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Indian AAR Grants Treaty Relief to Mauritius Taxpayer on Capital Gains Bringing Cheer to Investors

27 May 2010

In a recent ruling by the Authority for Advance Ruling ("AAR") in India, capital gains exemption was allowed to a Mauritius taxpayer (E Trade Mauritius Ltd) under the India-Mauritius tax treaty (the treaty). The AAR ruled that the capital gain arising on transfer of shares in an Indian company held by a Mauritian resident investor was subject to tax only in Mauritius, as per Article 13 of the treaty. Taxand India and Taxand Mauritius assess the ruling and the benefits (and relief) it brings to investors.

The AAR ruling assumes significance in the backdrop of a heated debate surrounding capital gains exemption provisions under the treaty and a more recent judicial controversy in the case of taxpayer-E*Trade itself. About a year ago, the taxpayer was denied treaty relief in respect of capital gains by the tax administration on the grounds that the beneficial ownership of the shares held by the taxpayer was seemingly with its US parent company and the treaty was not applicable as the Mauritius entity was a conduit.

A recap!
E*Trade Mauritius Limited, is a tax resident of Mauritius and holds a valid Tax Residency Certificate ("TRC") issued by Mauritius regulators. The taxpayer is an indirect subsidiary of E*Trade Financial Corporation, US (E*Trade US). The taxpayer sold its entire equity shareholding in an Indian company, Infrastructure Leasing and Financial Services Investmart Ltd ("ILFS Investmart"), to HSBC Violet Investments (Mauritius) Limited under a private arrangement.

Relying on the beneficial provisions of the treaty, the taxpayer made an application for a 'Nil' withholding tax certificate for receiving the consideration for sale of shares. The Revenue authorities denied treaty relief holding that the taxpayer was a 'shell' entity, as the real beneficiary of income on such shares was E*Trade US.

The High Court, without going into the merits of the case, referred back the matter to the Commissioner for exercise of his revisionary powers. The Commissioner denied treaty relief to the tax payer and tax was deducted and deposited with the Government.

Under these circumstances, the taxpayer applied to the AAR for determining the applicability of treaty relief on the sale of said shares.

AAR grants relief -- "Tax treaty - a legitimate planning tool"
The AAR dispelled all the contentions made by Revenue for denying treaty benefit. The Authority observed that shares were registered in the name of taxpayer and the Indian company has recognised the taxpayer as legal owner of these shares. The AAR observed that the fact that the taxpayer received funds for purchase of shares from its parent by way of capital contributions and loans and did not require any adverse inference to be drawn.

The Authority held that the beneficial ownership of the shares was with the taxpayer in view of the CBDT's circular [No 789 dated April 13, 2000], which was binding on the Revenue authorities and had been upheld by the Apex Court in its landmark ruling in Azadi Bachao Andolan's case. The Circular had clarified that holding a tax residency certificate issued by Mauritius authorities was adequate evidence of the entitlement to the treaty benefit relating to dividends and capital gains. The AAR also held that the separate legal existence of the taxpayer could not be ignored merely because the holding company exercises some control over the taxpayer or the funds received on sale were ultimately transferred to the holding company through dividends etc. The AAR emphasised that there have to be compelling reasons to dilute the separate legal existence of a subsidiary.

The AAR followed the principles laid down by the Supreme Court in the above case that treaty shopping and underlying objective of tax mitigation could not be equated to a "colourable device".

Ruling vindicates Governments' bilateral efforts
In the recent past, Governments of both countries have made significant efforts which underline socio-economic ties and the strategic bilateral relationship between the two countries. For successive years, Mauritius has been the single largest contributor to Foreign Direct Investment (FDI) in India; with most recent data (till January '10) indicating Mauritius contributions topped US$ 8 billion out of total FDI received US$ 18 billion.

Notwithstanding recurring controversies and 'tax haven' allegations against Mauritius, there have been recent developments that have made significant strides to purge conventional fears in the minds of investors. Last year in the G20 communiqu? on tax havens, the Organisation for Economic Cooperation and Development (OECD) accorded 'white list' nation status to Mauritius. Mauritius has also demonstrated its serious endeavours towards overcoming domestic 'harmful tax practices'.

The treaty with Mauritius has been debated by the tax administration and Courts in India with more interest than any other bilateral tax treaty. It is interesting to note that whereas the Government was defending the validity of its Circular No 789 before the Apex Court in Azadi Bachao's case, the tax administration at lower levels has repeatedly sought to deny the benefits. They are ignoring the same circular and trying to read a non-existent 'Limitation of benefits' clause in to the treaty.

The AAR ruling in the E*trade case vindicates these recent developments and the Governments' macro endeavours. One can only hope this ruling paints a more conducive landscape for the future relationship between two fast emerging economies.


Taxand's Take

Investors deserve certainty!
No doubt the recent AAR ruling would come as huge relief to investors. There is no gain in saying that Indian jurisprudence is fraught with situations where the tax administration has taken a view contrary to judicial and quasi-judicial precedents. Hopefully, the Revenue will follow the principles enunciated in the ruling but since an AAR ruling is binding only in the applicant's case, the possibility of the tax administration still disputing other similar transactions cannot be ruled out.

From a Mauritius perspective, the authority has tightened up the procedures around the issuance of TRCs. All global business companies must now route their application for TRC to the Financial Services Commission (FSC), accompanied by an undertaking that the Mauritius company is complying with the provisions of law with regards to central control and management. Once the FSC is satisfied that the company is in good standing, then only, it will recommend to the Director General of the Mauritius Revenue Authority (MRA) to issue the TRC. Upon receipt of the recommendation, the Director General of the MRA will also need to check whether tax returns have been filed and tax settled before issuing the TRC. This will certainly help investing entities prove substance in Mauritius.

While the E trade ruling reaffirms the tried and tested phenomena of the Mauritius route for investments, a word of caution is that one needs to maintain the hygiene around the tax residency of the Mauritius entity. Businesses need to demonstrate that central control and management is being exercised from Mauritius, that regular board meetings are taking place, and whenever any strategic decision is contemplated, the decision actually comes from Mauritius. Maintaining robust documentation will go a long way in defending against any action that the tax authorities may attempt to deny treaty benefits.

Your Taxand contacts for further queries are:
Mukesh Butani
T. +91 11 3081 5010

Anurag Jain
T. +91 11 3081 6254

Gary Gowrea
T. +230 405 2002

Aveenash Ramtohul
T. +230 405 2080

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