The Authority for Advance Ruling, New Delhi (AAR), in its order dated 26 March 2020 in Re Tiger Global International II Holdings, Mauritius denied the benefits claimed by the applicants under the India-Mauritius Double Tax Avoidance Agreement (DTAA) on the ground that the investment in question was structured strategically for the purpose of tax avoidance. The AAR rejected these applications preferred by the Mauritian entities, which pertained to exemption from taxation of capital gains on indirect transfer of shares of an Indian company under the DTAA. This ruling highlights concerns related to treaty shopping, and offers a probable solution under the Indian tax regime.
Background to the case
The applicants in the present case consisted of a group of companies incorporated in Mauritius, which were also its tax residents for the purposes of the DTAA. During 2011-2015, they invested in Flipkart, a company based out of Singapore, in various tranches. To this end, these companies were eligible to obtain the benefit of the grandfathering clause embedded into the capital gains tax provision, according to the amended DTAA between India and Mauritius. These shares held by the applicants in the Singaporean company were then transferred to another company, Fit Holdings S.A.R.L, which was incorporated under the laws of Luxembourg.
At present, Flipkart’s (Singapore) investment portfolio consists of several Indian companies, and it acts as the holding company of Flipkart India Pvt. Ltd., which is India’s largest e-commerce firm, and hence it derives substantial value from assets situated in India. The applicants approached the Indian tax authorities in 2018 under section 197 of the Income Tax Act, 1961 (‘Act’) for issuance of nil withholding certificate prior to consummation of the share transfer. This request of the applicants was rejected by the authorities citing that they were not eligible to avail the benefit under DTAA since the transaction was orchestrated to avoid taxes. This contextual interpretation of the treaty provision by the AAR marks a shift in practice.
Decoding the rationale behind the decision
Before delving into the intricate aspects of the AAR ruling, it is important to analyse provisions of the Indian legislation, and their consequent effect, which are applicable to this transaction. According to section 9(1) of the Act, all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situated in India shall be deemed to accrue or arise in India. The Supreme Court had earlier concluded in Vodafone International Holdings B.V. v. Union of India that the transfer of shares in a foreign holding company does not result in an indirect transfer of capital assets of its downstream subsidiaries situated in India and gains from such transfer could not be taxed in India. However, in the aftermath of this decision, section 9(1) of the Act was amended retrospectively to include such indirect transfers. Hence, it is a settled principle that capital gains arising out of sale of shares in such cases was liable to be taxed in India.
However, owing to the effect of section 90 of the Act, which specifically posits that government-entered treaties with other tax jurisdictions will enjoy primacy over domestic tax provisions, the India-Mauritius DTAA serves as the lex specialis in this case eclipsing the effect of section 9. Under the DTAA, as clarified by Circular no. 682 issued by the Income Tax Department, income arising to the resident of Mauritius from sale of shares of an Indian company would be liable to be taxed only in Mauritius. The applicants in Tiger Global argued that the sale of shares of overseas entities was non-taxable in India by placing reliance on this Circular and the decision of the Delhi High Court in DIT v. Copal Research Mauritius Limited, Moody’s Analytics, USA, which held that gains arising from the sale of a share of a company incorporated overseas will not be taxable under section 9(1)(i) of the Act read with explanation 5 thereto.
The AAR, however, disagreed with the contentions forwarded by the applicants owing to the fact that the overall structure of the transaction cast doubts on the underlying motive of the applicants. What is important to note here is that this was not a transaction in singularity. It formed a part of a broader transaction which led to the majority acquisition of Flipkart (Singapore) by Walmart Inc., a company incorporated in the United States of America (USA). Another important aspect that influenced AAR’s decision was the fact that the shares of an Indian company were not transferred directly; hence applicability of India-Mauritius DTAA was itself disputable. This acquisition was facilitated by indirect purchase of the shares of Flipkart (Singapore) from several shareholders, including the applicants. The AAR perused the factual matrix of the case and based its ruling on four rubrics which are discussed below:
- Structure of ownership and control;
- Decision making;
- Financial control; and
- Beneficial ownership
The Revenue highlighted that the applicant companies were set up as conduits for investment and were ultimately held by Tiger Global Management LLC (TGM LLC), a USA-based entity that invests globally through a web of subsidiary units operating out of low tax jurisdictions. The applicants, though conceding on this aspect, argued that the structure of ownership was not a relevant factor in determining the nature of transaction. On this issue, the AAR held ownership structure to be a significant factor in determining the real control, stating further that in this case it does not lie with the applicant companies.
Relying on the minutes of the meeting furnished by the applicants, it was brought to attention that each of the applicant companies had one USA-based director on their respective boards, who were responsible for taking crucial decisions, and that the Mauritian directors ‘were mere puppets and not independent.’ The applicants on this issue contended that major investment decisions were taken by all the members of the board of directors of the respective applicant entities. The AAR considered this factor to be crucial in determining whether the transaction was fashioned for tax avoidance, ultimately siding with the Revenue.
Further evidence put forth by the Revenue revealed that the funds of the applicant entities were ultimately controlled by one Mr. Charles Coleman, founder and partner at TGM LLC. Hence, the applicants’ control over their funds was limited. From this it was apparent that the real control over the transactions was exercised not by the entities, but by the partners at TGM LLC. The applicants attempted to refute this contention stating that the evidence does not prove that funds invested by the applicants were not independently owned and controlled by the applicants.
Relying upon certain disclosures made under Mauritian law for obtaining Category 1 Global Business License, the authorities argued that Mr. Charles Coleman was the beneficial owner of the shares in Flipkart (Singapore). According to the Revenue, this evinced mala fide intention as, owing to absence of direct relationship, they were able to avoid payment of tax on capital gains. The applicants argued that such ownership of shares was in an independent capacity and does not reflect applicants’ complicity, which the AAR did not accept.
The AAR, after deliberating on the abovementioned issues, ruled in favour of the Revenue holding that the transaction was designed as a measure for tax avoidance. It held that for such a decision, the transaction must be looked at from a holistic perspective taking into consideration not only the seller, but also the buyer. The dicta of this ruling illustrates how structure of ownership can be used as an instrument to derive the intention that drives the transaction. Putting this to application, in the present case AAR held that the way the transaction was structured reflects that the intention was to derive benefit under the DTAA, which is an ‘inescapable conclusion.’ The AAR concluded on the issue of control and management that it had to be deduced from the ‘head and brain of the Companies’ and not the day-to-day affairs of their business.
Implication of this decision
This decision of the AAR clarifies the position under Indian law that indirect transfers of Indian assets are not exempted under the DTAA. This ruling is important since it takes a position dissonant from the previous judicial pronouncements on this issue, by denying the benefit under India-Mauritius tax treaty in an ‘indirect transfer’ of shares of an Indian company to a foreign entity. This decision of the AAR garners support since several regulatory concerns in the DTAA were brought to light and it was criticized as being encouraging for tax avoiders to route investments into India through Mauritius-based shell companies which compounded to significant amount in foregone tax revenue.
This decision also evidences that tax authorities in India are scrutinizing in-depth the transactions involving Mauritius entities which intend to claim benefit of the DTAA. What this means for investing firms is that mere operational structure which formally checks the conditions under the treaty will not be enough to secure exemption under it. A contextual narrative, which in substance adheres to the provisions of the DTAA, will need to demonstrate actual compliance in terms of connected aspects of the transaction such as independence in decisions of the board, structure of ownership and financial control.
– Rajarshi Singh & Rakesh Sahu