Introduction
Recently, the High Court of Delhi delivered a ruling marking significant victory for international investors. The High Court reversed the findings of the Authority of Advance Ruling (‘AAR’) in the case of Tiger Global. The Court has ruled that the capital gains arising from the sale of shares of a Singaporean company (holding shares in Indian company) by a Mauritius-based investor were not taxable in India due to the grandfathering benefit provided under Article 13(3A) of the India-Mauritius Double Taxation Avoidance Agreement (‘India-Mauritius DTAA’).
While the judgment provides a significant relief for all the investors who are eligible for the grandfathering benefit, it may raise concerns for others. For instance, cases where acquisitions were made post 1 April 2017 (in the context of Mauritius treaty) or where the relevant tax treaty does not confer any grandfathering benefit at all (such as in case of France).
This article seeks to analyse the impact of Tiger Global judgment on taxation of indirect transfer of shares of an Indian company where grandfathering benefit is not available.
Treaty benefits in case of Indirect Transfers: Position prior to Tiger Global
In 2012, post the popular Vodafone ruling, amendments were proposed in the Indian domestic law to tax indirect transfer of assets (including shares) located in India as a result of transfer of shares of overseas entity. As per the amendment, in case the overseas entity’s shares derive substantial value from assets located in India, the capital gains arising on transfer of shares of overseas entity shall be taxable in India. The shares are considered to have derived substantial value from assets in India only if the value of assets exceed INR 10 crore and the value of assets situated in India (including shares held in I Co) represent at least 50% of all assets owned by the overseas entity.
Considering the amendments in the domestic law, the question which gained utmost importance is whether as per the relevant tax treaty, India shall have taxing right in case of indirect transfers or not.
In many of the tax treaties entered by India, there lies a specific paragraph which allocates taxing rights in case of transfer of shares of a company (‘Share Transfer para’). For instance, Article 13(3A) of India-Mauritius tax treaty, paragraph 14(5) of Indo-French tax treaty. In the said paragraph, if shares of Indian company are transferred, the tax treaty grants taxing rights to India.
Apart from the above paragraph, there lies a paragraph which applies if ‘any other property’ is transferred (‘Residual para’). For instance, Article13(4) of India-Mauritius tax treaty or Article 14(6) of India-France tax treaty. In terms of said paragraph, taxing rights are granted to the country where the alienator of the property is a resident. Meaning thereby, if a Mauritius resident sells said property, only Mauritius shall have taxing right.
In cases of indirect transfers of Indian Co’s shares, the key question which needs to be addressed is whether the Share Transfer para shall be applicable or Residual para of the tax treaty. The question is relevant because in case of indirect transfers, the shares of overseas company get transferred (and not Indian company). It is only as a result of such transaction that the controlling interest in the shares of Indian Co. gets shifted to the new shareholders.
The question has been adjudicated by the High Court of Andhra Pradesh in the case of Sanofi Pasteur[1]. In said case, the shares of a French entity were being transferred. The French entity’s shares derived value from shares of an Indian company. The Court in said case held that as the shares of French company were being transferred, only France shall have the taxing right in terms of Article 14(5) of the Indo-French tax treaty. According to the Court, the language or text of the provision did not specifically include taxation of indirect transfer of shares of an Indian entity and a ‘see through’ approach cannot be adopted as it would transgress the terms of the tax treaty. The Court also observed that the transfer of controlling interest in the Indian Co. shall fall within the ambit of the Residual para, and India does have taxing right in respect of the same.
The reasoning laid down in Sanofi Pasteur Holdings was eventually relied on and followed by the Tribunals in other judgments such as Sofina S.A., [2020] 116 taxmann.com 706 (Mumbai - Trib.), GEA Refrigeration Technologies GmbH, In re [2018] 89 taxmann.com 220 (AAR - New Delhi).
In view of the above cases, in case of indirect transfer of Indian Co’s shares, the Share Transfer para does not provide taxing right to India as the shares of Indian Co. are not directly getting transferred. Also, the transfer of controlling interest in the Indian Co. shall fall within the ambit of Residual para which grants taxing right to the country where alienator is resident.
Key findings of the Tiger Global judgement
In the judgment of Tiger Global, the primary aspect which the Court dealt with is whether the case in hand was designed to avoid tax and whether tax treaty benefit should be granted to the taxpayer or not. The Court reaffirmed the judicial principles laid down by the Supreme Court in the case of Azadi Bachao Andolan for grant of tax treaty benefits and followed in umpteen number of decisions thereafter. The Court held that presence of TRC and fulfilment of conditions mentioned in Limitation of Benefit clause in tax treaty, are sufficient to grant treaty benefit, unless some exceptional circumstances such as fraud, illegality, complete absence of economic substance, etc. exist. Also, the Court noted that the onus entirely lies on the Revenue to bring forth convincing evidence to prove existence of such exceptional circumstances.
By giving the above reasoning, the Court held that the benefit of grandfathering benefit clause in Article 13(3A) of India-Mauritius treaty should be granted in the present facts.
In this case, the Court did not express any views on the applicability of Residual para of the tax treaty and also on the aspect that whether India shall have taxing right under Article 13(3A), even without grandfathering benefit since the shares of Singapore company are being transferred. Although, the taxpayer argued on the applicability of the Residual para by placing reliance on the case of Sanofi Pasteur, the Court did not comment on said aspect, and rather restricted their conclusion to granting grandfathering benefit.
Potential issues post Tiger Global judgment
Considering the findings in the case of Tiger Global in relation to Article 13(3A), the Revenue Authorities may argue in other cases that cases of indirect transfers are covered under the Share Transfer para [such as Article 13(3A)]of tax treaty, and it is only because of the grandfathering benefit that the capital gains shall not be taxable in India. Resultantly, in cases where there is no grandfathering benefit in the tax treaty, India shall have the right to tax the capital gains (such as in case of India-France tax treaty).
In view of the authors, there lie arguments to defend the above allegation. One needs to appreciate that the Court in Tiger Global did not comment on the applicability of Residual para of the tax treaty and restricted its analysis to the grandfathering benefit. Accordingly, it can be argued that the Court has not given any finding on the applicability of Residual para.
It is a settled legal principle that a judgment is a law for what it states and not for what it can be logically inferred out of it.
Accordingly, it can be argued that if the Court in Tiger Global has not discussed the applicability of Residual para, the judgment should not be read to be contrary to the judgment in the case of Sanofi Pasteur. The plausible interpretation can be that the Court in Tiger Global provided relief only on grandfathering and has not expressed views on the correctness or otherwise on the other grounds raised by the taxpayer including applicability of Residual para in case of indirect transfers.
Conclusion
While the Tiger Global judgment shall be of utmost importance when it comes to applicability of the tax avoidance principles and granting of tax treaty benefit, it may pose hurdles in the cases of indirect transfers where grandfathering benefit is not available. Although there lie defenses to cross the hurdles, however, the path is not going to be as smooth as it was assumed post the judgment of Sanofi Pasteur.
[The authors are Associate Partner and Associate, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys]
[1] [(2013) 354 ITR 316 (AP)]
