The adequacy of TRC has often been questioned by the Income tax (I-T) department on the grounds that investing entities were mere dummies set up for treaty shopping and deriving tax benefit while actual control lay with holding companies and investors in other locations which do not qualify for tax exemption.
However, recent developments indicate that tax officials as well as quasi-judicial authorities are willing to let these overseas entities claim tax benefits even though they are owned by holding companies in other countries.
A few weeks ago, the Income Tax Appellate Tribunal (ITAT) struck down the I-T department’s argument that MH India (Mauritius), a company in Mauritius, was simply a conduit for The Netherlands parent from which it had borrowed to buy shares in India. In claiming tax on capital gains from the sale of shares by the Mauritius company, the tax officer had also pointed out India’s acceptance of the provisions of Multilateral Instrument (MLI) — a global framework that makes it tougher for MNCs to escape tax. At the core of MLI (which Mauritius is yet to accept) is an attempt to stop corporations from artificially shifting profits to low or zero-tax jurisdictions.
“The Tribunal has carefully reviewed the underlying facts and held that the Mauritius company is not a conduit company. Merely because it had availed loans from its holding company to invest in India, it cannot be denied the benefit of India-Mauritius tax treaty. The Tribunal also placed on the CBDT Circular No. 789 dated April 13, 2000 and the Supreme Court ruling in the case of Azadi Bachao Andolan. For the sake of completeness, the Tribunal also confirmed that in case Mauritius treaty benefits were not be granted, the
India-Netherlands tax treaty would apply- as a backstop. This is a welcome ruling and should help FPIs and private equity funds investing from Mauritius as it reaffirms that not all entities investing from jurisdictions like Mauritius are conduits,” said Shefali Goradia, Partner – Business Tax, Deloitte Touche Tohmatsu India LLP.
In the landmark `Azadi’ ruling, the Supreme Court had held that the provision in the Double tax avoidance Agreement would prevail over the general provisions contained in the IT Act.
“While the courts are settling down to accepting TRC to exempt tax on sale of grandfathered investments, the tax authorities are refusing to budge. The issue will become more prominent in 2023 as many funds have sold their pre-2017 investments this year,” said Saurrav Sood, practice Leader, international tax & transfer pricing at SW India.
The Assessing Officer, said the ITAT bench, has made a desperate attempt to overcome the ratio laid down in the Azadi case by “anticipating a futuristic event of ratification of MLI providing amendment to the preamble of India – Mauritius Tax Treaty by Mauritius Government, which is yet to happen”.
“This is one more ruling upholding the sufficiency and sanctity of a TRC issued by the Mauritian authorities.
Certain crucial aspects like period of existence, borrowings, intention to make additional investments into India were raised and discussed in the ruling. Arguments that the entity was a conduit, merely transposed to claim benefits
under the India – Mauritius tax treaty were not considered enough to negate the TRC as well as the binding value of the Azaadi Bachao ruling as well as multiple circulars issued thereafter by the Tax Department,” said Ashish Mehta, Partner at Khaitan & Co.
GOING BEYOND MAURITIUS / S’PORE
Though the ruling went against the tax office, some of the tax officials see the ITAT’s acknowledgement of the Dutch holding entity a silver lining: If the holding company of the Mauritius company was an US entity, instead of being located in the Netherlands, or Singapore, the tax department may find itself at a more advantageous position.
“Explanations have been sought from many Mauritius firms to explain their structure, directors, company details and investigation is underway to lift their corporate veil. Once that is done and the probe concludes that the beneficial owner is someone else, demand against them will be raised accordingly,” said a senior tax official privy to the development.
Under the revised India’s treaties with Mauritius and Singapore, no capital gains tax is imposed on sale of shares purchased before 2017. But, if the I-T department looks through the entity in Mauritius andSingapore to focus on the parent in the US — or any other country which does not have a comparable tax benefit provision in its treaty with India —- the taxman may have a better case before courts and tribunals.
However, in the case of another foreign VC fund, the tax department did not go look beyond Mauritius to argue that the law should look at ‘substance’ over `form’ while accepting the explanation given by the overseas investor. While the funds industry and their tax advisors are keeping their fingers crossed — as the department rarely looks at favourable rulings — they believe these developments nonetheless reassert the significance of TRC.
- I-T argues Mauritius/S’pore entities are controlled by others
- Tax officers want to go beyond these entities
- Tribunal has ruled that TRC of Mauritius entity is enough to claim tax benefit
- Tribunal however has acknowledged Holdcos/parents od Mauritius cos