Definitions And Development Offshore Financial Centre Accounting Essay

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The foundation of the International financial centre has primarily due to the contribution of the growing network of double taxation treaties for conducting investment abroad. Mauritius offshore financial centre stood as an example. One of the most chief motives for using OFCs by investors is the seeking of tax benefits.

Double Tax Treaties - an introduction

Due to immense growth in international trade and commerce and the culmination of globalization, residents of one country have tried to operate their business in other countries where income is being derived. Now being in a different country and at the same time being resident of another country, means that the taxpayer will have to pay tax in both countries that one where s/he is deriving income and one where s/he is being resident. In order for taxpayers to pay tax only once, the Double Taxation Avoidance Agreements (DTAA) has entered into force to avoid the discouragement which double taxation may provide in the free flow of international trade and international investment. As said by Egger et al. (2004), one of the most visible obstacles to cross border investment is the double taxation of foreign-earned income.

Scope of this Study

The global business sector has been the mainstay of the economy over the last few years. Having implemented internationally agreed tax regime has increased global investors' confidence and trust which have been proven beneficial to Mauritius. It has in fact concluded a numerous of bilateral double tax treaties in order to boost trade and investment between countries in question. Double tax treaties have proven to be favorable to Mauritius. While Mauritius remains the preferred route to invest in India, the DTAA signed in 1983 with the country has suffered during the last years, started in 1994 specifically. There were alleged abuses from Indian tax authorities and till now negotiations with regard to the treaty to plug any loopholes in the treaty is still in the pipeline.

The scope of this study will be to find the contribution of the global business sector to the economy and also the root of the problem with respect to the treaty with India and to propose any effective solution. Also, we shall see to what extent such treaty and the General Anti-Avoidance Rules have affected the Mauritian Global business sector.

Research Objectives

The primary goal of this work is to analyze the global business sector as a whole, paying attention to its contribution to the economy of Mauritius.

The other objectives are as follows:

To see if double tax treaties have a good impact on the performance of the global business sector.

To get a clear picture of what is happening with the treaty with India and whether the existing measures taken are sufficient.

To investigate to what extent the issue regarding the treaty with India has affected the global business sector.

To see what kind of negotiation will be needed to restore the issue between the two countries.

To study the aim of Mauritius to provide outbound investment opportunities for African businesses in a view to boost investment exchanges.

Overview of Chapters

Chapter One: The introductory part begins with some important background information. The scope of the study is revealed and the aims and objectives of the research project are clearly specified.

Chapter Two: This chapter deals with the literature review on the research subject matter such as the offshore financial centre, the evolution of the global business sector in Mauritius and its double tax treaties agreements and also their contribution to the economy.

Chapter Three: This chapter consists the introduction of the Indo-Mauritian double tax treaty and provides a brief on the evolution of the problems pertaining the treaty.

Chapter Four: The "Methodology" chapter explains the methods used to carry out the project. The research questions and strategy, the population, sample size and methods of data collection are defined.

Chapter Five: Chapter five presents two parts. The first part focuses on the financial data and analysis and the second part delineates the findings of the survey. Both parts carried out the analysis and discussions with regard to the results obtained.

Chapter Six: In the light of what have been investigated and results obtained, certain recommendations and suggestions are made. They aim at showing what solutions are available to the Indo-Mauritian DTAA, and how can the global business sector remain unaffected irrespectively of what decision is to be taken. The chapter ends with a conclusion proposing on the future progression of the global business sector.

Chapter 2: Literature review

2.1 Definitions and development: Offshore Financial Centre

Offshore financial centre became a vital ingredient in the evolution of the international financial system. In fact, OFCs began to have an impact on international financial markets in the early 1970s.

At its simplest, IMF states that an OFC can be defined as any financial center where offshore activity takes place.

According to Ahmed Zoromé (IMF Working Paper/07/87), an OFC is a country or jurisdiction that provides financial services to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy.

Dufey and Giddy (1978) term "offshore centers" as international financial centres that host financial intermediation activities primarily for non-resident borrowers and depositors. It should be noted that OFC was known under different names such as world financial sector (WFC). Regional financial center (RFC), international banking centre (IBC) (Yonn S.Park)

As R.Roberts (1994) puts it, "offshore financial centre is the operations of financial centres which, though physically located within a country, have little connection with that country's financial system." He also elaborated on the fact that the growth of the offshore financial centres has been witnessed by the expansion of the Eurocurrency market.

