Treaty-shopping is about to get more expensive

 

MBIZA, A BUSINESS that grows berries in Zambia and South Africa, and Niel Finance and Services, which owns the Central African Republic’s largest mobile firm, would seem to have little in common. But both have headquarters in Mauritius, an island of 1.2m people 2,000km off the mainland. The country, which tops the World Bank’s “ease of doing business” ranking for sub-Saharan Africa, has a robust legal system and amenities that make it an attractive place to set up shop. Perhaps a bigger draw, though, is a 15% corporate-tax rate, falling to as little as 3% on foreign income.

Mauritius also boasts an extensive tax-treaty network with many sub-Saharan African countries. It has ratified 15 since 1992; only South Africa arranged more over the period. Twelve more are in the works. Double-taxation treaties (DTTs) specify the rate applied by source countries on cross-border income, such as royalties or service fees. Over time Mauritius has secured advantageous terms, typically low or zero rates of withholding taxes—those deducted at source. Since it also has treaties with developed markets and other low-tax countries, multinationals with Mauritian intermediaries can repatriate the proceeds of African investments at minimal cost.

DTTs are supposed to encourage foreign direct investment (FDI) by making sure income is not taxed twice. But in a recent paper Sebastian Beer of the IMFand Jan Loeprick of the World Bank find that Mauritius’s DTTs have not channelled new investment towards co-signatories. Rather, they have led to “treaty-shopping”, with firms merely rerouting existing flows of money. That has deprived African treasuries of tax revenue: in countries with such treaties the corporate-tax take was on average 15% lower than in similar countries without them.

Some countries have balked. A handful, including Rwanda and South Africa, have renegotiated their treaties with Mauritius to raise withholding rates on interest payments and royalties. But the most forceful efforts to clamp down on treaty-shopping have been led by the OECD, a club of mostly rich countries, under its “Base Erosion and Profit Shifting” initiative.

In July it introduced a mechanism that will automatically update applicable DTTs. Rules will be tightened on beneficial ownership and on “principal purpose”—ie, whether the main motive for incorporating in a jurisdiction is to obtain tax benefits. Although Mauritius signed up, it initially excluded its African treaties. No public announcement has been made but it has now yielded to pressure and agreed to include all its African DTTs (except that with Cape Verde, which is not yet finalised).

In order to count as tax-domiciled in Mauritius, companies will soon have to employ more staff and spend more locally, says Rama Sithanen, a former finance minister and deputy premier. Pascal Saint-Amans, the OECD’s top tax official, reckons it should take no more than two years to revamp the DTTs. “Treaty-shopping is dead,” he says. Others are less sanguine. The automatic update mechanisms do not cover withholding taxes. As long as rates remain low or zero, some multinationals will continue to net a bargain.

This article appeared in the Finance and economics section of the print edition under the headline “Tit for tax”