelles. Just two hours’ flight away, the Seychelles’ reputation is of a classic criminal tax haven: money laundering carte blanche for everyone with all the trimmings. On paper it is the richest country in Africa with a per capita GNI of over $25,000, but the wealth of outlandish anecdotes and journalistic exposés that flow from the jurisdiction point to the Faustian bargain at the heart of its wealth.

Where Mauritius has moved to assure international audiences of its legitimacy and sophistication, the Seychelles has exuberantly embraced the darker parts of global investment flows. It has historically been seen as catering quite openly to criminals and corrupt officials engaging in money laundering. Seychelles’ long links with politically connected and protected dirty money date back to at least the Cold War, when it acted as an anchorage for the Soviet Navy.

The country’s president has been personally accused of money laundering many times, and does not appear to be alone in this in the political class. Paul Chow, a long-time leader in Seychellois offshore finance and former parliamentarian, has previously stated that in the Seychelles, “all kinds of unethical conduct goes unpunished or simply brushed under the carpet… it is this swamp that everyone operates under”. Chow also commented that “the British Virgin Islands registers 30,000 companies a year. We are at about 11,000. We are catching up.” He attributed Seychelles ‘success’ to resisting pressure from the OECD and other international powers: “Mauritius made the mistake of following the rules… whatever the OECD said, they followed, so that actually killed their offshore corporations.” Chow believes that the “OECD has no power”, describing it as “just a think tank”.

But not facilitating money laundering as much (or as openly) as the Seychelles is a low bar, and Mauritius is far from untainted. One investigation by the Guardian and the International Consortium of Investigative Journalists revealed that several high-profile ‘sham directors’, like the British aristocrat Andrew Moray Stuart, are still physically based in Mauritius. According to a well-placed British source, international bodies in Mauritius are also perceived as having turned a blind eye to funds from private-public procurement bribery being paid through the Mauritian jurisdiction.

Gauging the true strength of Mauritius’ commitment to eradicating money laundering is, for now, a waiting game. Citing anecdotal evidence is all very well, but two particular developments are worth monitoring more systematically.

The first is the new Financial Crime Commission (FCC), whose creation was spearheaded by the Prime Minister and the earnestly titled Ministry of Financial Services, Good Governance and Institutional Reforms. The FCC, which should launch in 2017, will be an apex body charged with combating white collar crimes, fraud and financial crimes. Its launch will coincide with reviews of the existing corruption, money laundering and terrorist financing legislation. Its willingness to prosecute high-profile residents and international visitors, as well as to cooperate with global AML partners, will be the most powerful litmus test available for Mauritius’ approach.

Another valuable metric will be the OECD’s latest country rating on practical implementation of its information exchange standards. Currently, Mauritius is rated as largely compliant (the second of four possible tiers). Having missed the ‘Compliant’ rating in its 2014 review by failing several criteria—providing information about ownership, accounting and banking, creating sufficient access powers, and preserving confidentiality in the exchange of information—its latest review began in the third quarter of 2016. The result, due to be announced in 2017, will be a good proxy for its commitment to international best practice on information shoring, and by extension, its willingness to zealously chase money laundering.

The end of the Mauritius Route challenges the island’s economic model

The crackdown on financial crime comes at an inconvenient time. Mauritius’ development model is currently under more extreme pressure than it has faced in three decades. The source is the winding back of a key double-taxation treaty (one of several dozen) which transformed it into a low-tax conduit for Indian foreign direct investment (FDI) dollars and capital gains.

The 1983 Double Tax Avoidance Agreement (DTAA) has frustrated India’s attempts to maximise its capital gains tax revenue by allowing investors to route inflows and outflows through Mauritius. The so-called Mauritius Route has been used heavily by private equity firms, MNCs and global fund houses investing in India, as well as private Indian individuals avoiding tax. Between 2000 and 2015 Mauritius accounted for over one third of FDI flows into India. These flows represented billions of dollars, as well as thousands of direct and indirect financial services jobs, for the Mauritian economy.