Some of the main financial offshore centres published by IMF are Bermuda, British Virgin Island, Cayman Island, Guernsey, Jersey, Luxembourg, New Zealand, Singapore, Bahamas, and including Mauritius as well. This list is not exhaustive though.

Some of the authors argued that OFCs has also benefitted in the process of globalization. Abbott and Palan put forward that OFCs have become "nothing less than the cornerstone of the process of globalization" (Abbott and Palan, 1995: 19). Same judgment was reached by Alan Hudson (1998) who said that the fall down of the Bretton Woods international monetary system in the year 1970,was due to the contribution of OFCs and as a result its evolution were boosted. The expansion of OFCs is linked with the course of financial globalization and the movement of a centralized international monetary system to a more decentralized system (Agnew and Corbridge, 1995; Helleiner, 1994).

However, while OFCs have contributed in the progression of international financial system by boosting investment in the major economies which in turn has enhanced economic growth and eventually sustained job creation and other aspects of business development (R. Hines,2010), have been characterized as tax havens. By tax haven, it means that it is a country where taxes are very low or there is no tax at all such as Bahamas and Bermuda which permits individual or corporations, from other parts of the world, to take advantage of tax evasion or tax avoidance. But it should bear in mind that tax havens are not used for illegal purposes, as they can be used for tax avoidance or tax mitigation. Tax avoidance and tax mitigation are considered as people's legal right, since they mitigate tax burdens. On the other hand, some use OFCs for tax evasion which is illegal in its full sense. Tax evasion is another form of money laundering. As A. Rose and M. Spiegel (2005), abridge in their working paper series, that tax havens and money launderers are likely to be OFCs, promoting tax evasion and immoral activity in neighboring source countries. OFCs offer wealthy individuals and corporations with financial bolt holes, as they are in a measure to carry out things with their money that they would not be permit to perform in their country (N.Shaxson, 2013). Offshore tax havens have been perceived as the best place to launder dirty money as it has been criticized that tax havens are unwilling to divulge important information for investigators to trace these money launderers as their companies has been set up, by the use of tax havens without mentioning shareholders, directors or owners.

2.2 Evolution of the global business sector in Mauritius

Since independence, Mauritius has undergone many remarkable progressions. This has been facilitated by the diversifying of its economy. The main pillars of the economy were mainly based on sugar, textile and tourism respectively. However due to considerable flaws in these sectors faced by international competition and the desire of the Mauritian government to break away from its focus on these main pillars, a new sector has to be found which is more resilient to existing problems and this leads to the creation of financial services sector. In 1990s, the textile industry, more specifically the Export Processing Zone (EPZ) was growing steadily and became very competitive. This resulted in large exports which in turn increase economic growth of the country. The way the EPZ was evolving, the same strategy was adopted for financial services, since EPZ was basically an "offshore" activity developed as an export-led growth sector. According to Iqbal Rajabalee (1995), there is a parallel relationship between the offshore sector and the EPZ. In that effect, in April 1992, Mauritius was declared as an offshore Financial Centre to mainly diversify its economy in a position to sustain economic growth.

However, the pioneer of offshore sector development started with offshore banking in 1989 by the Banking Act 1988. The offshore industry as a whole accelerated with the creation of the Mauritius Offshore Business Activities Authority (MOBAA) in 1992. MOBAA had as objectives to regulate offshore business activities and to issue offshore certificates. However by 2001, MOBAA was repealed, as in May 2000, Mauritius wrote a "commitment letter" to the OECD in order to avoid inclusion on the OECD's list of jurisdictions which offer unfair tax competition.

2.2.1 Major changes in the Mauritius financial services sector

On Dec 1 2001, financial services Commission (FSC) replaced Mauritius Offshore Business Activities Authority. It was then followed by a new companies Act 2001, Financial Services Development Act (FSD Act) and also Trust Act 2001. This is partly as a result of the commitment made to OECD.

In the same vein, terminologies such as offshore changed to 'Global Business', offshore company by 'category 1 Global Business License company' and international company by 'category 2 Global Business License Company' and lastly offshore Trust is now known to simply as a Trust. Therefore, our offshore sector is now known as Global Business Sector.

