The Delhi High Court has recently ruled that mere establishing tax friendly jurisdiction does not amount to treaty shopping and treaty abuse.
The bench of Justice Yashwant Varma and Justice Purushaindra Kumar Kaurav observed that 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. Action 6 of Base erosion and profit shifting (BEPS) Action Plan, which paved the way for adoption of Limitation of Benefits (LOB) clauses and Principal Purpose Test (PPT) test in treaties as well as the principles emanating from the Organisation for Economic Cooperation and Development (OECD) Commentary on Article 29 reveals that treaties incorporate disentitlement provisions to deprive persons who were not intended to fall under the ambit of the treaty availing those benefits in an indirect manner.
The bench while considering a foreign Courts in Cadbury Schweppes and Burlington, it would be erroneous to characterise legitimate business activities undertaken by entities as constituting treaty shopping, merely because it was situated in a favourable tax jurisdiction.
The court ruled that both Indian and International authorities have taken the consistent position that 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.
The three writ petitions were filed against the order of the Authority for Advanced Rulings (AAR) pursuant to which three applications have come to be dismissed with the AAR holding that the transaction in respect of which the ruling was sought was prima facie designed for the avoidance of tax and thus falling within the scope of clause (iii) of the Proviso to Section 245R(2) of the Income Tax Act, 1961. The AAR held that it was not obliged to render any findings on the merits of the question which stood posited, namely of whether the petitioner was entitled to avail the benefits of the Double Tax Avoidance Agreement between India and Mauritius in respect of the sale of shares of Flipkart Private Limited, a private company limited by shares and incorporated under the laws of Singapore and the question of taxability of capital gains connected.
The petitioner had essentially sought to derive benefit from Article 13(3A) of the India-Mauritius DTAA and which had been subjected to tax capital gains arising from an alienation of shares acquired on or after 01 April 2017. The petitioner had principally urged that Article 13 had thus grandfathered all acquisition of shares prior to 01 April 2017 and the gains arising from their transfer would thus be exempt from taxation. The petitioner had sought exemption from the levy of capital gains tax by virtue of it having admittedly acquired the shares of Flipkart Singapore prior to 01 April 2017.
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The AAR has essentially held that the petitioners were mere conduit companies and disentitled to claim benefits of the DTAA since the transaction lacked commercial substance and the establishment of an entity in Mauritius was principally aimed at deriving undue benefits under the DTAA.
The petitioner contended that Article 13(4) of the DTAA exempts all residents of Mauritius from capital gains tax that may accrue or arise in India. It was Mr. Kaka‘s submission that the term ̳resident‘ would clearly be guided by the CBDT Circulars as well as the concept of TRCs‘ which came to be adopted in the Convention.
The petitioner emphasised on the Circular itself acknowledging that a TRC once issued by the Mauritian authorities would constitute sufficient evidence of the status of residence as well as the issue of beneficial ownership for the purposes of applying the DTAA. The Circular, specifically alludes to the aforesaid prescription being equally applicable in respect of income in the form of capital gains arising from the sale of shares. The CBDT had accordingly clarified that Foreign Institutional Investors26 resident in Mauritius would not be taxed on income from capital gains arising in India consequent to a sale of shares in terms of Article 13(4).
The petitioner argued that the TRC remains the primary and constant requirement for the purposes of claiming treaty benefits and that the perceived motives underlying the incorporation or establishment of an entity in Mauritius would be wholly irrelevant
The respondent-Authority of Advance Ruling argued that the Supreme Court in Azadi Bachao Andolan had clearly held that while treaty shopping may be viewed as a permissible tax avoidance measure, it had clearly frowned upon colourable devices that may be adopted by unscrupulous parties seeking to avoid tax. Despite the sound and fury of the respondents over the so-called “abuse” of “treaty shopping”, perhaps, it may have been intended at the time when the lndo-Mauritius DTAC was entered e into. Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations. This Court cannot judge the legality of treaty shopping merely because one section of thought considers it improper. A holistic view has to be taken to adjudge what is perhaps regarded in contemporary thinking as a necessary evil in a developing economy.
The court concluded that it would be wholly incorrect to commence an inquiry while dealing with such an allegation on the premise that a subsidiary would not enjoy an independent status. The petitioners had proved that they had remained invested in Singapore for more than a decade and had participated in investments amounting to USD 330 million over a span of ten years.
The court opined that a parent or holding company would legitimately claim the right to exercise oversight and retain a broad supervisory role over the affairs of its subsidiaries. This could legitimately take the shape of seats on the BoD, placement or selection of key managerial personnel, regular audit of the affairs of the subsidiary or a periodical review and reporting process. The persuasive position in which a parent is placed, would not warrant the jettisoning of the separate legal persona which the subsidiary enjoys.
The court quashed the order and held that theorder of the AAR suffers from manifest and patent illegalities. Theorder takes a wholly untenable and unsustainable view with respect to the transaction. Its conclusion, therefore, that the transaction was aimed at tax avoidance is rendered arbitrary and cannot be sustained. The transaction stands duly grandfathered by virtue of Article 13(3A) of the DTAA.
Case Details
Case Name: Tiger Global International III Holdings Versus AAR
Citation: W.P.(C) 6764/2020 & CM APPL. 23479/2020
Tribunal: Delhi High Court
Decision Date: 28/08/2024
