Revelations of tax havens and their systems to facilitate tax avoidance spread throughout the last decade. Both legal and natural persons exploit tax structures and international bilateral agreements to carve out creative – but legal – pathways to avoid paying taxes. This readiness and persistent effort to avoid taxes call the notion and purposes of ‘taxation’ into question. Taxation has a simple give-and-take principle – one gives the funds to the government, and the latter has a duty to redistribute that wealth to the public through amenities, infrastructure, and services, among other things. States are nonetheless willing today to legalise tax exemptions for the sake of economic efficiency and tax competition. Nevertheless, legality does not mute the demand for equity. This article investigates how the legality of tax avoidance does not render this practice less unjust than tax evasion. Economic efficiency cannot trump justice and equity; the point of taxation is to balance economic efficiency and equity.
Part I: Legality
Taxes are imposed so that states accumulate enough funds to cater for the provision of public goods and services. They aim to decrease the wealth gap and income inequalities through the redistribution of wealth. Using domestic and international taxation laws, states retain the power to regulate the behaviour of their residents’ consumption and of foreign direct investments. It is then more of a political, economic, and social responsibility rather than a personal one to fulfil one’s tax obligations; avoiding taxes then could nearly look like an act of national betrayal. Non-compliance to taxation laws is a natural aftermath of the implementation.
To promote oneself as an investment destination, states have used taxation laws to their benefit for their financial development. They have legislated certain structures where one may “evade taxes legally”. Tax evasion and tax avoidance are distinguished by a thin dividing line. The UK’s Home Office Revenue Service addresses the practice of ‘tax avoidance’ as one which “bends the law” and as one “operating within the letter, but not the spirit, of the law”. Within the line, i.e., within the parameters of the law, one may strategize to not pay taxes, thanks to agreements and tax incentives. This is termed as ‘tax avoidance’. On the other hand, tax evasion is illegal once that line is crossed, i.e., once one steps outside the parameters of the law. Despite this difference in legality and penalties, they both are driven by the same factors and have similar consequences.
People today emphasise on their absolute right to their property, which includes one’s money. The enforcement of the obligation to pay taxes is then often viewed as a form of coercion or as an aggressive interference with one’s right to property. Both people and corporations increasingly stress upon entitlement to their hard-earned income and profits and to their enjoyment. No one else can claim to have a percentage of them.
Through this somewhat extreme libertarian approach of entitlement, the poor can easily be exploited by the rich. While individual freedom should indeed be maximised, there needs to be an autonomous agent which will strategize for economic efficiency and place a legal framework or certain restrictions in the public interest. For instance, one of the purposes of taxation is to reduce the wealth gap nationally. Without the give-and-take principle, the rich would only get richer, and the poor, poorer. Samuel Freeman proffers that “libertarians do not condemn all coercion”; marginal interference may be made for the sake of society.
The ‘entitlement theory’ is in stark contrast to what Adam Smith preaches. He establishes the undeniable responsibility of every person to contribute to the national economic growth that they will eventually benefit from. These contributions should be:
1. as little as possible from one’s pocket, and
2. representative of one’s capacity.
The amount of money owed to the State is then fair and proportionate.
When it comes to personal taxes, not everyone pays proportionately to one’s abilities and revenue, especially in cases where a flat income tax rate reigns in the jurisdiction. Mauritius had previously adopted a flat income tax of 15%. However, being taxed 15% of Rs. 50,000 and 15% of Rs. 500,000 seems to be largely disproportionate and unfair to the one earning Rs. 50,000. Through a recent amendment to the Income Tax Act 1995 via the Finance (Miscellaneous Provisions) Act 2022, the flat income tax rate was replaced by a progressive tax structure, whereby different ranges of salaries pay different percentages. The higher the salary is, the higher the tax rate ought to be.
Part II: The Compromise
The legalisation of tax avoidance frameworks is the compromise made by Mauritius, among various states, for the sake of economic prosperity. Despite the drawbacks that may follow tax avoidance, the latter’s frameworks have undeniably significantly propelled the Mauritian economy. Being a Small Island Developing State, Mauritius has for the longest time depended on its sugarcane, textiles, tourism, offshore and services industries to maximise the influx of foreign currency into the economy.
