The Hindenburg research report on Adani group was once again in the news recently with the stock market regulator requesting the Supreme Court to extend the deadline for submission of the status report on this issue. The regulator’s assurance that it is nearing the completion of its enquiry implies that interesting times lie ahead for foreign portfolio investors using the Mauritius route to move funds to India.

It has been an open secret for many decades now, that domestic money has been entering Indian stock markets disguised as FPI money, through low cost jurisdictions such as Mauritius, Luxembourg and Singapore. The Hindenburg report helped highlight that these practices are still in vogue.

The report stated that it has, “identified 38 Mauritius shell entities controlled by Vinod Adani or close associates….many of the Vinod Adani-associated entities have no obvious signs of operations, including no reported employees, no independent addresses or phone numbers and no meaningful online presence.”

These brass-plate companies are typically structured as multi-layered entities where the ultimate owner is hidden. But SEBI’s enquiry in to the Adani issue, which is being closely watched by all, could prove to be the last straw as far as these shell companies based in Mauritius go. FPI and FDI inflows from this country have already dwindled significantly. As regulatory scrutiny tightens further, the allure of Mauritius could fade further.

Fading allure of Mauritius

Numbers put out by SEBI show that much has changed over the last decade with heightened scrutiny and withdrawal of tax advantages resulting in the US displacing Mauritius as the top-most source of foreign portfolio money.

As on December 31, 2012, FPIs from Mauritius held 26 per cent of the assets under custody of foreign investors, featuring on the top of list of countries originating FPI money. US came second then, with slightly lesser holding. Singapore and Luxembourg followed with 13 per cent and 8 per cent share in FPI assets.

But in the years that followed, the US has displaced Mauritius as numero uno source of FPI money. In July 2023, FPIs from the US held 39.32 per cent of FPI assets under custody, amounting to ₹22,62-lakh crore. Singapore came next with 9 per cent, followed by Luxembourg (7.3 per cent) and Mauritius (6.5 per cent).

A lion’s share of incremental FPI money since 2012, amounting to ₹19.19-lakh crore came from the US with Singapore and Luxemboug accounting for around ₹6.5-lakh crore. Assets of FPIs from Mauritius have remained flat between 2012 and 2023. If capital appreciation of the assets is excluded, the value of assets held by FPIs from Mauritius would register a decline.

US pips Mauritius

Mauritius was initially the preferred channel for foreign portfolio and foreign direct investors due to the tax advantage that accrued to them due to the Double Tax Avoidance Agreement which the two countries had signed. The DTAA laid down that capital gains tax had to be paid in the country where the foreign investor was based. Since the rate of capital gains tax in Mauritius was zero, investors from this country paid no capital gains tax.

But that is now history. The DTAA has been altered so that for shares purchased after April 1, 2017, capital gains arising from an investment in an Indian company will be taxed in India. With the double tax avoidance treaty with Singapore being linked to the agreement with Mauritius, investments from Singapore have also been brought in to the Indian tax net.

The drastic drop in the number of foreign investors as well as the funds from Mauritius shows that foreign investors from other jurisdictions such as the US, who were earlier channelling the funds through Mauritius to take advantage of the low tax, are now investing directly.

Another reason for the jump in money from the US could be the easy money policy followed by the Federal Reserve during the pandemic which would have led to more funds in the hands of investors in the US, which would have been deployed in high-growth emerging economies including India.

The US is far ahead of other countries in terms of FPIs registered with SEBI, with 3,464 FPIs.

While there are only 576 FPIs from Mauritius, number of FPIs from Luxembourg is quite high at 1,275. It’s quite possible that increasing scrutiny on fund flows from Mauritius is resulting in re-channelling the dubious flows through Luxembourg.

Adani-Hindenburg fallout

The Hindenburg report is going to impact the dwindling FPI flows from Mauritius further. With the tax advantage being withdrawn, the current use of this channel appears mainly to launder money or to manipulate domestic share prices through flows from abroad.

While there have been efforts by Indian tax authorities as well as market regulators to get information about the shell companies in this jurisdiction, these efforts have not been too successful. The Hindenburg report highlights the existence of glaring lapses in rules in the island country which allow brass-plate companies to be set up with the objective to round-trip money back to India.

Recent SEBI moves such as asking FPIs to declare their ultimate beneficiary and asking FPIs with greater concentration to a single stock to provide granular details about their shareholding to their custodians, are intended to tighten the screws on the entities operating out of tax havens and involved in illicit practices.

If SEBI’s investigation in the Hindenburg report reveals the exact modus operandi used by the Adani group to conceal the ultimate owner, then new set of regulations are likely to follow, plugging more loopholes. This could result in more so-called FPIs moving away from Mauritius.

Considering the copious amount of foreign portfolio money which came into India during the pandemic and in recent months, it is evident that India remains a preferred destination for foreign funds. Therefore, concerns about external account and the rupee need not influence decisions on clamping down on money laundering.

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