In the case at hand, the taxpayer entity is a private company domiciled in Mauritius. The entity intended to operate as a pooling vehicle for investments held a Category I Global Business and had aggregated funds from investors worldwide. The entity had acquired shares of a Singapore based company before 1 April 2017 which has in turn invested in the shares of the Indian companies and thus derived their value substantially from the assets in India.
The taxpayer filed an application before the AAR for determination of the tax implications in India on account of the grandfathering under Article 13 of the India-Mauritius Double Taxation Avoidance Agreement (DTAA or Tax Treaty). The taxpayer primarily relied on Article 13(3A) of the DTAA, which exempts Mauritian residents from Indian capital gains tax for shares acquired prior to April 1, 2017.
The AAR[1] denied the application under Section 245R of the Income Tax Act,1961(ITA) on the premise that the transaction was designed for avoidance of tax and observed including, inter-alia, Tax treaty capital gain tax benefit should be denied for want of beneficial ownership.
The Delhi High Court whilst dealing with the Writ petition filed by the taxpayer against the above ruling at the outset observed that the AAR has erroneously proceeded on the premise that Tiger Global Management LLC (TGM LLC, which was the Investment Manager) was the parent and holding company of the taxpayer and such fundamental mistake tainted the impugned orders beyond repair. Further, the High Court observed that since the AAR had travelled beyond forming the preliminary opinion on tax avoidance, the Court was justified to exercise its power of judicial review especially since the taxpayers would be prejudiced if AAR decision continued to exist and were to be read as having already decided all aspects of the impugned transaction.
The High Court took into account various factors with respect to the Mauritius route for Indian investments, landmark Supreme Court decisions in Azadi Bachao Andolan and Vodafone, favorable tax jurisdictions, Central Board of Direct Taxes (CBDT) Circulars No. 682 and 789, Limitation of Benefit (LOB) provision in the Tax treaty, et al for drawing up the following conclusions and/or takeaways:
- establishment of investment vehicles in tax friendly jurisdictions cannot be considered to be an anomaly or give rise to a presumption of being situated in those destinations for the purpose of evading tax or engaging in treaty abuse. There cannot be an assumption of treaty shopping and treaty abuse merely because a subsidiary or any related entity is established in a tax friendly jurisdiction. It would be wholly erroneous to presume that investments originating from Mauritius are inherently suspect or that fiscal residence of an entity in Mauritius would require viewing such entities through a tainted prism
- principles of substance over form must be considered to be the prevailing norm and the doubt on the bona fides of a transaction can only be in those situations where the transaction involves a sham device intended to achieve illegal objectives or formed on illegal motives
- issuance of a TRC by the competent authority must be considered to be sacrosanct and due weightage must be accorded to the same as it constitutes certification of the TRC holding entity being a bona fide entity having beneficial ownership domiciled in a Contracting State and doubting validity attached to the TRC would entail erosion of faith and trust reposed by jurisdictions
- Tax treaty benefits may be denied only in those cases where the transaction is a sham, where fraud is sought to be committed or where entities are incorporated as mere conduits and in a manner contrary to the schema of the treaty itself
- corporate veil of a TRC holding entity can be pierced only in extremely narrow circumstances of tax fraud, sham transactions, camouflaging of illegal activities and complete absence of economic substance
- LOB clause in the India-Mauritius Tax treaty and the TRC comprehensively and adequately addresses concerns in relation to potential treaty abuse and it would be impermissible for the Revenue to manufacture additional roadblocks
- parent entity may exercise shareholder influence over its subsidiary. However, that would not lead to an assumption that the subsidiary in question was operating as a mere puppet or that it was wholly subservient to the parent entity. Subsidiaries are also recognised in law to have a distinct and independent legal persona which is liable to be ignored only in the event of apparent fraud, interposition to camouflage sham transactions or being created to perpetuate an illegality and lacking in economic substance.
- concept of beneficial ownership would get attracted if it be established that the holder of income had no control over the income and merely holds the same till such time it be instructed to deploy that income to another entity or if the income is controlled or regulated by a third party with the holder having no real or substantive control over that income
The Court decided that the taxpayer was not an entity lacking in economic substance and the taxpayer’s transaction was duly grandfathered under Article 13(3A) of the India Mauritius Tax treaty and thus would exclude the transaction ambit of capital gains tax in India.
The Delhi High Court ruling provides clarity and certainty on many aspects involved in Tax treaty benefits, viz. indirect transfers, grandfathering, GAAR applicability. It should pacify non-resident investor concerns as it reaffirms that the Tax treaty benefits would be available to genuine investors with requisite economic substance irrespective of investment through tax friendly jurisdictions based on valid TRC.
[1] Tiger Global International II Holdings, In re [2020] 116 taxmann.com 878 (AAR – New Delhi)