The proposed introduction of section 90, sub-section 5, specifying that the availability of a Tax Residency Certificate is a necessary but not sufficient condition for claiming tax benefits under the Double Taxation Avoidance Agreement has stirred a hornet’s nest.
From the time India opened doors to foreign direct investment, Mauritius has been a catalyst for increased FDI inflow. Investors took advantage of the favourable capital gains provisions in the treaty and routed investments through Mauritius.
Why is the Indo-Mauritius treaty popular?
Under Article 13 of the Indo-Mauritius DTAA, capital gains from selling shares of Indian companies would be taxed only under Mauritian laws. However, the Mauritian laws do not impose capital gains tax on an offshore company resident in Mauritius, so there is no capital gains tax either in India or in Mauritius. This made Mauritius the most preferred platform for investing into India.
The story so far...
While the Indo-Mauritius treaty was a blessing to investors, Indian Revenue authorities frowned upon it and chose to disregard the Mauritius entity for want of substance, beneficial ownership of shares and so on, and held that the favourable provisions of the treaty would not be available.
The Authority for Advance Ruling’s past decisions (NatWest and AIG) clearly called upon the Mauritius investor to demonstrate commercial substance and beneficial ownership of shares to claim treaty benefits.
In an attempt to clear the air and gain investor confidence, the Indian government had early in 2000 issued Circular 789, clarifying that the TRC issued by Mauritius is conclusive for claiming DTAA benefits.
Consequently, this circular was challenged through a public interest petition. In 2003, the Supreme Court, in the Azadi Bachao Andolan case, not only upheld the circular but also the validity of treaty shopping.
Since then, though tax authorities have delivered a few favourable decisions (as in the case of E*Trade Mauritius), they have kept a close watch on this area. Recently, the Bombay High Court ruling in the case of Aditya Birla Nuvo created a few ripples.
After a detailed examination, the court differentiated the facts from the Azadi case and held that the Mauritius entity is not the legal/beneficial owner of shares and, hence, denied the treaty benefit.
However, the treaty stood up to the resistance posed by courts and revenue authorities, drawing strength from the Vodafone ruling in which the Supreme Court noted that the TRC, though accepted as conclusive evidence for residential status and beneficial ownership, cannot be ignored if the treaty is abused for tax evasion.
Impact of proposed amendment
The proposed section 90(5) overturns the assurance provided by Circular 789, and investors risk losing treaty benefits on grounds of lack of substance in the Mauritius entity.
Tax authorities can then disregard the legal framework as well as structure of transactions and go beyond the form. FDI through Mauritius, which has significantly stepped up inflows, would be hampered. The fact that the proposed amendment is effective retrospectively from April 1, 2012, further dampens investor sentiment.
The issue was discussed during last year’s budget, where a memorandum explaining the introduction of section 90(4) has provided that the TRC is a necessary but not sufficient evidence for claiming treaty benefits. However, the move to introduce this language under the statute muddies the waters around this issue.
Judicial precedents, the Central Board of Direct Taxes circular and recent amendments — all summarising the conditions for obtaining treaty benefits for Mauritius entities: first, satisfy the test of beneficial ownership/ substance of the entity; second, obtain a valid TRC in the format prescribed; and last, but not least, do not abuse the treaty or structure of transaction for evading tax.
While these conditions are understood and appreciated with respect to all other treaties entered into by India, the benefit of Circular 789 appears to have been withdrawn for the Indo-Mauritius treaty.
Finance Minister’s clarification
Finance Minister P. Chidambaram has since clarified that Circular 789 would continue to be respected, and there will be suitable modifications in the language of section 90(5) when the Finance Bill is taken up. While this message is soothing for investor sentiments, in effect it takes us full circle, and we are back to where we started. So, what was the Government’s intent in introducing the provisions in the first place?
The author is Executive Director, Tax and Regulatory Services, PwC India
Archana Korlimarla, Manager, Tax and Regulatory Services, contributed to the article.