Investments Through DTAA Route in India and Strategic Tax Planning

Abstract

The tax consulting fraternity had already been reeling in the recent past with the shocks of the Bombay High Court decision in Vodafone International Holdings B.V. v. Union of India (2010) 329 ITR 126 (Bom), which effectively unsettled the categorical enunciation of the Supreme Court decision in Union of India v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC) on the correctness of availing income tax benefits under the India Mauritius Double Tax Treaty. The Government of India has also publicly announced ongoing negotiations with the Government of Mauritius for reworking of the Treaty. A recent decision of the same High Court in the matter of Aditya Birla Nuvo Ltd. & Ors. v. Deputy Director of Income Tax (Writ Petition No. 730 of 2009 decided on 14.07.2011) brings forth fresh issues to be pondered over the fate of corporate structures routing investments in India through Mauritius.

This article examines the recent decision in perspective, wherein the petitions filed by Aditya Birla Nuvo Limited (‘ABNL’ for short) and Tata Industries Limited (‘TIL’ for short) challenging the decision of the Income Tax Department have been dismissed by the High Court.

The Income Tax Department had held that capital gains tax was payable by New Cingular Wireless Services Inc, a US Company (‘NCWS’ for short) on sale of shares of Idea Cellular Ltd. (‘ICL’ for short) in the year 2005 by AT&T Mauritius, a company incorporated in Mauritius to ABNL and TIL. Since no deduction was made by ABNL and TIL on payment made to NCWS, the IT Department had also proceeded against ABNL and TIL as representative assessees of NCWS. Both ABNL and TIL claimed before the High Court that since the shares were of AT&T Mauritius, capital gains tax was exempt under the India Mauritius Treaty and thus actions of the IT Department were without jurisdiction. The High Court, however, disagreed.

The High Court traced the root of the controversy to the year 1995 when the Joint Venture Agreement was signed between Birla Group Companies and AT&T USA, leading to the current ICL, to hold that the original understanding showed that the shares where legally owned by AT&T USA in the Joint Venture and AT&T Mauritius was only held these shares as the ‘permitted transferee’ of the US company. The High Court noted that all the decisions of the Joint Venture were taken by the US Company (which was succeeded by NCWS) and therefore when the shares belonging to NCWS in ICL were purchased by ABNL and TIL, even though the payment had been made to AT&T Mauritius, these actually vested in NCWS and thus capital gains arose to NCWS on sale of ICL shares to ABNL and TIL.

The High Court held that the action of the IT Department could not be held to be one of lifting of corporate veil (paragraph 50) and taking a holistic view of the shareholding it could only be concluded that AT&T Mauritius was only a conduit for making payments whereas the entire control vested in the NCWS. In coming to this conclusion the High Court duly noted that the payments made by ABNL and TIL to AT&T Mauritius were transferred to NCWS the very same day. Since this shareholding arrangement was not intimated to the IT Department, in the opinion of the High Court, the certificated granted by the Department under Section 195 to make payment without deducting tax at source could not come in the way of the IT Department to taking action in accordance with law and proceeding after both NCWS as well as ABNL and TIL (as representative assessee) to collect the capital gains tax on the sale transaction.

Taking stock of the decision one is reminded of the oft-quoted phrase in legal circles – hard cases make bad laws. The peculiar shareholding arrangements on record and the conduct of the parties in suppression the information from the Department, it seems titled the case turtle for ABNL and TIL. One can take solace however, that the outcome hinged on the peculiar facts of the case and the High Court did not in any manner dilute the legal position for direct transaction between India and Mauritius to take benefit of the Double Tax Treaty. Corporate planners, however, will have to tread the Mauritius route with caution as such peripheral and overriding agreements (such as the original Joint Venture agreement in this case) run a potent risk of being challenged by the IT Department in the wake of this recent success before the High Court. In any case, further, the hitherto adopted tax-planning strategies will require revisiting in the wake of the changes proposed in the Direct Taxes Code Bill, 2010 and especially the provisions relating to the ‘General Anti-Avoidance Rules’ therein.

Keywords: International Taxation, India-Mauritius DTAA, Aditya Birla Nuvo

JEL Classification: E62, H25, H26, K34