Mauritius, a small island in the Indian Ocean with a population of 1.3 million and gross domestic product of $14.2 billion, is nonetheless one of the biggest investors in India.

For the six months ended September 2019 – the single largest source of foreign direct investment into India was Singapore with $8 billion in investments. But Singapore was closely followed by Mauritius at $6.36 billion, a figure far greater than the U.S. ($2.15 billion), the Netherlands ($2.32 billion) and Japan ($1.78 billion).

Over the longer term, Mauritius’ investments into India far surpassed Singapore.

Since 2000, Mauritius FDI to India has totaled $134.5 billion, versus $83 billion for Singapore.

Why does Mauritius pour so much money into India?

In a study for the Center for Budget and Governance Accountability, a think tank based in New Delhi, Suraj Jaiswal wrote that between 2000 and 2017, of all the FDI India received, Mauritius accounted for 34%, the largest share.

Jaiswal said that the main reason for Mauritius’ outsize investment flows to India has to do with its status as a tax haven and how the island state is used as a conduit for investments made by parties in other countries.

While Mauritius has a corporate tax rate of 15%, the effective tax rate is only 3%. In addition, the island has no withholding tax and no capital gains tax on dividends.

Jaiswal hypothetically proposes a company based in the U.K. “makes an investment in three Indian firms, namely A, B and C, through a number of subsidiaries based in Mauritius and Cyprus. For these investments, the country reported as the source of investment will be Mauritius and Cyprus, while in actuality the investment is coming from the U.K.”

Jaiswal estimated that more than 90% of investments made by Mauritius, Singapore and Cyprus (all tax havens) were actually just rerouted through these counties by parties elsewhere. In all cases, firms and individuals are taking advantage of the lower tax rates on gains in countries like Mauritius and forming shell companies there to make investments in India.

This form of tax evasion is also called “investment round-tripping” whereby capital is routed through a low tax jurisdiction and sent to the original country (in this case India) in the form of investments or FDIThe vast majority of FDI from Mauritius is believed to follow this circuitous route.

“It was round-tripping and going elsewhere using Mauritius as a springboard,” said James Zhan, the United Nations’ Conference for Trade and Development’s director for investment and enterprise.

John Christensen, director of U.K.-based think-tank Tax Justice Network said: “it has become extremely difficult to distinguish between round-tripped capital and genuine FDI globally.”

Another common practice is “re-invoicing” whereby, for example, an Indian company exporting to Europe, will invoice their goods through Mauritius. “Profit accrues to the company in Mauritius, and that company doesn’t pay any taxes,” Christensen said.

And the capital that accrues in the Mauritius shell company is then imported back into India, disguised as FDI in the capital account.

Mauritian authorities insist that they are a responsible financial transaction center.

“We don’t want to be used as a base for [people] to bypass their taxation duties to their home countries,” said the chief executive of the Stock Exchange of Mauritius, Sunil Benimadhu.

However, India has taken steps to crack down on fishy FDI activities.

In April 2019, capital gains on investments made in India through firms in Mauritius and Singapore became fully taxable. India had amended its double tax avoidance agreements with these countries as far back as 2016, however it took time to phase them in.

“Investors have factored in the higher tax into their calculations. The increased tax incidence has not dented India’s attractiveness as an FDI destination. Investors see commercial reasons in investing in India," said Amit Maheshwari, partner, Ashok Maheshwary and Associates, a chartered accountancy.