Although Mauritius will lose a historical advantage, it does not lose a competitive advantage because Singapore, the other key financial centre for investment in India, will also be subject to similar capital gain changes.
The government on May 10 signed an amendment to its three-decade old Double Tax Avoidance Agreement (DTAA) with Mauritius to remove a longstanding advantage that allowed investors to avoid paying capital gain taxes in India by channeling their investment through Mauritius.
"The taxation agreement is credit negative for Mauritius because its financial centre will be a less attractive platform for investing in India than it used to be," Moody's said in its credit outlook report.
A curtailment of new investment flows through Mauritius would cause deterioration in its balance of payments equal to 1-2 per cent of GDP annually, and consequently put pressure on its foreign exchange reserves.
"However, a sharper shift in investor sentiment would have more dire consequences," it said.
Mauritius' financial industry is the primary source of net financial inflows from abroad. It contributed 10 per cent of GDP in 2015 and substantial financial net inflows over the past five years allowed foreign-exchange reserves to double to $4 billion between 2010 and 2016.
"The tax changes will weaken its balance of payments, consequently increasing its external susceptibility," it said.
Companies using the DTAA operate in Mauritius under a Global Business Company-1 (GBC1) licence are subject to Mauritian tax jurisdiction, and benefit from an advantageous tax regime, including low corporate taxes and nil capital gain tax.
At the end of 2014, Mauritian companies with GBC1 licences held $200 billion in Indian assets, according to the Financial Sector Commission of Mauritius, constituting 38 per cent of their $520 billion total assets held worldwide, including Mauritius.
These assets are invested abroad and in countries that have DTAAs with Mauritius.
For firms utilizing internationally focused financial centres such as Mauritius, the traditional business model is mainly to channel funds with limited effect on host country.
"For Mauritius, the funds involved are so large relative to the national scale that they affect the country's balance of payments and banking sector," Moody's said.
About two-thirds of total net financial inflows in Mauritius have historically been related to investment in India.
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