With regard to interpretation of the tax-treaties in particular context to treaty shopping, the observation of Hon’ble Supreme Court (see UOI vs. Azadi Bachao Andolan [263 ITR 706]) are worth noting “Because treaty negotiations are largely a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides.” The Hon’ble Court further observed that in developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital for technology. “There are many principles in fiscal economy which, though at fist blush might appear to be evil, are tolerated in a developing economy, in the interest of long-term development. Deficit financing, for example, is one; treaty shopping, in our view, is another.”
The aforesaid judgment was delivered by the apex court with reference to Indo-Mauritius tax treaty. It was held that while Indo-Mauritius treaty may be used to avail substantial tax benefits which otherwise are not available under the Indian law, the treaty nevertheless is binding both on Indian and Mauritius tax authorities. The Court went on to observe “Despite the sound and fury of the respondents over the so called ‘abuse’ of ‘treaty shopping’, perhaps, it may have been intended at the time when the Indo-Mauritius DTAC was entered into.”
After Azadi Bachao Andolan’s case (supra) it was believed that the controversy relating to Indo-Mauritius tax treaty is now over. But, it appears the tax benefits which the treaty provides are not palatable to the Indian tax authorities.
In a recent case (AAR No. 866 of 2010), the AAR on the issue of Indo-Mauritius tax treaty observed that “In the light of the decision of the Supreme Court in Azadi Bachao Andolan, no further enquiry on the question is warranted or justified.” The issue for consideration before the AAR was whether the capital gain arising to a Mauritian company on sale of Indian company’s shares is taxable in India or not. Under the normal provision of the Indian tax law, share capital gain is liable to tax in India. But as per Article 14.4 of the Indo-Mauritius tax treaty, the capital gain arising on sale of shares is not liable to be taxed in India.
The Authority finally ruled that the Mauritian company had made investment in the shares of the Indian company over the last 10 years. Investment in India was made legally and following the relevant procedure. The Mauritian company was a separate legal entity and the beneficial ownership also vested in the subsidiary. Therefore, there was no justification in piercing the veil as contented by the tax department.
The Authority heavily relied on the decision of Azadi Bachao Andolan (supra) and observed that “may be, the formation of this subsidiary in Mauritius was with an eye on the Indo-Mauritius treaty. At worst it might be an attempt to take an advantage of a treaty but, that by itself cannot be viewed or characterised as objectionable treaty shopping.” The Authority also observed significantly that the decision in McDowell (154 ITR 148) did not deal with treaty shopping and the only guidance is provided by the decision in Azadi Bachao Andolan.
The view taken by the Authority is a consistent view taken in several other cases. In the meantime, the Mumbai high court in the case of Aditya Birla Nuvo Ltd vs DDIT in Writ Petition no. 730 of 2009 had held that when shares of the Indian company are beneficially not owned by a Mauritian company the advantage of Indo-Mauritius tax treaty can not be availed.
The contradictory view taken by the Mumbai high court needs to be settled by the apex court as early as possible because it has a very serious impact on the decision making process of foreign investors who are contemplating to make investment in India in a tax efficient manner.
H P Agrawal (Author is a senior partner at SS Kothari Mehta & Co)
Email: hp.agrawal@sskmin.com