In fact, The Financial Services Commission (FSC) is an emanation of the Financial Services Development Act (FSDA) 2001 which was repealed and replaced by the Financial Services Act (FSA) 2007.

2. 2.2 Offshore Vehicles

The main vehicles for conducting global business activities in Mauritius by being resident entities are:

Global Business Company 1 (GBC1)

Global Business Company 2 (GBC 2)

Trust

Partnership

The two types of Global business is defined under section 19 of the Financial Services Development Act 2001 as activities which are conducted business outside Mauritius and deals with people who are non Mauritian resident and also where the business is carried out in a currency other than the Mauritian currency.

According to the Trust Act 2001, there can be the creation of a foreign trust provided it does not go against the law of Mauritius and not having objectives contrary to the public policy. A trust may carry on a 'qualified global business' after obtaining a category 1 global business license. But, a trust may not apply for a category 2 global business license. Leo Gough (1997) defines an offshore trust as "not a person in law in the way that a company or an individual is….it can't own anything itself-the assets of the trust are vested in the trustees, who can be companies or individuals".

The general (unlimited) partnership and the limited partnership in Mauritius are governed by the Code de Commerce Act 1985. There are known as the Societe and accordingly can carry the global business status. Partners may be individuals or corporations.

2.2.3 Contribution of the global business sector

Though different studies have been carried out about the contribution of the global business sector, a country's GDP remains an important indicator. R. Bryant (1989) explains that the contribution of the Financial Services Sector to the singapore's GDP can measure the interconnection between financial data and the economic activity in Singapore.

While relying on the ten-year review of the economic impact of banks and trust companies in the Bahamas, Huggins and Grene (1988), suggests that the economic contribution can be measured in terms of:-

"Employment generation;

Total expenditure (salaries, accommodation, utilities, professional services);

Revenue accrued to government"

Based on their study, they said that the economic contribution is substantial and "its performance over the past ten years has indeed been encouraging".

T. K. Jayaraman and Chee-Keong Choong (2010) in their recent study elaborate that the contribution of OFC institutions is claimed to be in terms of employment, expenditure comprising wages and salaries and the total expenditure as percentage of GDP appears to be the best proxy variable for estimation purposes. From this, the hypotheses were drawn such as OFC positively influences output, banking sector credit directly affects output and dummy variable for political instability. However, they concluded that OFC do not benefit the economic growth of Vanuatu. This study was carried out on a period of 24 years (1983-2007)

2.3 Tax treaties

Taxation is the backbone of the global business. R. McGhee (1997) states that "One of the main reasons for going offshore is to minimize tax and reduce potential tax liability". Mauritius despite being a low tax jurisdiction has entered a large number of double tax treaties offering tax advantages.

Generally speaking, the success of the Mauritian Global Business sector has been largely due to the increasing network of double tax treaties as revealed by the Annual report 2011 of FSC. However, there are also others factors that have contributed to expansion of this sector; this is shown in Appendix A.

"Double Taxation Agreements are tax agreements between two countries which basically allow tax deducted at source from payments from one country to be offset against tax which would be otherwise be payable by the taxpayer resident on other country" (R. McGhee, 1997). The agreement chiefly established in which state tax will be paid. Appendix B provides two methods that are frequently used to lessen the international double taxation.

It is good to underline that Mauritius started to ratify DTAAs well before the launching of the global business sector making its first DTAA agreement in 1981 with United Kingdom in a view to avoid double taxation of taxpayers and to prevent fiscal evasion.

2.3.1 Functions of tax treaties

As outlined by Blonigen and Davies (2004), tax treaties perform four primary functions. The first is to standardize tax definitions of treaty partners in order not to lead to double taxation and inefficient capital flows. The second role is to promote the exchange of tax information by reducing transfer pricing or any forms of tax avoidance. The third goal of tax treaties is to prevent treaty shopping. Finally, tax treaties affect the actual taxation of multinational corporations. They do so through the provisions for double taxation relief and the rules that reduce maximum allowable withholding taxes on three types of remitted income: dividend payments, interest payments, and royalty payments.

