This Background Paper and Statistical Annex examines selected issues pertaining to the Mauritian economy, which are all related to the question of how Mauritius will be able in the future to sustain its export-led development and diversify its economy. The paper discusses the impact of the Uruguay Round agreement on the Mauritian economy. The paper also utilizes available data to assess Mauritius’s external competitiveness, which is a major issue as regards the sustainability of high export growth.

Abstract

This Background Paper and Statistical Annex examines selected issues pertaining to the Mauritian economy, which are all related to the question of how Mauritius will be able in the future to sustain its export-led development and diversify its economy. The paper discusses the impact of the Uruguay Round agreement on the Mauritian economy. The paper also utilizes available data to assess Mauritius’s external competitiveness, which is a major issue as regards the sustainability of high export growth.

III. The Offshore Financial Center in Mauritius

In Mauritius, the offshore financial services sector (or offshore financial center (OFC)) is often referred to as the “Fourth Pillar” of the economy, after sugar, tourism, and the Export Processing Zone (EPZ). This note reviews the context in which the OFC developed in Mauritius, including the factors that have facilitated its development (Section 1); and reviews the intermediary role of the Mauritius OFC, including in a comparative context with other offshore centers (Section 2).

1. The development of the Mauritian OFC

The establishment of the Mauritian offshore sector in 1988 was part of the authorities’ attempt to continue the diversification of the economy by providing an impetus to the services sector. Further, the authorities have since then augmented the services that Mauritius has to offer to include entrepot trade and transhipment services by setting up the Mauritius Freeport Authority. 1/ For discussion purposes, the companies that operate in the offshore sector are divided into banks and non-bank entities.

The key legislation that initiated the establishment of the offshore sector, and offshore banking activity in particular, was the Banking Act of 1988. The legislation laid down the framework for the operation of offshore banks and gave supervisory authority over them to the Bank of Mauritius (BOM). Initially, banks with an offshore license were only allowed to deal with nonresidents in any foreign currency. However, the residency requirement has been relaxed somewhat over the past few years, with the banks first being allowed to lend to EPZ companies and more recently to both residents and nonresidents, although only in foreign currencies. In practice, however, only a few parastatals have taken out loans from the offshore banks, and these transactions have all taken place only after the BOM granted approval. 2/

This change has important implications for the financial sector since it has blurred the line between the onshore and offshore activities. With the offshore banks now being allowed to lend to domestic companies, albeit in foreign currencies only, they are able to compete directly with the domestic banks for such lending business but are subject to fewer regulations. For instance, unlike the domestic banks, the offshore banks are fully exempted from monetary policy measures such as reserve requirements and certain other prudential requirements. Moreover, the offshore banks face a zero tax rate on all profits, although they can opt to pay tax at a higher rate to optimize tax benefits under double-taxation agreements with their countries of origin. In addition, all documents relating to offshore transactions are exempt from stamp duties, and there is no withholding tax on interest or other payments by the banks to nonresidents. Further, the delineation between the offshore and onshore banks has become vague since the authorities fully liberalized the capital account of balance of payment in July 1994, thus allowing domestic banks to be able to lend and borrow freely in foreign currencies.

Seven banks presently operate with offshore licenses, and as of December 1994, these banks had total assets of $504 million (Table 1). 1/ The number of banks with offshore licenses has not increased since 1991 in large part because of the conservative stance that the BOM has to issuing licenses. The Bank requires applicants either to have a sound reputation or the backing of a major international bank. In fact, except for two banks (Banque Privée Edmond de Rothschild (Océan Indien) and Bank of Baroda), all the others have sister banks with a substantial presence on the domestic scene, reflecting, in part, the cautious stance of the BOM in issuing licenses.

Table 1.

