In the recent MIH India (Mauritius) Limited case, the Delhi Bench of the Income-tax Appellate Tribunal (the “Delhi Tribunal”) held that the income earned by way of capital gains by a Mauritius tax resident on the sale of shares of an Indian company is not taxable in India under the pre-amended Article 13(4) of the double taxation avoidance agreement between India and Mauritius (the “Mauritius DTAA”).
Background and facts
Article 13(4) of the Mauritius DTAA, inter alia, provides that the gain from the alienation of any property is taxable only in the Contracting State of which the alienator is a resident. On May 10, 2016, India’s Central Board of Direct Taxes (the “CBDT”) issued a press release
announcing the signing of the protocol amending the Mauritius DTAA under which India now has the right to tax capital gains arising from the alienation of shares of an Indian resident company that are acquired on or after April 1, 2017. However, shares acquired before April 1, 2017 (i.e., the pre-amended period) will not be subject to capital gains tax even if transferred after April 1, 2017 (commonly known as the grandfathering provision).
MIH India (Mauritius) Limited (the “Taxpayer”) holds a valid tax residency certificate issued by the Mauritius tax authorities and is a subsidiary of a company based in the Netherlands. The Taxpayer acquired the shares of an Indian company in September 2016 and sold the shares before March 31, 2017 to another India-based company resulting in short-term capital gains that was claimed as exempt under Article 13(4) of the Mauritius DTAA. The Indian tax authorities held that the Taxpayer was merely a conduit entity through which its holding company in the Netherlands had invested, and hence, the Taxpayer was not entitled to benefits under the Mauritius DTAA. The Indian tax authorities took the view that because the effective control and management of the Taxpayer was with holding company in the Netherlands, the provisions of the India-Netherlands DTAA should apply to the transaction.
At the time the assessment order was passed in this case on April 6, 2022, India and Mauritius were signatories to the “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting,” referred to as the Multilateral Instrument (the “MLI”) that was deposited by India with the OECD. The Indian income tax authorities took the position that the MLI came into force in India on October 1, 2019, and therefore, the Mauritius DTAA was now a Covered Tax Agreement (the “CTA”), i.e., a double taxation avoidance agreement in force between parties but as modified by the MLI. In the case of Mauritius-based tax residents, this enabled the Indian tax authorities to take a position that the settled law in the Azadi Bachao Andolan case would not apply.
Delhi Tribunal Ruling
Notably, the Delhi Tribunal relied on the CBDT Circular Number 789 dated April 13, 2000 (the “CBDT Circular”) and held that the tax residency certificate issued by the Mauritian tax authorities in favour of the Taxpayer would constitute sufficient evidence to accept the residential status as well as beneficial ownership of the Taxpayer in Mauritius. The Delhi Tribunal ruled that as the shares were acquired prior to April 1, 2017, the Taxpayer would be covered under the pre-amended Article 13 of the Mauritius DTAA on capital gains tax benefit (generally referred to as the grandfathering provision), and the CTA would not come into play.
In addition, the Delhi Tribunal highlighted that the Taxpayer was not a conduit company or a fly by night operator, as it had been incorporated in Mauritius in 2006 and had been carrying on investment activity in India as well as other jurisdictions on a consistent basis. Further, the audited financial statements indicated that the Taxpayer had made substantial investments in India. Merely because the Taxpayer had taken loans from its holding company to invest in the shares of the Indian company could not be a reason to treat the Taxpayer as a conduit company.
The Delhi Tribunal reviewed all pertinent documents in detail to rule that the Taxpayer was not a mere conduit company. It took cognizance of the CBDT Circular and the ratio of the Supreme Court in the Azadi Bachao Andolan case. In addition, the Delhi Tribunal excoriated the Indian tax authorities for having made a desperate and unacceptable attempt to overcome the ratio laid down in the Azadi Bachao Andolan case by bringing in the ratification of the MLI (which was not applicable here because (i) Mauritius had not ratified the MLI in accordance with its domestic law and deposited the instrument of ratification with the OECD; and (ii) neither India nor Mauritius had issued a notification to the effect that the Mauritius DTAA would be covered by the MLI as a CTA). Therefore, this decision can be very helpful in arguing against the tax department’s extreme reliance on MLIs in such types of cases.
Interestingly, the Mumbai tax tribunal, in the Blackstone Capital case, had also dealt with the applicability of beneficial ownership provisions in relation to capital gains under the Mauritius DTAA. The Mumbai tax tribunal had stated that unlike in the dividend or interest provisions of the Mauritius DTAA which specifically require beneficial ownership in Mauritius to claim the benefit, there is no such provision in the capital gains article. Therefore, the concept of beneficial ownership is not relevant in the context of the capital gains article under the Mauritius DTAA. Capital gains tax related benefits under the Mauritius DTAA have been a matter of consistent debate and litigation in India. Treaty benefits are denied by the Indian tax authorities on the basis of lack of commercial substance in most cases and beneficial ownership in some. While this is a welcome ruling for the Taxpayer, it is abundantly clear that the concept of grandfathering of shares purchased by a Mauritius tax resident prior to April 1, 2017 and sold at any time will not be mechanically acceptable to the Indian tax authorities, and each case will be assessed on its own facts.
About the Author
Ravi S. Raghavan has more than 25 years of experience in corporate tax advisory work, business re-organizations, international taxation (investment and fund structuring, repatriation strategies, treaty analysis, advance rulings, exchange control regulations, FPI taxation), tax litigation services and other tax issues (including withholding taxes, capital gains tax, permanent establishment concerns, employee taxation, and tax holiday schemes).