Makar Sankranti, in the south of the country, particularly in Tamil Nadu, is the harbinger of a new solar month that is eagerly awaited to start new initiatives—a marriage in the family, buying a house, or starting a business.
Even the most sanguine in the finance ministry would not have anticipated celebrating this day with so much joy and jubilation!
It is the day when the highest court in the land extended it the key to a treasure trove, the size of the fabled Alibaba’s cave!
Over the decades, India has been strategically invested in the island of Mauritius. In the early-1980s, the country even contemplated a military action, Operation Lal Dora, to ensure that Mauritius did not slip out of its strategic grip. Since then, the strategic significance of Mauritius has only grown from the Indian point of view.
It was in this context that India came to sign a trade, investment and tax treaty that offered unusually favourable terms to the island nation.
In 1982, when the bilateral agreement was signed between the two countries, the Mauritian economy was a midget in comparison to the Indian economy which, at that time, was quite modest in heft.
In the first decade post-signing this agreement, the actual foreign direct investment (FDI) from Mauritius doesn’t figure in any source—meaning, it was nil or negligible. The reason is not far to seek; India had little FDI in the period before 1991!
It was the opening up of the Indian economy under the watch of the Narasimha Rao and Manmohan Singh duo that started the FDI flow.
Mauritius itself introduced the offshore business activity-related law (MOBA Act) only in 1992 which paved the way for foreign companies to set up and make overseas investments out of Mauritius.
Why would a country the size of Mauritius seek and India extend a tax concession that would make sense only in the context of a large capital-exporting country? There could have been little illusion on either side that the citizens of Mauritius had any capital to invest in India and enjoy tax breaks!
Yet, this concession was written in.
It was the time when the global private capital flows started in a big way post the Thatcherite and Reaganomics of free trade and greater opening up of major economies, like US, UK and greater integration of European economies leading to the formation of the European Union (EU).
Investment flows in and out of these countries were facilitated through a network of tax havens, known by the more elitist term—offshore financial centres (OFCs)! These OFCs, which hardly had any land to build factories on, generated a new wave of a service economy of lawyers, accountants, bankers and others, to act as a conduit for making investments.
By design, these centres had no ability to put flesh and blood into any business and no senior staff or personnel would rent places in these countries to live and operate any business.
For Mauritius, this model made sense, as it was at a strategic point to act as a bridge to India and Africa. Whether conceived initially when the 1982 treaty was signed or post India’s opening up in 1991, it found its sweet spot in becoming an OFC and creating a service sector around this ecosystem.
For India as well, especially in those times, it would have been politically suicidal to extend direct tax concessions to countries like US or UK.
This would have been considered a sellout, especially in the wake of the 1991 reforms that evoked vigorous swadeshi activism against implementing the IMF prescriptions.
Therefore, Mauritius and later, Singapore, became the route through which a lion’s share of the mainstream FDI reached this country. The data of the government reflects this reality.
When the funds flowed in, it didn’t hurt. It melded with the domestic capital and boosted the economic growth. All political parties opposed FDI when in opposition and embraced it while in power!
The tax department, with its own pressure on collection, is not expected to defer to the strategic origins of a double taxation avoidance agreement (DTAA) - even pause to wonder why a DTAA that exempts capital gains would be signed with a country that had no capital of its own!
When the time came to reckon whether an investment routed through Mauritius should be exempt from tax on the gains, questions surfaced—many that had never existed in anyone’s imagination in the first place: place of effective management, multiple companies at the same address, who signed the cheques, how much was spent locally and a host of other concerns.
The allure of taxing an unearned passive income like capital gains is difficult to resist, treaty or no treaty!
Therefore, the many debates and the dalliance with this subject, followed at all levels, administrative, political, diplomatic and judicial.
There have been many a pull and pressure from the affected segment of the global financial community that had taken the exemptions for granted and made promises to their constituents, based on legal opinions and rulings that prevailed at different points in time.
This seesaw, tug-of-war, between the tax officers and the taxpayers has been on show in many courts and tribunals. Yet, there remained some hope that the past investments that came in trusting this to be an accepted mode, will be spared and the rigour of applying the tax avoidance test would be extended to the newer ones which anyway had notice of the changing dynamics of the tax department and considerable vacillation at the judicial level to go by the strict letter of the law and the treaty.
The mother of all decisions,
in the Tiger Global case, leaves little room for doubt as to the threshold for exemption. It is practically closed!
In its judgement, the apex court emphasised that tax treaties cannot serve as shields for artificial arrangements lacking a commercial rationale. "India retains sovereign rights to tax income arising within its borders," the Court stated, rejecting the idea that a tax residency certificate (TRC) alone suffices for treaty benefits without deeper scrutiny of the transaction's substance.
