2024 (9) TMI 26 - HC - Income Tax

Accrual of income in India - Capital gains tax payable by the Mauritian entity in regard to the sale of shares to the petitioner therein - investments originating from Mauritius - Beneficial ownership of shares - Treaty Benefits under India-Mauritius DTAA - whether sale of shares was not covered by Article 13 (3A) of the DTAA ? - determination of shareholding pattern and the role of key individuals - Validity of order of the AAR as concluded that the Applicant was controlled by Tiger Global Management LLC (TGM LLC), USA, through a web of entities based in Cayman Islands and Mauritius. The AAR observed that the real control of the company did not lie within Mauritius, but with TGM LLC, USA. Beneficial Ownership of Shares - HELD THAT - The finding in the impugned order that TGM LLC is the holding or parent company of the petitioner is wholly erroneous. The petitioners have consistently taken the unvacillating position with respect to the shareholding position of the writ petitioners and of TGM LLC being the investment manager of the petitioner and not the holding or parent company. None of the funds invested in the petitioner originated from TGM LLC, there has been no equity participation or investments made by TGM LLC in the writ petitioners or any evidence put forth with respect to any monies being repatriated to TGM LLC from the writ petitioners. As a result, we find that the AAR erred when it concluded that TGM LLC is the parent or holding company and has incorrectly observed that the said contention was uncontroverted by the petitioners. This incorrect and misconceived finding of fact by the AAR has thus sullied the impugned order and rendered it riddled with manifest and patent errors. The facts as they emanate from the record categorically establish that the petitioner cannot be said to be an entity lacking in economic substance. The petitioners were intended to operate as pooling vehicles for investments, held a Category 1 GBL, had aggregated funds from more than 500 investors located across 30 jurisdictions worldwide and had TGM LLC as its investment manager. The entire stockholding in Flipkart Singapore was acquired between October 2011 to April 2015 and the share transfer in question was undertaken on 18 August 2018. The petitioner is stated to have incurred expenditure amounting to USD 1,063,709 roughly translating to MUR 36,436,182 as against the threshold of MUR 1,500,000 as prescribed in Article 27A and additionally had its total liabilities and shareholders equity at USD 1,764,819,299 with its net increase in shareholders equity resulting from operations being pegged at USD 267,633,593. Therefore, and in view of the aforenoted facts the petitioner cannot be said to be lacking in economic substance or that it was domiciled in Mauritius with a sole view of engaging in treaty abuse. Income and Source of Funds - A parent or a holding company would have a legitimate right to exercise oversight and broad supervision over the affairs of its subsidiaries which could conceivably take the form of seats on the BoD, appointment of key managerial personnel, auditing of affairs of the subsidiary and so on. Subsidiaries are also recognised in law to have a distinct and independent legal persona which is liable to be ignored only in the event of apparent fraud, being interposed with a view to camouflage sham transactions or of being created to perpetuate an illegality and of being a mere puppet and lacking in economic substance. Merely because a parent entity may exercise shareholder influence over its subsidiary that would not lead to an assumption that the subsidiary in question was operating as a mere puppet or that it was wholly subservient to the parent entity. In light of the aforesaid, it is clear that merely because two of the members of the Board of the petitioner, namely, Mr. Charles P. Coleman and Mr. Steven Boyd are connected with the TG Group does not in itself render credence to the argument that the writ petitioners are mere puppets. An overall conspectus of the board resolutions reveals that the decisions were undertaken by the BoD of the petitioner collectively. Furthermore, though Mr. Charles P. Coleman was authorised to permit expenditures exceeding USD 250 million, the power thus conferred was a decision taken by the Board as a whole and any such decisions were necessarily required to be countersigned by the Group C Mauritian based directors. Moreover, the members of the BoD were also signatories to the Constitution document. In view of the aforesaid facts, the BoD of the writ petitioners cannot be said to be deprived of decision-making powers or reduced to a subservient status. Treaty Benefits under India-Mauritius DTAA - The mere factum of an entity being situated in Mauritius and of investments in Mauritius being routed through that nation cannot result in a default adverse inference or raise a presumption of illegality or of such an entity being a colourable device, nor are Mauritian entities required to satisfy any separate standard of legitimacy or stricter standard of proof. Thus Mauritius is one of the more favourable jurisdictions for FII s seeking to invest in India as a result of its proximity to India as well as the wide array of agreements that it had entered into with various nations across the globe. Liberalized exchange controls, favourable investment climates and the prevailing socio-political stability appears to have additionally favoured facilitation of Mauritius as a gateway for investments flowing into the Asian and African continent and accordingly lead to Mauritius becoming the preferred destination for various investors wishing to route investments towards South East Asian economies and with India subsequent to the liberalization measures adopted in 1991 seeing almost fifty percent of the FDI volume in India originating from Mauritius in the year 2012. Accordingly, and bearing in mind the observations rendered in Azadi Bachao Andolan 2003 (10) TMI 5 - SUPREME COURT , Vodafone 2012 (1) TMI 52 - SUPREME COURT and the facts and data available on