By Anupriya Nair, A fourth-year student at NALSAR, Hyderabad

On 26 March 2020, The Authority for Advance Ruling, New Delhi (‘AAR‘) in the case of  Re Tiger Global International II Holdings, Mauritius  denied the capital gains tax exemption pertaining to the indirect transfer of shares of Indian companies under the India Mauritius Double Tax Avoidance Agreement (‘DTAA‘). The ruling was a result of a favourably designed DTAA  which allowed Mauritius-based companies selling Indian shares to benefit from the exemption, and to promote tax avoidance practices involving the repositioning of investments into India via Mauritius-based shell entities.

This article examines the economic implications of the AAR decision in light of the uncertainty brought about by COVID-19. The ruling in the instant case brings forth a substantial shift in practice with regard to the interpretation of the DTAA and will have a lasting effect on international investment relationships with India.

Brief Facts of the Case

The applicants in Re Tiger Global International II Holdings, Mauritius, comprising of Tiger Global International II, III, and IV Holdings (‘TGM’), were part of a tripartite structure of private companies which engaged in long term investment activities undertaken for the purpose of gaining capital returns. These three companies are residents of Mauritius for taxation purposes pertaining to the DTAA.

The applicants invested in Flipkart (Singapore) between 2011-2015 which attributed a significant value of its shares to India as a result of its investment in various India-based companies. The three Mauritian taxpayers subsequently transferred a portion of their Flipkart (Singapore) shares to Fit Holdings S.A.R.L.(Luxembourg) . This sale was a consequence of a larger transaction involving Walmart’s acquisition of a majority stake in Flipkart (Singapore).

Initially, the applicants approached the Revenue Tax authorities (‘Revenue’) in August of 2018 under Section 197 of the Income Tax Act 1961 (‘IT Act’) seeking a ‘nil’ withholding certificate in relation to the aforementioned transfer. The request was denied on grounds of ineligibility arising out of lack of independence and control and the Mauritian applicants held in the transaction in question.

Subsequently, the applicants approached the AAR under Section 245Q (1) of the IT Act in order to determine whether the transaction would be taxable under the existing DTAA.

Breaking Down the AAR Ruling

The AAR’s ruling, after consideration of the factual matrix of the case, upheld the ruling of the Revenue. It was held that the share transfer transaction in question was an investment strategically designed for tax avoidance purposes. The AAR made the following key observations:

• Since the financial statements of the applicant revealed that Flipkart (Singapore) was their only recorded investment, it was concluded that the transaction was an exploitation of the DTAA that Mauritius specifically shared with India.
• The operating structure within which the transaction was to function, although not held to be a definite indication of tax avoidance, reflected an intention to exploit the benefits of the DTAA. This was termed as an ‘inescapable conclusion’ by the Court.
• The role of Charles Coleman (a US-resident) over the entirety of the TGM group structure, as a director, beneficial owner, and applicant appointed signatory of bank cheques, gave the AAR reason to believe that the real control and management of the business was not situated in Mauritius but in the USA. Determining the ‘head and brain of the Companies’ as opposed to the daily affairs of business activity was a deciding factor in this aspect.
• The AAR concurred with the Revenue to conclude that the holding-subsidiary structure in combination with the USA-based control and management of the business was indicative of the intention of applicants to exploit the DTAA as ‘see through’ entities.
• Since the transaction involved the share transfer of Flipkart (Singapore) which only procured a substantial value of its company from India, and not an Indian company, the DTAA was held to be inapplicable and the applicants ineligible to claim benefit under the premise of the investment.

Exploring the Implications of the decision

Economic Implications

There is an air of uncertainty and impermanence that surrounds the present state of economic affairs owing to the pandemic. The AAR ruling in the instant case will deter investors from engaging with the Indian market. Mauritian investors were operating under the premise that all existing investments up to March 31, 2017 have been grand-fathered (protected) and exits/shares transfers beyond this date will not be subject to capital gains tax on exit. However, exit plans for Mauritian entities were constricted by virtue of amendments in the convention between India and Mauritius for the avoidance of double taxation and fiscal evasion with respect to taxes on income and capital gains. The denial of treaty benefits, despite the existence of the grandfathering rule, is likely to attract ramifications on future exits by start-up investors who have routed money from tax havens.

The added rigidity in the parameters for the exemption of tax under DTAA will encourage international investors to move their investments to alternate routes and investment destinations. This can cause severe implications on an economy already on the brink of recession owing to the pandemic.

Context-Specific Approach

The context-centric approach adopted by the AAR may mark a shift in the analysis of claim for benefits with respect to tax treaties in the future. A key take-away from the ruling is the increased relevance placed in the examination of substance matter of the parties involved in the DTAA. Further, the holistic perception of the transaction was deemed indispensable, wherein the roles of not only the sale of the shares, but rather the purchaser/buyer involved were also analysed. The intention behind the transaction was also determined by careful perusal of the structure, credibility, conduct, ownership and control of the business.

This level of specificity in the analysis of the transaction leads to the question of the possible arbitrariness in future AAR rulings due to the broadening of scope of analysis made available to them. In the instant case, the AAR found one of the purposes of the transaction arrangement to be for obtaining tax benefit, failing the Principal Purpose Test. However, despite the AAR having utilised the aforementioned test, it was not explicitly mentioned in the ruling, leaving scope for wider analysis/interpretation of operational structure and consequently, easier deconstruction of DTAA in the future.

An Uncertain Future

The CBDT Circular No. 789/2000 clarifies that the tax residency certificate (TRC) issued by the Mauritian Tax Authorities would constitute sufficient evidence of residency as well as beneficial ownership of the Mauritian entity for application of the tax treaty. Further, the landmark ruling of the Hon’ble Supreme Court in the case of Vodafone International Holdings B.V. wherein the apex court unequivocally found that the language of the IT Act was inadequate to tax offshore indirect transfers, upholds the eligibility to claim benefits under the treaty (grandfathering rule).

It is therefore essential to understand that the ruling in the instant case was rooted in the scrutiny of the specificities of the factual matrix presented before the AAR and is not to be held as the conclusive and settled jurisprudence on the DTAA between the two countries. Although it is an important AAR ruling, it is important to consider its position in jurisprudence in light of the above-mentioned circulars and judicial pronouncements. The primary relevance of this judgement lies in its dissonance from this previously deep-rooted position of law.

This discord in the position of law created by this ruling will create an uncertainty in the mind of investor. Further, the way in which the standard treatment of indirect transfer of shares with respect to capital gains exemption will be affected by the current AAR ruling with Tiger Global is unpredictable. We can only wait and observe the way in which issues surrounding the economic impact, grandfathering clause and principle purpose test will be addressed when Tiger Global moves to Delhi High Court to challenge AAR’s decision.