Affirming the findings of the Authority For Advance Rulings (AAR), the Supreme Court put an end over the dispute of treaty benefits vis-à-vis tax evasion & tax avoidance, and ruled that once the unlisted equity shares of a foreign entity (Flipkart Pvt Ltd, Singapore), on the sale of which the non-resident taxpayer entity (respondent) derived capital gains, were transferred pursuant to an arrangement impermissible under law, the respondent entity is not entitled to claim exemption under Article 13(4) of the respective Double Tax Avoidance Agreement (DTAA).
Since the Revenue Department has proved that the transactions in the present case are impermissible tax-avoidance arrangements, and the evidence prima facie establishes that they do not qualify as lawful, the Apex Court applies Chapter X-A of the Income Tax Act.
The Apex Court found that the applications preferred by the respondent before the AAR relating to a transaction designed prima facie for tax avoidance were rightly rejected as being hit by the threshold jurisdictional bar to maintainability, as enshrined in proviso (iii) to Section 245R(2) of the Income Tax Act. Accordingly, the Court concluded that the capital gains arising from the transfers effected after the cut-off date, i.e., April 01, 2017, are taxable in India under the Income Tax Act read with the applicable provisions of the DTAA.
A Two-Judge Bench of Justice J.B. Pardiwala and Justice R. Mahadevan observed that the statutory amendments to the Income Tax Act, particularly the introduction of Chapter X-A (GAAR), and the 2016 Protocol amending the India-Mauritius DTAA, have fundamentally altered the legal framework for assessing tax avoidance and treaty eligibility. Precedents and circulars from the pre-amendment era cannot be relied upon without considering these changes.
The Bench also observed that a Tax Residency Certificate (TRC) is not conclusive evidence of residence for claiming treaty benefits, and the Tax authorities are empowered to “look through” a transaction and deny benefits if it is established to be an impermissible avoidance arrangement lacking commercial substance.
The Bench noted that the legal landscape has “completely changed” following the judgment in Vodafone International Holdings BV v. Union of India [(2012) 6 SCC 613], and emphasised that subsequent amendments to the Income Tax Act (insertion of Chapter X-A on General Anti-Avoidance Rule – GAAR), the Income-tax Rules (Rule 10U), and the DTAA itself have fundamentally altered the analysis of such transactions.
The Bench analysed the interplay between the grandfathering provision in Rule 10U(1)(d) and the overriding provision in Rule 10U(2), and observed that while Rule 10U(1)(d) protects investments made before April 1, 2017, Rule 10U(2) clarifies that GAAR shall apply to any arrangement, irrespective of its date, if the tax benefit is obtained on or after April 1, 2017. This significantly dilutes the grandfathering protection for arrangements designed for tax avoidance.
The Bench found there was “clear and convincing prima facie evidence” that the arrangement was designed with the sole intent of evading tax. The fact that the respondent was claiming exemption in both India and Mauritius ran contrary to the spirit of the DTAA, which is to prevent double taxation, not to enable double non-taxation. Once a mechanism is found to be a sham, it becomes an “impermissible avoidance” or “evasion”.
The Bench elaborated that if tax evasion and tax abuse happen under the umbrella or shield or in the guise of money laundering or trafficking or round tripping, it not only weakens a Nation, it makes it less powerful or even powerless in given circumstances tearing apart the social fabric and texture of a Nation and its people. Every anti abuse law must not only appear to be a deterrent but should be implemented to achieve the underlying goal of preventing an abuse by anyone against one’s Nation and its people. Any lenience is yet another form of compromising tax sovereignty.
The Tax treaties, international agreements, protocols and safeguards should be very engaging, transparent and capable of periodical reviews with the power to renegotiate with strong exit clauses to avoid unfair outcomes safeguarding Nation’s strategic and security, prevent erosion of tax base and loss or weakening of democratic control and introduce explicit carve outs safeguarding the Sovereign’s right of taxation, added the Bench.
As far as safeguards to be taken while entering into any International Treaties, is concerned, the Bench suggested inclusion of a Limitation of Benefits (LOB) Clause, so as to prevent treaty shopping by shell companies set up only to exploit treaty benefits. The Bench also suggested inclusion of a General Anti-Avoidance Rule (GAAR) Override, so as to ensure India can override treaty benefits if the primary purpose of an arrangement is tax avoidance.
The Bench cautioned that the Treaties must include provisions that recognise “significant economic presence” (SEP), not just physical presence, and allow India to impose equalisation levies or digital services taxes on foreign digital platforms. The Bench also called to preserve Source-Based Taxation Rights, so that India must retain the right to tax income arising in its territory, especially: (i) capital gains on shares of Indian companies; (ii) interest, royalties, technical fees; (iii) business profits from Indian operations; and (iv) avoid residence-based taxation-only models, which favour tax havens and developed countries.
Additionally, the Bench suggested to avoid “Most Favoured Nation” (MFN) Clauses, since MFN clauses can bind India to give better terms to one country if they are given to another in the future. This can also undermine India’s flexibility in future negotiations. The Bench further suggested a clear definition of “Permanent Establishment” (PE), which will prevent avoidance through techniques like commissionaire arrangements and fragmentation of business activities.
Briefly, the respondents are three private companies incorporated in Mauritius: Tiger Global International II, III, and IV Holdings, and they held a Category I Global Business License (GBL-I) and valid Tax Residency Certificates (TRCs) issued by the Mauritius Revenue Authority. The Respondents held shares in Flipkart Private Limited, a Singapore-incorporated company, and the value of Singapore Company’s shares was substantially derived from assets located in India. During the relevant year, the respondents transferred these shares to Fit Holdings S.A.R.L., a Luxembourg company, as part of a larger transaction involving the acquisition of Singapore Co. by Walmart Inc.
In the meantime, the respondents sought a nil withholding certificate under Section 197 of the Income Tax Act, which was denied by the tax authorities. The I-T Authorities held that the respondents were not eligible for benefits under the India-Mauritius Double Taxation Avoidance Agreement (DTAA) because control and decision-making did not lie in Mauritius.
The respondents then approached the AAR seeking a ruling on whether the gains from the sale of shares would be chargeable to tax in India under the Act and the DTAA. The AAR rejected the applications, holding that the transaction was prima facie designed for the avoidance of income tax and was therefore barred under proviso (iii) to Section 245R(2) of the Income Tax Act. The High Court, however, quashed the AAR’s order, and held that the respondents were entitled to treaty benefits and their income was not chargeable to tax in India.
Appearances:
Additional Solicitor General N Venkataraman, for the Appellant/ Revenue
Senior Advocates Porus Kaka and Harish Salve, for the Respondent/ Taxpayer