the record, we are of the view that it would be wholly erroneous to presume that investments originating from Mauritius are inherently suspect or that fiscal residence of an entity in Mauritius would require viewing such entities through a tainted prism. The establishment of investment vehicles in tax friendly jurisdictions cannot be considered to be an anomaly or give rise to a presumption of being situate in those destinations for the purpose of evading tax or engaging in treaty abuse. The decision of Azadi Bachao Andolan acknowledged how nations seek to compete with each other by highlighting treaty benefits that could be obtained by investors from its treaty networks, because of which there was nothing inherently objectionable about treaty shopping but that any concerns surrounding the practice of treaty shopping is best left for the consideration of the executive which may examine the political and economic implications of any measures taken by it to combat treaty shopping, particularly in light of the changing world order requiring nations to adopt measures to attract capital and technological inflows. In a similar vein the decision of Vodafone 2012 (1) TMI 52 - SUPREME COURT noted that there has been a steady increase in multinational corporations seeking to invest in markets and businesses across the globe, which would thus lend credence to the position that establishment of offshore companies could be motivated by bona fide commercial purposes. Accordingly, the decisions of the Supreme Court accepted the changed world order necessitating cross-border movement of capital and investments and those in turn resulting in the creation of trans-national corporations, the incorporation of entities in different jurisdictions and thus facilitating investments in diverse parts of the world which inevitably led to entities seeking to reside in jurisdictions with established treaty networks. The creation of new investment pathways ought not be halted by skepticism or mistrust except on the basis of well-established parameters. The principles of substance over form must be considered to be the prevailing norm and the Revenue entitled to doubt the bona fides of a transaction only in those situations where it be found that the transaction involves a sham device intended to achieve illegal objectives or formulated based on illegal motives. In light of the decisions rendered in Azadi Bachao Andolan and Vodafone, treaty shopping in itself cannot be rendered abhorrent unless it were categorically established that the device was incorporated with a view to evade tax and in a manner contrary to the intent of the Contracting States to the treaty. Therefore, it is only in those situations where no other conclusion can be drawn other than the entity being a conduit or lacking in commercial substance and intending to perpetuate fraud that the Revenue would be justified in doubting the nature and character of that transaction. The issuance of a TRC by the competent authority must be considered to be sacrosanct and due weightage must be accorded to the same as it constitutes certification of the TRC holding entity being a bona fide entity having beneficial ownership domiciled in a Contracting State to pursue a legitimate business purpose in a Contracting State. The Revenue would thus not be justified in doubting the presumption of validity attached to the TRC as it would inevitably result in an erosion of faith and trust reposed by Contracting States in each other. Piercing the corporate veil - The circumstances under which the Revenue could pierce the corporate veil of a TRC holding entity is restricted to extremely narrow circumstances of tax fraud, sham transactions, camouflaging of illegal activities and the complete absence of economic substance and the establishment of those charges would have to meet stringent and onerous standards of proof and the Revenue being required to base such conclusions on cogent and convincing evidence and not suspicion alone. It is only when the Revenue is able to meet such a threshold that it can disregard the presumption of validity which would be attracted the moment the TRC is produced and LOB conditions are fulfilled. Treaties are entered into by Contracting States in exercise of their sovereign powers and based on economic and political considerations. In view of the same, such reciprocal arrangements cannot be subjected to aspersions cast on its validity. It would accordingly be erroneous for courts to manufacture grounds of disqualification from treaty benefits over and above those as formulated by the Contracting States. Section 90 of the Act itself formulates the legislative intent to lend primacy to treaty enactments. Courts have accordingly taken the consistent stand that treaty benefits ought not be overridden by provisions and that the sanctity which attaches to a treaty restrains parties from attempting to subvert the same by way of unilateral amendments. There cannot be an assumption of treaty shopping and treaty abuse merely because a subsidiary or any related entity is established in a tax friendly jurisdiction. Action 6 of BEPS Action Plan, which paved the way for adoption of LOB clauses and PPT test in treaties as well as the principles emanating from the OECD Commentary on Article 29 reveals that treaties incorporate disentitlement provisions to deprive persons who were not intended to fall under the ambit of the treaty availing those benefits in an indirect manner. In that light and bearing in mind decisions rendered by foreign Courts in Cadbury Schweppes and Burlington, it would be erroneous to characterise legitimate business activities undertaken by entities as constituting treaty shopping, merely because it was situated in a favourable tax jurisdiction. Therefore, both Indian and International authorities have taken the consistent position that treaty benefits may be denied only in those cases where the transaction is a sham, where fraud is sought to be committed or where entities are incorporated as mere conduits and in a manner contrary to the schema of the treaty itself. The