Mauritius: Summary Accounts of Offshore Banks, 1990–94

(In thousands of U.S. dollars: end of period)

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Source: Bank of Mauritius

The other important step in the establishment of the OFC was the amendment of the Company Act of 1984 in 1990 to allow for the operation of offshore nonfinancial companies in Mauritius (see Bikoo (1993)). The relaxation in regulatory controls, however, was not enough and the number of new offshore companies remained small until the enactment of new legislation specifically tailored for the offshore center, viz., the Mauritius Offshore Business Activities Act (MOBA Act), and the Offshore Trusts Act, were introduced in 1992. In particular, the MOBA Act--which allowed for the establishment of the Mauritius Offshore Business Activities Authority (MOBAA), giving it both the role of promoting the center and supervisory authority over all nonbank offshore companies--was important for the rapid growth of the center. 1/

Mauritius allows for two types of offshore companies to be set-up: the ordinary status company and the international status company. The former are required to have a capital stock in excess of US$1 million, file annual audited accounts, and can elect to be taxed at a rate from 0 to 35 percent. Insurance companies, banks, and other companies that have dealings with the public are required to acquire this status. Ordinary status is also necessary to be able to benefit from the Indo-Mauritian DTA. By contrast, companies that have international status face virtually no regulatory restrictions, can be set up in a single day, and are not liable to taxation. The services of these companies are often employed to register ships and aircraft in Mauritius. Local residents are not allowed to set up offshore companies, although there have reportedly been instances where the MOBAA has granted a few individuals permission to form offshore companies.

As of May 1995, 2,428 offshore companies 2/ were registered with the MOBAA. Of these, some 1,410 were ordinary status companies and the remainder 1,018 had international or similar status. 3/ A large part of the growth in the number of these companies has taken place since early 1994; at the end of 1993 the total number of offshore companies stood at about 800. The activities in which offshore companies are engaged are diverse; for example, the 1,410 ordinary status companies included 45 fund management companies, 761 investment holding companies, 111 international trading firms, and 21 offshore management service companies.

In line with the Government’s stated objective of integrating the onshore and offshore sectors, some steps were taken in the 1995/96 budget to begin this process. All ordinary status companies established after the end of the 1997/98 fiscal year will be liable to profit tax at 15 percent. However, the process of integration will be limited and slow, to the extent that companies that are presently operational and those formed up to that date will continue to be able to choose to be taxed at a rate from 0 to 35 percent. Another measure announced in the budget was the requirement that all offshore management services companies pay a reduced profit tax of 15 percent after July 1998, the same rate of tax as that which applies to domestic companies.

2. The Mauritius’s OFCs intermediary role

Although the previous section has stressed the importance of a minimal regulatory regime in attracting offshore companies, other considerations that affect a company’s decision to domicile itself in a particular offshore center include political stability and geographic location. The extent to which Mauritius has these and other attributes relative to a few OFCs is discussed briefly in this section.

a. Mauritius in comparison with other OFCs

Mauritius is a relative latecomer to the offshore banking scene. As of 1993, there were more than 25 countries and cities describing themselves as offshore financial centers (see Hampton (1994)); some of these offshore centers have been in existence since the early 1960s. On the basis of the ratio of deposit money banks’ foreign assets to export of goods and services, the IMF identifies seven countries as being major offshore banking sectors--namely, The Bahamas, Bahrain, the Cayman Islands, Hong Kong, the Netherlands Antilles, Panama, and Singapore. Although the OFC in Mauritius is not considered a major center, it has some of the attributes that have been identified as being necessary to the successful development of OFCs. These include strategic geographic location, political stability, and a conducive regulatory framework.

With regard to geographic location, OFCs tend to be found in three clusters--generally, in and around the Caribbean basin (servicing North and South American residents), in the Pacific (to attract East Asian capital), and Europe. This adds weight to the argument that OFCs mainly exist to service the needs of clients residing in much larger and wealthier economies. In this respect, sharing the same time zone as the country in which the majority of clients are based, as well as proximity to these clients, would seem to be an advantage. Mauritius is unique as an OFC in that it is not close to any one of the three major economic zones. However, to the extent that there are proximate larger economies than its own to exploit, they are those of India and South Africa. 1/ Nonetheless, the OFC’s growth may ultimately be constrained by the absence of many rapidly growing economies in close proximity. 2/

In terms of the political climate, success as an OFC, as with much else, depends on a stable political environment. In this connection, recent experience has shown that instability in the region in which an OFC is domiciled, as well as in the country hosting the OFC, can lead to a rundown of assets held at the center, and so, a decline in its use. 3/ Mauritius, having had a stable democratic system of government for more than the last two decades, has fared well on this account.

