South Africa urged to finalise renegotation of Mauritius tax treaty
CAPE TOWN — South Africa needs to finalise the renegotiation of its tax treaty with Mauritius as soon as possible to prevent the loss of large sums of money through “treaty shopping” the Davis tax committee has urged.
The committee released its interim report on ways to prevent base erosion and profit shifting last week, one of the chapters of which dealt with treaty abuse.
South Africa’s renegotiated draft tax treaty with Mauritius was signed in May last year and ratified by Parliament five months later but according to the tax committee report its finalisation “appears to have stalled” as it has not yet been ratified by the Mauritian authorities.
According to the committee’s interim report South Africa’s current double tax treaty with Mauritius — which is meant to apply only to residents of both countries — allows for treaty shopping. This is when non-residents use the benefits that a tax treaty grants to residents of the contracting states by using a “conduit company” in one of these states in order to shift profits out of them. “When a conduit company is set up in a tax-haven jurisdiction, this can result in tremendous loss of revenue for the signatories to the treaty,” the report notes.
South African investors have used Mauritius as a vehicle for investing in other countries with which Mauritius has beneficial double taxation treaties. Likewise, international investors from other countries that have tax treaties with Mauritius have used Mauritius as an intermediary to invest in South Africa. Foreign direct investment of 2.8bn rupees flowed into Mauritius from South Africa in 2012 compared with 38m in 2006.
On the other hand the flow of foreign direct investment from Mauritius to South Africa has been flat in the period 2006 to 2009.
The report says: “This is indicative of the ease of doing business as well as the attractiveness of the Mauritius tax regime. However, with the proposed draft treaty, these flows could reverse as it will not be beneficial for South African companies to use Mauritius as a gateway for Sub-Saharan African expansion.
“South African companies often route investments into other Africa countries via Mauritius since Mauritius has negotiated better benefits in its tax treaties with some African countries than South Africa has. This is especially so with regard to withholding tax rates (on dividends, interest, royalties and management/technical fees) in treaties between Mauritius and other African countries, which are generally lower than the withholding tax rates in tax treaties between South Africa and other African countries.
“There is no doubt that the draft treaty (if ratified) will put Mauritian companies in a less beneficial position vis-à-vis South Africa than is currently the case. This is so, specifically in the context of dual-resident companies, loans to South African borrowers and investments in companies owning immovable property in South Africa,” the report says.
The report observes that the World Bank and the International Finance Corporation have consistently ranked Mauritius as one of the best sub-Saharan African countries in which to do business because it is a member of African regional trade organisations; has a vast network of treaties with countries; is party to 35 double taxation agreements; has no capital gains tax; and has a low corporate income tax rate of 15%, which translates into an effective tax rate of 3% after taking into account available credits.
The renegotiated draft treaty with Mauritius provides for the mutual agreement on the residence of taxpayers, increased the rates of withholding tax, repealed the clause cutting out capital gains tax for property rich companies and removed a tax sparing clause which was replaced by alternative relief in the form of a foreign tax credit. It would limit the extent to which South African residents can make use of double tax treaties Mauritius has signed with other countries — for example with India — for treaty shopping purposes.
By routing their investments into these third countries via Mauritius they can benefit from the tax advantages offered by the tax treaties Mauritius has with them, for example the exclusion of the payment of capital gains tax, as well as a tax on dividends, interest or royalties.
It widens South Africa’s tax net as it increases South Africa’s ability to identify Mauritian companies that should be regarded as resident here. It could also help to bring into the tax net certain Mauritian branches of South African companies. The draft treaty also provides that capital gains earned by Mauritian tax residents could be subject to South African CGT (capital gains tax) if the gain is from the disposal of shares in a South African company holding immovable property — a “land rich” company. This will have an impact on Mauritian companies that currently hold South African based investments in the mining or property sector.
The Netherlands is another jurisdiction highlighted by the report as being the source of many inbound investments flow into South Africa especially for acquiring ownership of South African immovable property. The double taxation treaty South Africa has with both the Netherlands and Mauritius provides protection against South Africa’s capital gains tax on companies from these countries who own shares in a South African company holding immovable property. This is called a capital gains tax “carve-out clause” which is source of possible leakage to the fiscus.