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Where Legislature, Executive and the Judiciary Differ: Mauritius tax Treaty Debate with no Full Stop!
Income tax law is notoriously complex, though the reasons are often misunderstood. Obvious reasons include tax law must address a huge and never-ending range of business transactions and structures. Last month's Bombay High Court decision in the case of Aditya Birla Nuvo, Tata Industries and New Cingular (popularly called AT&T case) raises an interesting debate. The judgment stipulates that in a transaction involving sale of shares of an Indian entity (Idea Cellular) by AT&T Mauritius, the latter is not the real owner of the shares of Idea. AT&T US had acquired these shares through AT&T Mauritius and allowed them to be registered in the name of AT&T Mauritius as a 'permitted transferee'. The Government Counsel's pleadings focused deeper into the relationship between the parties evidenced by complex (and confusing) legal arrangements between the parties. The Court observing that since the real owner of the shares was not a Mauritius resident (entitled for treaty benefit), there was no significance of holding a valid tax residency certificate, and the treaty claim was rightfully denied by the administration.
Taxand India discusses the Mauritius tax treaty and reasons behind the differing opinions of the Legislature, Executive and Judiciary.
A comedy of errors for a decade!
The saga started with the department of revenue issuing the (un)famous Circular No. 789 in 2000 to placid reaction of Foreign institutional investors and foreign investors investing via Mauritius and claiming benefits of liberal capital gains regime. This was keeping in mind the terms of the treaty by which Mauritius retained the right to tax capital gains on its residents. The investor community reacted to tax administrations actions denying benefits of the treaty by offloading stocks of listed companies, thereby causing significant loss of market capitalisation and shareholder value in a week's trade. The circular merely clarified that a tax residency certificate issued by the Mauritius authorities' acts as a conclusive proof of residence in Mauritius for the purposes of eligibility for capital gains tax exemption. Subsequently, the department of revenue had to defend its own guidance in a Public interest litigation filed by an NGO,Azadi Bachao Andolan, alleging tax evasion. After receiving the Apex Court's stamp of approval in 2004, Indian law makers made unsuccessful attempts to renegotiate the Mauritius treaty and restrict its benefits to Mauritius residents who are also its beneficiaries and not merely conduits. Recent media reports suggest that the tax administration is seeking intervention of the Supreme Court for a review of Azadi Bachao decision upholding the circular.
Has India signed an obituary of the treaty?
Besides adherence to principles of International convention and Vienna convention on tax treaties, the answer (in my view) is a big NO. The Indian Constitution recognises Supreme Court decisions to be the law of the land, and until a decision is overruled, it reigns supreme. Thus, there is no reason to doubt its continuity until the two sovereign's renegotiate or rescind the treaty. An important aspect emerging from the AT&T ruling is that each case henceforth will be weighted on its facts thereby triggering what scholars call 'factual ectopia' - a gap between tax law and investment structure to which tax law applies. It's a settled position in India that the corporate veil of an entity cannot be pierced unless the structure is a sham or a colorable device to avoid tax. However, while the facts of AT&T case may have played devil and influenced the Courts decision, it certainly provides an impetus to the tax authorities to challenge investments structured through Mauritius.
However, investors are yearning for certainty
The treaty debate sounds alarming to foreign investors besides making the outlook jittery for private equity and acquisition deals. A witch hunting approach if resorted to by tax authorities violates the principle of freedom of contract besides creating legal insecurity. In such situations, decision making for exits and acquisitions is becoming tougher, with tax withholding obligations on deals becoming a sore point in investor negotiations. At the same time, lately, doing India based deals including global reorganizations where there is nexus to Indian jurisdiction is becoming expensive. Another emerging trend is rise of international insurers to insure tax risk arising out of Indian deals due to the continuing uncertainty. Mitigation of risk is becoming a key factor in deal negotiations and negotiating stronger tax indemnities has become a norm.
Substantive breadth of tax arbitrage will change in future
Advent of cases such as E*Trade, AT&T, is indicative of proactive approach of the judiciary. The AT&T case is a grim reminder (to investors) for watching out their facts rather than relying on a broad based principle of law articulated by Indian courts in the context of a different era. Development of economic substance is an increasing global shift and Indian legislators are not behind in their endeavor to replace the long followed principle of form over substance by proposing general anti-avoidance ruled under the proposed Direct taxes code.
Coordinated action between the Legislative& Executive arms is required
On the other hand, the tax administration will continue to follow a more provocative approach, challenging and increasing tax litigation particularly in high value transactions. While nations across the globe consider double non taxation to be as much of an issue as double taxation, legally, the India Mauritius tax treaty does not contain a 'limitation on benefits' clause. In absence of any in build treaty anti-abuse provision, combined with absence of domestic anti-avoidance regulations to combat alleged 'misuse' of the treaty, can one really blame the use of Mauritius treaty for making investments into India? Following the age old principle laid down in the Duke of Westminster case, a business enterprise is entitled to arrange its affairs in a manner that it achieves maximum benefit of law. And, if the administration disagrees with established judicial principles, time is ripe for the legislature to step in and remove the uncertainty surrounding the treaty. This will avoid multiplicity of matters being escalated to Courts besides fostering legal security and certainty.
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