A Case Of Divergent AAR Judgements On Mauritius Tax Treaty Benefits
The tax residency certificate issued by Mauritius authorities is not enough to obtain treaty benefits with India.
Just when everyone thought that Mauritius is out of the Indian tax authorities’ glare – due to the recent renegotiation of its tax treaty with India – it’s back in focus because of India’s Authority for Advance Rulings (AAR).
The AAR, while ruling on applications by two Mauritius companies of the same group – for the same corporate restructuring transaction – came to different conclusions on the availability of the India-Mauritius tax treaty. The AAR upheld the availability of capital gains exemption (as per Article 13 of the treaty) in the case of AB Holdings, Mauritius-II and denied the same in the case of AB Mauritius. The AAR gave different conclusions largely on account of the differences in the factual matrix of the two cases.
In the recent past, there has been a lot of litigation in India on whether the Mauritius treaty benefit is available to a non-Mauritius investor – in other words, investors from different countries (generally United States, United Kingdom, etc.) routing investments into India through a Mauritius holding company.
After prolonged negotiations, India and Mauritius recently agreed to revise the tax treaty, whereby the benefit of capital gains tax exemption with respect to equity shares was taken away. Instead, the revised tax treaty provided for complete protection of existing investments (investments made till March 31, 2017, will not attract capital gains tax in India, irrespective of when they are disposed) and provided a beneficial or reduced tax rate of half of the Indian capital gains tax rate for a period of two years i.e. acquisition after April 1, 2017, and disposal before March 31, 2019.
The revised treaty also provided for the limitation of benefits with an aim to make available treaty benefits only to those companies that have substance in Mauritius and not to sham transactions.
It appeared that with this revised treaty, there would be tax certainty and litigation would significantly reduce. So, the recent AAR rulings have come as a surprise, especially as the authority has taken divergent positions on identical transactions involving companies of the same group.
The AB Group had two companies in Mauritius. Both held valid tax residency certificates . The main purpose of both companies was investment activities in India and other Asian markets. They had made investments in two different Indian companies. Under a group reorganisation, the shares of these Indian companies were required to be transferred to a newly incorporated Singapore company, ‘AB Singapore’. This was done for business and commercial reasons, to obtain operational and cost benefits from centralising ownership in investments and operations in the Asia-Pacific region.
It needs to be highlighted here that the ruling is quite detailed on the discussion of facts. It demonstrates the effort put in by the tax authorities to substantiate the conduct of the Mauritius companies and their relationship with overseas group companies.
Implications Of The AAR Rulings
The key takeaway is that the tax residency certificate issued by the Mauritius authorities is not conclusive evidence to obtain India-Mauritius tax treaty benefits.
The key factor which would enable authorities to decide on this question is whether, factually and in practice, the Mauritius company was acting independently and on its own will. Was it the legal and beneficial owner of the Indian investments? Some of the parameters to determine this fact could be:
- Whether the board of the Mauritius company is functioning independently and not as a puppet of its parent company? (Limited overviewing or guiding function should not be an issue).
- Whether the Mauritius company is actually into investment activities and is not merely a fly-by-night operator?
- Whether the business or investment activities of the Mauritius company are adequately documented to substantiate its beneficial ownership?
It needs to be noted at this juncture that AAR rulings are binding only on the applicant and the tax authorities of the said applicant. However, while the rulings do not carry a binding impact on other cases, they do have persuasive value.
As a result, foreign investors in India want to know whether the Indian tax authorities will now seek to scrutinise the investment structures involving treaty-friendly jurisdictions such as Mauritius, Singapore, Netherlands, etc., before granting tax treaty benefits.
The next question is, with the tax treaty being revised and also with the proposed introduction of long-term capital gains tax in Budget 2018, what impact could this have on existing, as well as future, investments?
Investments made prior to April 1, 2017: Technically speaking, tax authorities have always had the power – during assessment proceedings – to apply the Supreme Court’s rationale of denying tax treaty benefits if the investment holding structure is a ‘sham’ that is in place to avoid taxes in India. However, the authorities have exercised this power only in select cases where the tax avoidance was obvious and apparent.
Considering that the recently-introduced General Anti-Avoidance Rules have also grandfathered gains from investments made prior to April 1, 2017, such foreign investors should ideally not be subject to increased scrutiny.
This, however, may change now due to these two AAR rulings that will give tax authorities more ammunition to make their case. Accordingly, foreign investors may still want to consider reviewing the business and commercial substance in their holding company’s jurisdiction (especially if the investment was made a long time ago).
Investments made on, or after, April 1, 2017: While investments after April 1, 2017, would be governed by the revised India-Mauritius tax treaty, since the beneficial rate of 50 percent of the capital gains tax rate prevailing in India is still available tax authorities would want to scrutinise the transaction and rationale of the Mauritius investor.
Such investments will also be subject to GAAR, as well as the limitation of benefits clause under the revised India-Mauritius tax treaty.
Foreign investors need to be mindful of all these factors, which could impact any potential tax treaty benefits, before implementing their investment structure.
Conclusion
Foreign investors, especially foreign portfolio investors, that seek to obtain tax treaty benefits in India should hereon consider reviewing the business and commercial substance in their holding or investing company’s jurisdiction. Any lapse on this part could result in potential litigation with Indian tax authorities.
Maulik Doshi is a partner and Abbas Jaorawala is a senior manager at SKP Business Consulting LLP.
The views expressed here are those of the authors’ and do not necessarily represent the views of BloombergQuint or its editorial team.