Delhi High Court (‘HC’ or ‘the Court) has held that the capital gains from the sale of shares by Mauritius investors shall be duly grandfathered by Article 13(3A) of India-Mauritius Double Tax Avoidance Agreement (‘the DTAA’).

Brief Background

• Mauritian-based Tiger Global International II Holdings, Tiger Global International III Holdings and Tiger Global International IV Holdings (all of them together referred to as ‘taxpayers’) had acquired shares of Flipkart Singapore, which is the holding company of Flipkart India, during the period between October 2011 and April 2015;
• The investors are equity capital investors and investments of taxpayers are managed by Tiger Global Management LLC (‘TGM LLC’) based in US;
• The shares in Flipkart Singapore were acquired by Walmart in August 2018 and post such sale, the taxpayers filed an application with the private ruling authorities (‘AAR’) seeking an opinion on exemption of capital gains arising out of sale under the DTAA;
• The AAR rejected the application under Section 245R(2) of the Income Tax Act (‘the ITA’) stating that the transaction in question is designed prima facie for the avoidance of income tax;
• The taxpayers filed writ petitions before HC impugning the order passed by AAR.

Key excerpts from the ruling

• The taxpayers had incurred expenditure amounting to USD 1,063,709 translating to Mauritian Rupees (‘MUR’) 36,436,182 as against the threshold of MUR 1,500,000 as prescribed Article 27A – Limitation of Benefits (‘LOB’) of the DTAA. The taxpayers held a valid Category I Global Business License, had aggregated funds from more than 500 investors across 30 jurisdictions across the globe and had TGM LLC as their investment manager. Therefore, in view of the said facts, the Court held that the taxpayers can not be said to be shell/ conduit companies lacking in economic substance.
• The taxpayers have been incorporated to act as pooling investment vehicles to access new market opportunities. They came to be domiciled in Mauritius principally due to the investor friendly environment prevalent in that nation. The Court held that the mere fact that the members of the Board of Directors of taxpayers are connected with TG Group does not per se render the taxpayers as mere puppets and subservient to the wishes of TGM LLC.
• The taxpayers had no contractual or legal obligation to transmit revenue from operations to TGM LLC. In the line of such fact, the Court held that it would be incorrect to ascribe beneficial ownership to TGM LLC if the taxpayers were entitled to avail of such income themselves and therefore, the revenue obtained from transfer of shares was a result of actions undertaken by the taxpayers not under the command or wishes of TGM LLC.
• The ruling warrants that a Tax Residency Certificate (‘TRC’) issued by a bona fide authority is sacrosanct and the corporate veil of a TRC holding entity can be pierced by an authority only under circumstances of tax fraud, sham transactions, camouflaging of illegal activities, absence of economic substance and transactions being in contravention of underlying objects/purposes of the DTAA. The Court held that the AAR cannot establish such charges against the taxpayers with suspicion alone and convincing evidence must be produced to back such conclusions.
• In light of decisions of Apex Court rulings in the case of Azadi Bachao Andolan and Vodafone, the Court held that creation of new investment pathways ought not be halted by skepticism or mistrust except on the basis of well-established parameters.
• The Court, referring to decisions rendered by foreign Courts in Cadbury Schweppes and Burlington, further held that it would be erroneous to characterise legitimate business activities undertaken by an entity as constituting treaty shopping, merely because it is situated in a favourable tax jurisdiction.
• Therefore, the impugned order of AAR is quashed and the capital gains arising out of the sale of shares of Flipkart Singapore to Walmart should be duly grandfathered by Article 13(3A) of DTAA wherein exemption is granted for gains on alienation of shares of Indian companies acquired prior to 1st April, 2017 to Mauritian Residents. In other words, Indian GAAR provisions should not apply.

This ruling will carry a lot of weightage specific to cross-border investments especially while adopting a view that establishment of investment vehicles cannot be considered a shell/ conduit entity or give rise to a presumption of being situated in those destinations for the purpose of evading tax or engaging in tax treaty abuse.

Therefore, it is imperative to analyse the economic substance of such entities prior to availing tax treaty benefits. These principles will equally apply for other streams of income as well, where tax treaty benefits are explored.