The OECD estimates that 4-10% of global corporate income tax revenues, or around $100-240bn, is lost through Base Erosion and Profit Shifting (BEPS) each year. The growing momentum of the OECD/G20’s BEPS project, in which India has been intensely involved, has consolidated the view that double taxation treaties should not lead to double non-taxation. Riding this wave, India introduced General Anti Avoidance Rules (GAAR) laws in 2012. It followed these with a May 2016 deal to close the DTAA capital gains loophole. The deal will force Mauritius to give up 50% of its taxing rights on capital gains for Indian investments from 1 April 2017, rising to 100% from 2019.

But the trend is by no means unidirectional. Mauritius also recently joined the OECD’s BEPS framework, making it responsible for implementing new rules announced in October 2016 by the OECD’s Secretary General. These reforms were declared at the time to be “the most fundamental changes to international tax rules in almost a century”. Though the devil is in the implementation, the changes are at least intended to put an end to double non-taxation and render BEPS-inspired tax planning structures “ineffective”.

There is a combination of interest and principle at play for both countries here. Economic growth has allowed India to alter the balance of its priorities in Mauritius, moving from encouraging trade flows to eliminating double non-taxation. This move attempts to remove tax arbitrages and create a (more expensive) uniform playing field for investors in India. For Mauritius, it is clear which way the wind is blowing, and its credibility as a transparent financial destination—a non-tax haven—has become increasingly dependent on well-publicised compliance with these emerging norms.

How do you solve a problem like Mauritius?

But compliance comes at a cost. Many in the Mauritian finance sector are pessimistic about the effects of the reforms. Samade Jhummun, the chief executive of Global Finance Mauritius (GFM), argues that they may have profound negative consequences: “We took 20 years to build the foundations of the global business sector, with India as plinth.” One bright spot is the reduced rate of 7.5% on new debt claims from April 2017, which has historically been taxed at domestic rates for all non-Mauritian-bank lenders, and which could make the jurisdiction attractive for debt investments into India.

The government is now scrambling to counteract the economic hit from these reforms. A turn towards African economies is at the top of the billing. Developments include a trading platform for hedging African currencies against the US dollar, closer ties to stock exchanges in Johannesburg and Nairobi to encourage cross-listing of shares and other areas of cooperation, and creating incentives for more front-office activity and regional headquartering for corporations. A memorandum of understanding has also been signed with India’s stock exchange, designed to boost cross-listing and turn the country into more of a conduit for Indian investment in Africa.

But it may not all be smooth sailing. Without favourable tax incentives Mauritius will face a tougher sell on all fronts. Moreover, greater transparency and diversification involves offering more specialized products and services, like complex funds and collective-investment schemes. These require greater regulatory skill and involve a greater vulnerability to scams, according to Dr Jason Sharman of the University of Cambridge. That said, if the transition is managed carefully it could allow the island to capitalise on the riotous growth of African economies by becoming a highly credible entry-point jurisdiction: incorporating there would signal the credibility of a business to potential investors.

And then there is the possibility of an awkward silver lining for Mauritius: by following international rules of which the enforcement has proven largely ineffective, it may continue to reap the benefits of increased credibility without realising the expected blow to revenue. Keeping dirty money out of the international financial system has proven to be a fiendishly difficult regulatory challenge.

As Sharman writes, “a huge amount of regulation has been introduced in the last 20 years internationally, but it is hard to see much evidence that financial crime or money laundering has declined as a result.” Euan Grant concurs, and adds that while the global reforms may lead to some clean up of the ‘formal economies of tax evasion’, they are unlikely to do the equivalent for less formal flows, like criminal money laundering. He also points out that the company formation and banking fees will be proportionately more important with any loss of tax revenue from India. Given the length and complexity of chains of company ownership, and regulators’ historically poor record in combating money laundering, Grant argues “there is little reason to suggest that Mauritius will be different”. A rather cautious brand of optimism may be in order.

Author profile: Lucy Wark is a graduate of the Universities of Cambridge and Chicago in political science and finance. She writes on politics and business for a range of publications including The Guardian, Quartz and the Sydney Morning Herald.