2.3.2 Eligible entities

It should underscore that it is possible for a foreign company to get access to the tax treaties by incorporating its company in Mauritius and by obtaining a Tax Residence Certificate (TRC) issued by the Mauritius Revenue Authority thus it will be then a Mauritian resident company. However, it should bear in mind that only Global Business Company 1 (GBC 1) benefits from the pool of double tax treaties in Mauritius. GBC 2 on the other hand, do not have access to double tax treaties as they are not tax resident in Mauritius. As for, global business partnerships, the Finance Act 1996 made it possible to allow them from benefitting the Mauritius' double tax treaties. Ultimately, the benefits of tax treaties are accessible only to resident bodies or persons.

2.3.3 Model of DTAA in Mauritius

The OECD Model Tax Convention on Income and on Capital and the UN Model Double Taxation Convention between Developed and Developing Countries are among the DTAA models which are widely used worldwide for drawing up double tax treaties. But the majority of DTTs are based on the OECD model (Arnold, Sasseville and Zolt). As far as Mauritius is concerned, it adopts the OECD Model to draft its double taxation avoidance treaties. The updated OECD Model has known some changes enumerated in Appendix C. The OECD Model favours more country of residence and serve interest of developed countries on the other hand the UN model established the principle of source and serve better interest of developing countries. (See Appendix D for historical tracking of DTAAs)

2.3.4 Double Taxation Agreements with different countries

Till date Mauritius has concluded 37 treaties as shown below and another series of treaties is under negotiation.

Source: Board of Investment: available on http://www.investmauritius.com/Resources3a.aspx

Source: Mauritius Revenue Authority Available on: http://mra.gov.mu/index.php/taxation/double-taxation-agreements

The taxation rates applicable of these countries are presented in Appendix E

Sometimes it takes several years for the treaty to take effect. Similarly, some treaties fail multiple times before they are finally ratified. For instance the original draft of the U.S / Cyprus treaty was signed in 1981 but did not pass the Senate. An amended version failed in 1985. In 1987, a final version of the treaty was signed but was not ratified until 1988 (Blonigen and Davies). On the other hand, some treaties go to the final stages (See Appendix F for Stages in the life of a double tax treaty) but are never bought to use may be because of changes in domestic laws which overrides the existing provisions of the treaty. Normally when one country wants the termination of such treaty, it should give notice to the other country much before the date of termination. As per OECD Model DTAA, it stipulated that notice of termination should be given "at least six months before the end of any calendar year after the year…." The DTAA treaty also makes provisions with regards to its termination.

2.3.5 Number of DDTs worldwide

The figure below shows the number of Double Tax Treaty, Bilateral Investment Treaty and other IIA from 2000 to 2010. Even though DDT is increasing at a decreasing rate coupled with economic crisis, countries continued to negotiate DDT for the betterment of their economy.

Figure 2.1: Number of DDTs

2.3.6 Contribution of double tax treaty

Few academics have addressed the issue of the impact of double tax treaties, most of them have studied the impact of bilateral investment treaties on Foreign Direct Investment such as the works of Salacuse and Sullivan (2005); Hallward-Driemeier (2003); Egger and Pfaffermayr (2004); Tobin and Ackerman-Rose (2005) and finally Neumayer and Spess (2005). Nevertheless, Blonigen and Davies have been important authors as regards to the impact of double tax treaties on FDI.

One of the overriding objectives of tax treaties is to increase inbound and outbound FDI. Blonigen and Davies (2000) based their study on the effect of bilateral tax treaties on FDI covering 65 countries for the period 1966 -1992. They concluded that tax treaties do have a positive and significant effect on FDI and reported that FDI activity can increase between 2 and 8 percent for each additional year a treaty is in place.

However, according to their study in the year 2004 for the analysis of US inbound and outbound FDI over the period 1980-1999, they found that the treaties concluded by the country had no statistically effect and instead brought a negative effect on the FDI. Similarly, Figueroa (1992) said taxes do not affect foreign investor's investment decisions which imply that double tax treaties are futile in increasing FDI.

Till Siegmann in his paper 'Impact of bilateral investment trade and double tax treaty on FDI' finds clear empirical evidence by the use of knowledge capital model and gravity model that BITS and DTTs have positive effects on FDI. As regards to percentage this seems to affect FDI around 30% for DTTs and between 30% and 40% for BITs.

2.4 Conclusion

In this literature review, the evolution of the offshore financial centre and the global business sector of Mauritius and element of double tax treaties have been highlighted and also their overall contribution has been noted. The quest for panoply of double tax treaties are seen as a major reason of the development the offshore centre. The next chapter pays particular reference to the Indo-Mauritian treaty.

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