incorporation of LOB provisions in a taxation convention will result in those provisions being determinative of allegations of treaty abuse and purported illegitimate claims of treaty benefits. The right of the Revenue to cast aspersions on the validity or legitimacy of a transaction would be constrained by the requirements of exacting and compelling standards of proof with the onus placed squarely in the domain of the Revenue to establish that a transaction in question would be disentitled to the benefits of a treaty being a sham, a colourable device and imputed with illegality and giving rise to the conclusion that Contracting States never intended for such transactions being accorded treaty benefits. Contracting States did not intend for domestic taxation authorities to deploy their own subjective standards in view of the enactment of LOB provisions which had also adopted ascertainable standards to defenestrate presumptions of treaty abuse. It is the finding of this Court that taking any view to the contrary would amount to privileging domestic legislation over and above the enactments in the treaty provisions adopted by Contracting States and would amount to holding that jurisdiction inheres in taxing authorities to question the validity of transaction on parameters alien to the negotiated terms of the treaty. Furthermore, the LOB clause in the India-Mauritius DTAA came to be included when Chapter X-A had already come to exist and Article 27A accordingly chose to grandfather all transactions relating to alienation of shares acquired prior to 01 April 2017. This further lends credence to the position that the Contracting States formulated LOB provisions bearing in mind the enactments in the domestic legislation because of which the Revenue is not entitled to erect additional barriers towards the receipt of treaty benefits by parties. We find that LOB provisions and the TRC comprehensively and adequately addresses concerns in relation to potential treaty abuse and it would be impermissible for the Revenue to manufacture additional roadblocks or standards that parties would be required to meet in order to avail of DTAA benefits, subject to caveats of illegality, fraud and the transaction being in contravention of the underlying object and purpose of the treaty. The provision of Article 13 (3A) embodies the intent of the Contracting States to ring-fence all such transactions which had been consummated prior to 01 April 2017. Article 13 (3B) restricted its scope to prescribing separate tax rates for the period between 01 April 2017 till 31 March 2019 but no such tax rate was prescribed for capital gains arising from sale of shares acquired prior to 01 April 2017 which categorically demonstrates the intent of the parties to the India-Mauritius DTAA to exclude capital gains emanating from shares acquired prior to 01 April 2017 from the ambit of taxation. Therefore, the grandfathering clause in Article 13 (3A) would exclude the transaction undertaken by the writ petitioners from the ambit of capital gains tax. Domestic tax legislation cannot be interpreted in a manner which brings it in direct conflict with a treaty provision or with an overriding effect over the provisions contained in a DTAA since the same would in effect amount to accepting the right of the Legislature of one of the Contracting States to unilaterally amend or override the provisions of a treaty and would result in the elevation of a domestic subordinate legislation over that of the provisions embodied in a treaty entered into between sovereign nations. The argument that the transaction undertaken by the petitioners would not be grandfathered in light of Rule 10U is sans merit, as is the claim that sub-rule (2) takes away from the preceding provision of clause (d) of sub-rule (1), since the term without prejudice is intended to mean that sub-rule (2) would operate in contingencies not contemplated by sub-rule (1)(d) of Rule 10U. The imputation of beneficial ownership of TGM LLC over the writ petitioners is manifestly erroneous in light of the principles governing attributability of beneficial ownership. Notwithstanding that on facts it has been established that TGM LLC is not the parent or holding company of the petitioner, it is apparent in would be incorrect to ascribe beneficial ownership if a conduit was entitled to avail of income itself and was not contractually obligated to forward that income to any other entity. The concept of beneficial ownership would get attracted if it be established that the holder of income had no control over the income and merely holds the same till such time it be instructed to deploy that income to another entity or if the income is controlled or regulated by a third party with the holder having no real or substantive control over that income. Tested on those precepts, it is apparent that TGM LLC cannot be said to be the beneficial owner of shares since no evidence has been rendered to suggest that the writ petitioners are under a contractual or legal obligation to transmit revenue to TGM LLC or that the revenue obtained from transfer of shareholding was as a result of actions undertaken by the writ petitioners at the behest of TGM LLC. As a result, and in the absence of any material or evidence underlying the claims made with respect to beneficial ownership, we are of the view that such submissions are based on mere surmises and conjectures. We consequently and for all the aforesaid reasons come to the firm conclusion that the impugned order of the AAR suffers from manifest and patent illegalities. The impugned order takes a wholly untenable and unsustainable view with respect to the transaction in question. Its conclusion, therefore, that the transaction was aimed at tax avoidance is rendered arbitrary and cannot be sustained. The transaction, in our considered opinion, stands duly grandfathered by virtue of Article 13 (3A) of the DTAA. We affirm the view canvassed by the writ petitioners of the impugned transaction not being designed for avoidance of tax. The petitioners shall be entitled to all consequential reliefs.