The regulatory framework is another important factor determining the success of an offshore center. OFCs often have to strike a balance between offering companies a very relaxed regulatory environment and ensuing a supervisory regime capable of preventing illegal activities, such as money laundering; in general, failure by an OFC to prevent illegal activities from taking place or the perception of an OFC as a haven for money laundering often leads to the loss of reputation. This has reportedly been the case for a number of the Caribbean offshore centers. At the same time, one of the attractions of OFCs to their clients is their secrecy laws.

Other more specific factors may, however, induce companies to gravitate to a particular OFC. For example, the Mauritius OFC is attractive to investment funds wishing to invest in India, because by being registered in Mauritius, the funds will lower the tax burden they would otherwise have faced (see below). In a similar vein, the Cayman Islands have attracted a lot of insurance business, which, in turn, has created a snowball effect attracting more and more such companies. Jersey, for its part, markets itself as a high quality (more stringently regulated) center for fund management. Hence, the ability of OFCs to lure companies already domiciled in another OFC seems very limited; in this sense, each OFC may be considered a niche player.

b. The Indo-Mauritian double taxation agreement

The Mauritius OFC generally raises funds in the industrialized countries, and places them in India. This has been the case largely due to the Indo-Mauritian DTA. Under this agreement (which was signed well before the OFC was established), withholding tax and capital gains tax rights of Mauritian resident companies engaged in business in India were transferred to Mauritius. In turn, since the establishment of the OFC, Mauritius has waived the rights it has to these taxes in order to attract companies to domicile themselves in Mauritius.

In particular, ordinary status Mauritian offshore companies derive three distinct tax benefits. First, they have complete exemption from capital gains taxes on the sale of property (including shares) in India. Second, they receive a reduction in Indian withholding taxes on dividend payments from 20 percent to 5 percent, where a Mauritian offshore company owns at least 10 percent of the Indian company (if less than 10 percent, the withholding tax is reduced from 20 to 15 percent). Third, these companies have complete exemption from Indian withholding tax on interest payments made by an Indian company to a Mauritian offshore company creditor, where the loan has been approved by the Indian Government.

In order to be eligible for these benefits, however, an offshore company has to satisfy a number of criteria, designed to ensure that the company is domiciled in Mauritius and to generate business for the offshore banks, offshore management companies, and accountants. These criteria include that the company: be liable to taxes in Mauritius; 1/ be managed locally, which entails having at least two local directors, plus a qualified person as company secretary; have a bank account in Mauritius; hold at least one board meeting in Mauritius annually (though foreign directors can participate via the telephone); and its accounts be audited locally.

Investment funds totalling more than $4 billion have been channelled into India through Mauritius offshore companies. The large scale of these flows has, however, reportedly caused some concern in India (at least in the press) about the tax revenues that are being lost. To some extent, the steps announced in the 1995/96 budget to change the tax regime of offshore companies, albeit starting in July 1998, are part of the Mauritian authorities’ attempt to reduce adverse sentiments about the use of the offshore center for “tax avoidance” purposes in India and with other potential treaty signatories. Another move that has been taken by the Mauritian authorities was to allow Indian accountants to certify the accounts of Mauritian offshore companies. The offshore management companies and banks in Mauritius are more sanguine about the future of the DTA with India. They point to fact that India has recently signed a similar treaty with Cyprus, which also hosts a very successful OFC--though, this, of course, will mean increased competition for the Mauritius OFC in its niche market.

c. Other offshore activities

The Mauritian authorities are aware of the pitfalls of relying too much on a single country such as India; consequently, they have sought to increase the number of countries with which they have DTAs. Over the past year, some DTAs have been signed (including with Pakistan and South Africa) and others are being negotiated (including with China, Russia, and Sweden). While the treaty with South Africa is tax neutral and is not expected to generate a significant amount of new business for Mauritian companies, that with Pakistan allows companies to enjoy tax benefits by domiciling themselves in Mauritius and is thus expected to generate business for the OFC.

