India-Mauritius Tax Treaty has always attracted interest of international investor community as well as the tax authorities. While the law on the application of this treaty was settled by the Hon’ble Supreme Court in its land mark ruling in the case of Azadi Bachao Andolan in 2003; on ground, application of this treaty has often been the subject matter of challenge and dispute from the tax authorities. Recently, the Hon’ble AAR has delivered two rulings in the context of this treaty. Interestingly, though seemingly pronounced in relation to the same group restructuring, in one case (‘Negative Ruling’, AAR No. 1128 of 2011), the Hon’ble AAR has denied the treaty relief to the Mauritius seller; and in the other case (‘Positive Ruling’, AAR No. 1129 of 2011), the benefit of Article 13(4) has been granted. This article seeks to analyse both these rulings on facts and sets out the takeaways from the same.
AAR Rulings - AAR No. 1128 of 2011 and AAR No. 1129 of 2011
The principal subject matter of both these applications was similar – viz, whether the capital gains arising to a Mauritius resident company from the sale of shares of an Indian company in FY 2011-12 were liable to tax in India having regard to Article 13 of the India – Mauritius tax treaty. Additionally, both the rulings also dealt with issues regarding applicability of withholding tax provisions, transfer pricing provisions and MAT provisions in relation to such sale.
In both the rulings, the Mauritius seller company was incorporated in Mauritius, was a tax resident of Mauritius, was not a fly-by-night operator, possessed a valid Tax Residency Certificate granted by Mauritius tax authorities and held a Category 1 Global Business License. Thus, while the Positive Ruling decided the question in favour of the applicant and held that the capital gains arising to the Mauritius seller company were not taxable in India; in view of the peculiar facts in the Negative Ruling, the Hon’ble AAR denied the treaty relief to the Mauritius seller company by holding that the Mauritius entity did not genuinely acquire the shares of the Indian company.
With respect to the other questions that were raised in these rulings, the answers are clear., viz. (i) withholding tax provisions would not apply if there is no chargeability to tax in India, viz. if the Mauritius seller is entitled to capital gains tax relief under the India – Mauritius tax treaty, the buyer will not be required to withhold any tax under the provisions of Indian income-tax law, (ii) transfer pricing provisions would apply even if the Mauritius seller is entitled to capital gains tax relief under the India – Mauritius tax treaty because there is no requirement in the Indian income-tax law that the transaction should result in income chargeable to tax for transfer pricing provisions to get attracted, (iii) MAT will not be applicable to foreign companies.
What does the Negative Ruling mean for India – Mauritius tax treaty?
In our view, this ruling of Hon’ble AAR is fact specific and does not really change/upset the settled legal position concerning applicability of tax treaty to residents of Mauritius with respect to taxability of capital gains in India in the relevant period. After detailed analysis of the factual position in this case, Hon’ble AAR reached a conclusion that shares of the Indian company were not really owned by the Mauritius entity and that they were an investment made by its US parent entity. Accordingly, on that basis, the Hon’ble AAR ruled negatively denying the benefit of tax treaty.
Even before this ruling, it was a general experience that in most of the cases involving this tax treaty, the tax authorities have been investigating and examining the facts and ‘substance’ aspect in detail including whether shares of the Indian company were owned by the Mauritius entities, whether the Mauritius entities are managed and controlled outside India, any round tripping angle and so on. We believe this ruling does not change the legal position; it only re-emphasizes that one will have to examine the facts and substance aspect of a given case in detail.
What factors would be relevant to demonstrate that the Mauritius entity is the legal and beneficial owner of the shares of Indian company?
While there is no express list of factors which, if addressed, would establish that the Mauritius entity is the legal and beneficial owner of the shares of Indian company and thus, entitled to the capital gains tax relief under the treaty; the aforesaid two recent rulings by the Hon’ble AAR throw light on some of the factors that would be relevant in this regard and should be appropriately addressed while assessing the Mauritius entity’s eligibility to claim treaty benefits:
- Who paid the consideration when the Mauritius entity acquired the shares of Indian company?
- Who executed agreements for acquiring the shares of the Indian company?
- Educational and technical qualifications of the Board of Directors of the Mauritius entity.
- Composition of the Board of Directors of the Mauritius entity. In case at least majority of the Board are local Mauritius residents, the burden of proof is on the revenue authorities to establish that the control and management of the Mauritius entity is not in Mauritius.
- In case of non-local directors occupying major positions, whether they were present in Mauritius when essential business decisions were taken in Mauritius.
- Quantum of expenditure incurred by the Mauritius entity on its operations. The nature of expenditure would depend upon the type of business in which the Mauritius entity is engaged. For instance, for an investment holding company, even administrative expenses and legal & professional fees can be said to be operational expenditure.
- Number of employees, staff etc employed in Mauritius.
- Office area in Mauritius commensurate with the nature of business in which the Mauritius entity is engaged.
- Whether the Mauritius entity has made investments in jurisdictions other than India as well?
- Place where the meetings of Board of Directors of the Mauritius entity are held.
- Language of the minutes of meetings of the Board of Directors of the Mauritius entity.
- this should demonstrate that the Mauritius entity is an independent legal entity capable of taking its own decisions,
- this should demonstrate that the Board of Directors of the Mauritius entity engaged in deliberations, discussions etc – prior to making the investment into the shares of Indian company – with respect to business decisions related to the Mauritius entity.
It may be noted that these rulings dealt with a period which was governed by the pre-amended India – Mauritius tax treaty. Though these rulings are very fact specific and do not really change the legal position in relation to the India – Mauritius tax treaty, it does give a sense of the factors that are being considered by the judicial authorities in evaluating the claim of a foreign entity for treaty relief. In summary, the foreign entity’s claim for treaty relief would invariably depend, amongst other, upon the twin elements of intention to invest (control and management) and the contribution of consideration by such foreign entity.
The assessment becomes tricky in cases where the foreign entity’s parent entity exercises influence over its decisions. While some level of shareholder level influence is bound to be there in such cases, it is worth noting that there is a difference between having the power and having a persuasive position. Having said so, in such type of cases, as long as it can be demonstrated that, inter alia, the foreign entity was acting as an independent legal entity (and not as a puppet of its parent entity), taking its own decisions, had made investments out of its own funds through banking channels, signed proper agreements for acquisition of shares, and doing business over a considerable period of time, had a sound business objective, and had invested in other companies as well, its claim to treaty relief becomes strong. Thus, these rulings re-iterate the need for having ‘substance’ for claiming treaty relief even in respect of income from transfer of investments which stand grand-fathered under the relevant tax treaty as well as under the GAAR (i.e. investments which were made prior to 1 April 2017).