Summary

Issues Involved:

1. Ownership and Control of the Applicant
2. Beneficial Ownership of Shares
3. Income and Source of Funds
4. Treaty Benefits under India-Mauritius DTAA
5. Applicability of GAAR and Chapter X-A Provisions
6. Validity and Conclusiveness of Tax Residency Certificate (TRC)
7. Economic Substance and Commercial Rationale
8. Role and Authority of Board of Directors
9. Lifting of Corporate Veil and Piercing the Corporate Veil Doctrine
10. Impact of the 2016 Protocol and Grandfathering Clause

Detailed Analysis:

1. Ownership and Control of the Applicant:

The AAR concluded that the Applicant was controlled by Tiger Global Management LLC (TGM LLC), USA, through a web of entities based in Cayman Islands and Mauritius. The AAR observed that the real control of the company did not lie within Mauritius, but with TGM LLC, USA. This conclusion was based on the shareholding pattern and the role of key individuals such as Mr. Charles P. Coleman, who was identified as the beneficial owner and had significant control over financial transactions.

2. Beneficial Ownership of Shares:

The AAR noted that the Applicant did not mention any beneficial owner in its application for Category 1 Global Business License. However, it was inferred from other documents that Mr. Charles P. Coleman was the beneficial owner of the shares. The AAR concluded that the real control did not lie with the directors based in Mauritius but with those in the USA, making the directors in Mauritius mere name lenders.

3. Income and Source of Funds:

The AAR observed that the Applicant had no income of its own and that the sources of funds for investments were capital contributions from entities based in Mauritius, controlled by entities in Cayman Islands, and ultimately by TGM LLC, USA. The AAR concluded that the Applicant was a conduit for the investment of TGM LLC, USA, through a web of other conduit companies.

4. Treaty Benefits under India-Mauritius DTAA:

The AAR held that the treaty benefits under the India-Mauritius DTAA were not available to the Applicant. It concluded that the transaction was designed for tax avoidance and that the ultimate beneficiary of the shares of the Indian company was TGM LLC, USA. The AAR relied on the ruling in the case of AB Mauritius and the judgment of the Bombay High Court in Aditya Birla Nuvo Limited vs. DDIT.

5. Applicability of GAAR and Chapter X-A Provisions:

The AAR did not explicitly address the applicability of GAAR and Chapter X-A provisions in the impugned order. However, the arguments presented by the respondents and the analysis of the Shome Committee Report and CBDT Circular No. 7 of 2017 indicate that GAAR provisions would apply only in cases of abusive, contrived, and artificial arrangements. The Shome Committee Report recommended that where specific anti-avoidance rules (SAAR) are applicable, GAAR should not be invoked.

6. Validity and Conclusiveness of Tax Residency Certificate (TRC):

The AAR's conclusion that the TRC was not conclusive was challenged by the petitioners, who argued that the TRC should be accepted as evidence of residence and beneficial ownership. The Punjab and Haryana High Court in Serco BPO held that a TRC issued by the Mauritian authorities should be accepted as valid and that its genuineness should not be questioned by Indian authorities.

7. Economic Substance and Commercial Rationale:

The AAR concluded that the Applicant lacked economic substance and was set up solely for tax avoidance purposes. However, the petitioners argued that the Applicant was a legitimate investment vehicle with substantial investments and expenditures, and that the decision to invest in Flipkart Singapore was commercially driven.

8. Role and Authority of Board of Directors:

The AAR concluded that the Board of Directors of the Applicant were mere puppets and that key decisions were taken by individuals associated with TGM LLC, USA. The petitioners argued that the Board of Directors in Mauritius exercised control and management over the Applicant's affairs and that the decisions were taken after proper discussions and deliberations.

9. Lifting of Corporate Veil and Piercing the Corporate Veil Doctrine:

The AAR applied the principle of piercing the corporate veil to conclude that the real control of the Applicant was with TGM LLC, USA. The petitioners argued that the lifting of the corporate veil should be limited to cases of fraud or sham transactions and that the Applicant was a legitimate entity with commercial substance.

10. Impact of the 2016 Protocol and Grandfathering Clause:

The AAR concluded that the transaction was not covered by the grandfathering clause in the 2016 Protocol to the India-Mauritius DTAA. The petitioners argued that the grandfathering clause should apply to investments made before April 1, 2017, and that the transaction should not be subject to capital gains tax in India.

Conclusion:

The impugned order of the AAR dated March 26, 2020, was quashed on the grounds that it suffered from manifest and patent illegalities. The Court held that the transaction was not designed for tax avoidance and that the petitioners were entitled to all consequential reliefs. The Court emphasized the importance of the TRC, the LOB provisions in the DTAA, and the need for the Revenue to meet a high standard of proof when alleging avoidance and abuse.