A recent ruling by the Authority for Advance Rulings (AAR) in the case of Bidvest has stirred the proverbial hornets' nest when it comes to the issue of treaty protection, and has reignited the debate of substance over form when it comes to availing the benefits of a tax treaty.
In the case at hand, a Mauritian company, Bid Services Division (Mauritius) Limited (Bidvest), had sought an advance ruling to determine its capital gains tax liability arising from the transfer of Indian shares undertaken in the financial year 2011-12 in terms of Article 13(4) of the India – Mauritius double tax avoidance agreement. Bidvest is a wholly owned subsidiary of Bid Services Division (Proprietary) Limited, a company incorporated in South Africa. Bidvest Group Limited (Bidvest Group), is the ultimate holding company which is also a South African entity.
The facts of the case were that the Airport Authority of India (AAI) had issued an invitation to participate in an international competitive bidding process to form a joint venture in India for a project relating to the Mumbai airport. GVK-SA Consortium filed its expression of interest as part of the bidding processes. The Bidvest Group was a part of this Consortium. Before the final bidding, the Bidvest Group decided to form a SPV in Mauritius for this project. Thus, Bidvest came into existence two weeks prior to the submission of final bid by GVK-SA Consortium. AAI with the approval of government of India, selected the Applicant for the project. A shareholders agreement was entered into between Bidvest, AAI and other entities whereby Bidvest acquired 27% shareholding in Mumbai International Airports Private Limited (MIAL) out of which 13.5% was later transferred and a capital gains tax exemption under the India-Mauritius double tax avoidance agreement was claimed.
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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