AAR Ruling

In light of the aforementioned, the AAR analyzed the purported role of the Mauritian company i.e. Bidvest in the joint venture. The AAR relied on the doctrine of substance over form and scrutinized the transaction considering various documents like minutes of the board meetings, financials, etc. to analyze the role of the Mauritian company in relation to the investment and the project as well as the commercial need of setting up an entity in Mauritius. The AAR observed that Bidvest did not contribute in the decision making process and only noted and endorsed decisions of the Bidvest Group in its Board meeting. The AAR also observed that the Mauritian company did not have (a) any tangible assets, (b) business activities (except for owning shares), or (c) independent source of funds.

Further, the AAR noted that the beneficial owner of shares in MIAL was the ultimate holding company in South Africa and the formation of SPV a few days prior to the final bidding had only changed the manner in which funds were routed for the project. It also noted that the double tax avoidance agreement between India-South Africa did not provide any tax benefit on capital gains tax in India. The AAR thus concluded that the purpose behind incorporation of the Mauritian company was solely to avoid tax in India.

It also placed reliance on the decision of the Supreme Court in Vodafone International Holdings, wherein the apex court had observed that the tax department can deny treaty benefits if it is established, that a Mauritian entity has been interposed as an owner of shares in India, at the time of disposal of the shares to a third party, solely with a view to avoid tax without any commercial substance. It had further observed that a tax residency certificate does not prevent enquiry into tax fraud, say for example where an overseas corporate body is used by an Indian resident for round tripping or any other illegal activities. The AAR took a view that the aforesaid observations were applicable to the current case, since the pith and substance behind the Supreme Court’s observations was that holding a tax residency certificate could not prevent an enquiry into tax treaty eligibility if it can be established that the intermediate entity was setup merely as a device to avoid tax in India.

Our View

In terms of the present facts, the reliance placed by the AAR on the decision of the Supreme Court in Vodafone Intl. Holdings seems misplaced. For one, the observation of the Apex court was in connection with the interposing of an intermediate entity prior to the sale of shares and not prior to the purchase of such shares. In the case in hand, the Mauritian company was not interposed at the time of disposal of shares to the third party. Further, it is noteworthy, that the Supreme Court has in the Azadi Bachao Andolan case held that a treaty benefit can be availed as long as a Mauritian resident possesses a valid tax residency certificate.  Can one therefore not reasonably argue that in the instant case, the taxpayer may possibly have structured his affairs to avoid tax legitimately but not to evade them?

It is pertinent to note that while the Mauritian treaty has been renegotiated and now provides that India has a right to tax the capital gains arising to a Mauritian resident from the sale of an Indian companies shares, it provides for a grandfathering of investments made prior to April 2017. Thus, the capital gains tax benefit is very much available to investments made in prior period no matter when such shares are finally sold. Further, the provisions of the general anti avoidance rules i.e. GAAR were not in effect when the transfer of shares in the present case took place.

The Bidvest ruling has in some ways set the cat amongst the pigeons, and one fears that it may embolden the tax authorities to question other such exits as well. Tax avoidance by way of legitimate structuring done pre April 2017 cannot be termed illegal and placed at par with tax evasion as the AAR seems to have done. If pre April 2017 investments are going to be scrutinized on the basis of substance over form then not only would it be at odds with the Supreme Court rulings and tax authority circulars on the subject, but could potentially tarnish India’s image as a premier investment destination.

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