Tax avoidance frameworks indeed give rise to healthy tax competition. To stand out from other jurisdictions, Mauritius secured Double Taxation Avoidance Agreements (DTAA) with other countries to reassure companies that their profits will not be taxed. Mauritius has signed and ratified with nearly 51 countries, of which 45 are enforceable. This has encouraged more foreign direct investments to go through Mauritius first before investing into another State. The tax incentives arranged by the Mauritian government have strengthened its place on the financial market as investors would prefer Mauritius while “treaty shopping”. The tax avoidance framework creates fiscal interdependence which is important for healthy tax competition.
Mauritius has had an agreement with India whereby profits made from Mauritian investments in India would be exempted from ‘capital gains’ tax. It was reported that in a span of 15 years, 34% of foreign direct investments in India, “valued at USD 93.6 billion,” came from Mauritius. While the capital does not remain in Mauritius, the corporations – which are incorporated in Mauritius and before taking advantage of the DTAA – create jobs and contribute to the Mauritian economy through their daily spending here, whether it concerns rent or other expenses. Without the facilitation that Mauritius provides through the DTAA, these corporations would have had no interest in fitting Mauritius into the investment equation. On a political and economic basis, therefore, the DTAA framework has proven to be highly effective for the Mauritian economy.
The Organisation for Economic Co-Operation and Development (OECD) encourages tax competition, but it does not endorse the secrecy and lack of transparency that ensues. As it addresses the drawbacks, the best way to tackle these is to institutionalise taxation. The OECD prefers a uniformity in tax rates, regulated by an autonomous body. It also proposes the setting up of a global minimum corporate tax rate of 15%. While these tax regulations and controls would help bring more revenue to the State and would decrease the injustice of tax avoidance, the setting up of a base will dampen Mauritius’ jurisdictional competitiveness from a tax perspective.
Part III: Injustice
The criticisms of tax avoidance are somewhat similar to those of tax evasion. By creating a framework which frees a person from one’s obligation to pay one’s taxes, a State loses out on potential revenue that it would otherwise have made. Tax avoidance frameworks are mostly developed for foreign investors and companies, but persons within the jurisdiction find ways to take advantage of these frameworks. For instance, individuals have registered themselves as companies so that their personal consumption would be concealed under “purchased inputs”.
In simpler terms, foreign companies are incorporated in Mauritius before they can invest in India; they are then covered by the DTAA between Mauritius and India to avoid capital gains taxes. The loss in revenue borne by India could be qualified as “tax abuse”, which triggered a renegotiation of the Agreement in 2017. Afterwards, companies were meant to pay a 7.5% tax rate on capital gains for the first 2 years, after which the tax rate reverts to 15%. While zero tax rates do attract businesses, states are, or will be following India’s example, increasingly reluctant to subject themselves to such tax abuses.
Given that less revenue is being obtained from taxes because of these tax avoidance frameworks, the tax incidence consequently falls onto the citizens of the country. By using these frameworks, companies shift their tax burdens unto the consumers or the residents of the country. This then exacerbates social inequalities. This would only increase the gap between the rich and the poor, since the latter lack the comparable capacity to the rich to conveniently pay the increased tax rate. While the rich, apart from earning more money, may afford to pay for tax planning or arbitrage services to take advantage of legal loopholes to avoid taxes, lower socio-economic groups are the ones that tend to shoulder a major part of the responsibility. The poor usually may earn income that is exempt from taxes since they lie below the threshold.
Through disguise, some persons can hide their actual income. Doubts arise regarding the definition of ‘income’, and therefore, dividends and cryptocurrency, which are the new-age income, are not included in the definition and are free from taxes. Tax avoidance defeats the principles and equity on which tax structures were built on.
Taxation is an area whereby states have intentionally created loopholes that could be used to their advantage via tax avoidance. The rationale behind the condemnation of tax evasion and the endorsement of tax avoidance practices seems to be justified through a business lens. While foreign direct investments and DTAA frameworks have been a catalyst to Mauritius’ economy, they have also resulted in a shift in legal tax incidence, lost revenue, and non-compliance to established maxims and principles. It is through the equity perspective however that these justifications are questioned. While the importance of a prosperous economy can indeed be acknowledged, it cannot trump the injustice that ordinary people bear.