The judicial benchmark of substance (Judicial Anti-Avoidance Rule!) can be met only when a domestic Mauritius company makes an investment into India. It is unlikely to be sympathetic to any investment originating outside Mauritius being channelled through the island. It is quite unlikely that any major overseas fund or investor would have a management located in Mauritius that acts independently.
This decision will be threadbare analysed by experts in the domain and many views may emerge on the sweep of the Court’s findings. The mischief of the verdict may not be confined only to FDI.
It appears to fire a broadside at any effort to seek tax minimisation in the conduct of business.
The observations may unsettle past actions. Like a retrospective law, this decision can deal with actions already concluded when a consequence of that arises currently or anytime in the future.
The present government has stuck to its commitment of not making any retrospective tax changes. That is torpedoed by this order. The government will get no blame for operating this order to its fullest effect as there is no escape from doing it. Without losing political capital, it can augment the tax collections!
Cases that remain open in any forum can be jolted by applying this principle. Cases that are not fully beyond the period of a fresh look can be picked up.
The judgement is in two parts. The main order prepares the coffin for the Mauritius treaty to be applied to any case of capital gains. Even if some cases may escape for argument’s sake, they may be very few, as the JAAR conditions outlined by the Court will fail in most cases!
The second part of the judgement sharpens the nails that are to be driven into the coffin to close it airtight. This order expands the reach of the judgement to every case where the Court sees a tax treaty as restricting the tax sovereignty which is the exact role of a tax treaty!
This portion marks a novel approach in judicial orders where the court outlines a particular philosophy or ideology that should govern the approach to taxation by a country like India that has chalked out an ambitious path to attain the ‘Viksit’ state as quickly as possible.
Every word in this order will be highly palatable to the tax inspector. The international investing community may freeze on reading this. A portion that encapsulates the spirit of what the Court thinks is tax autonomy/ sovereignty, is extracted for a quick read-
The aspect of tax sovereignty and no doubt entering into bilateral treaties has yielded its own good, consistency and stability. But with newer and newer trade complexities emerging in the global arena, Nations should rethink very long-term treaties. There is no need to carry the burden or legacy of formative years of treating making and even more when it comes to the interpretation of such treaties. Interpretations which are more sound and currently relevant should yield to archaic and behind the scheduled objectives. To assume or perceive every future possible transaction stands visualised and contemplated and need to be ring fenced within a static dimension may not be an apt or a relevant approach. When current trade affairs are so dynamic, a contextual and meaningful interpretation of such instruments would not only make it currently relevant, but also vibrant matching with the progressive global business dynamics. Any attempt to widen the gap and push it backwards when trade dynamics surge ahead should be eschewed. This is yet another dimension of tax sovereignty.
A judicial mind that sees consistency in applying a tax treaty over the years as a vice of stasis is certainly quite revolutionary. The parallel question may arise that if two commercial enterprises have a long-term agreement can the interpretation be varied periodically because the business climate is never static?
Switzerland’s building materials conglomerate Holcim Group will not incur capital gains tax or any other tax following the stake sale of its Indian assets – Ambuja Cements and ACC – for about US$10.5bn (billion) to Adani Group. This gains importance as Hong Kong-based Hutchison was marred in a controversy following a US$11bn deal with UK’s Vodafone Group in 2007.
“Our analysis comes to the conclusion that there is no capital gains or any other tax for this transaction. Never know if any complication would arise, but we assume we will get the 6.4bn Swiss francs as net proceeds,” Holcim Chief Executive Officer Jan Jenisch said in an analysts’ call on Monday.
This is because there is no capital taken out of the country, while Holcim has also not provided assurance of any indemnities or warranties. Further, all liabilities arising out of ongoing litigations would have to be dealt by the new owners, he said.
Can it be said that the Indian courts have said the last word on this emotive subject of the Mauritius treaty? Since a good proportion of the investors who finally pick up the tax bill may be out of the US, it is possible that some political pressure may be brought to bear given the recent history of how the US state responds when its might get challenged.
If the US president has a direct or indirect stake in this matter, he may decide to play his trump card of tariff to get the Indian policy in line with what he wishes. If that happens and the impact of the decision is diluted, that may be a faster course than a review or a curative appeal!
Until anything changes, the companies that lived in the hope that past tax planning—whether international or local—is free from challenge, had better revisit if the liability is still contingent or a threat of a liability arises. Audit committees had better wake up!
(Ranganathan V is a CA and CS. He has over 44 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as a senior advisor post-retirement, handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)