The authorities’ broader ambition is for Mauritius’s OFC to be at the center of trading and financial activities in the Indian Ocean region. For instance, it is hoped that offshore banks will be active in opening and guaranteeing letters of credit for trade transactions within the region; since these banks do not pay any taxes and generally face minimal regulation, they enjoy an advantage in this respect over other banks in the region. In addition, the cost of funds to most of the offshore banks is relatively low, or at least they do not face a country premium by virtue of the fact that most of them are part of reputable international banks. To date these advantages have generated trade-related business for the offshore banks.

References

  • Bikoo, S.D.,Offshore business in Mauritius” in Industry Focus, Vol. 5, April, a publication of the Ministry of Industry and Industrial Technology, Port Louis, 1993.

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  • Hampton, M. P.,Treasure islands or folls gold: can and should small island economies copy Jersey?” in World Development, Vol. 22, No. 2, pp. 237250, 1994.

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1/

This chapter will concentrate on the offshore financial services. Freeport activities were legislated for in 1992, and only became operational last year (see the accompanying staff report SM/95/284).

2/

It is unclear why the offshore banks have so far not taken advantage of the favorable tax and regulatory regime under which they operate to lend to other resident entities in foreign currencies. In particular, the fact that OFC banks can only lend in foreign currencies is not an impediment, because of the existence of a forward foreign exchange market.

1/

As of June 1995, the 1995/96 Budget speech put the total assets of the banks at $790 million. The seven banks operating in Mauritius are: Barclays Bank Pic, Bank of Baroda, Banque Nationale de Paris “Intercontinental,” State Bank of International (a joint venture between the State Bank of India and the State Bank of Mauritius), Banque Privée Edmond de Rothschild (Océan Indien), Banque Internationale des Mascareignes (a joint venture of Credit Lyonnais, Banque de la Réunion, and the Mauritius Commercial Bank), and Hong Kong and Shanghai Bank Corporation.

1/

The recent growth of the OFC has greatly been facilitated by the double taxation agreement (DTA) that Mauritius has with India, which enables companies incorporated in Mauritius to reduce greatly the tax burden they face when investing in India (see below).

2/

By June 1995, the number of offshore companies had reached about 2,600 as stated in the 1995/96 Budget speech.

3/

Of the 1,018 international status companies, 448 companies are what are known as exempt status companies. These companies are the equivalent of present day international status companies under the old Company Act, but can benefit from DTAs between Mauritius and other countries, including India. Another 34 companies in the category are actually offshore trusts, and have a different legislation, the Offshore Trusts Act of 1992, governing them. Presently, about half of all the companies registered in the offshore sector are thought to be active.

1/

Johannesburg, South Africa’s financial capital, is more than 2,000 miles away from Mauritius, and Bombay, India’s financial capital, more than 3,500 miles away. Increasingly, however, technological developments may mitigate the handicap that Mauritius suffers from being very far away from even its closest trading partners.

2/

The rapid growth of Singapore as an OFC in the late 1970s, for example, was helped significantly by its proximity to other rapidly growing economies in East Asia.

3/

The problems faced by the Bahrain Offshore Banking Unit at the time of the 1990–91 Gulf War is illustrative of the first case: assets held by the offshore banks in Bahrain declined from US$72.6 billion in 1989, to around US$53 billion in the aftermath of the War, while there has been an increase in the level of assets since then, they have not reached their former levels. Developments in Panama in the late 1980s illustrate the second case: whereas offshore deposits had been around US$25 billion in 1982, these deposits slumped to US$8 billion at the height of the political instability in 1988, and, by 1993, had recovered to only US$16 billion.

1/

Ordinary status offshore companies can elect to pay a profit tax rate between 0 and 35 percent (unlike the Indian DTA, some DTAs do not allow offshore companies to pay no profit taxes at all). In practice, virtually all of the companies choose to pay no taxes, as they still can benefit from the DTA with India.