Taxability of share sale under India Mauritius DTAA | Judgement summary

Domestic taxability 

The Court clarified that the issue must be addressed sequentially. First, domestic taxability must be determined under the Income Tax Act, 1961. Second, the Court had to consider whether such taxability is curtailed or overridden by the DTAA. This inquiry turns on three questions: whether the taxpayer is a resident of Mauritius; whether the transaction falls within the scope of Article 13 of the DTAA; and whether protection under Article 13 is barred by the treaty’s Limitation on Benefits (LoB). The final limb concerns the application of anti-avoidance principles. 

The Finance Act, 2012 introduced Explanations 4 and 5 under Section 9(1)(i). This clarified that capital gains arising from indirect transfers are taxable in India. An indirect transfer is a transfer of shares of a company registered in a foreign country that derive substantial value from assets located within India. The Court held that although Flipkart was incorporated as a Singapore holding, it derived substantial value from Indian assets. Capital gains arising from the sale of Flipkart shares were therefore taxable under Indian domestic law. 

Determination of residence

The first limb of analysis to determine the extent of treaty applicability was to establish whether the Mauritius-based entities could be considered residents of Mauritius. While the AAR had held that the TRCs merely veiled the true intent of the arrangement, the respondents contended that residence was a matter to be determined exclusively by Mauritius and could not be tested againstIndian doctrines such as substance over form. 

Referring to circulars of the Central Board of Direct Taxes (CBDT) and Union of India v Azadi Bachao Andolan (2003), Tiger Global argued that TRCs are sufficient evidence to claim the benefits under Article 13. They also referred to Vodafone International Holdings BV v Union of India (2012) and its emphasis on a “look at” rather than “look through” approach, pointing out that TRCs could be scrutinised only in cases involving fraud or sham transactions. Notably, they submitted that in both Azadi and Vodafone, the validity of the Mauritius route was acknowledged because developing countries often permit treaty shopping to attract scarce foreign capital and technology.

At the outset, the Court held that while circulars bind tax authorities, they operate only within the legal regime existing at the time and cannot override subsequent statutory amendments. Drawing from amendments made post-Vodafone, it noted that Section 90(4) and (5) of the IT Act make it clear that TRCs are only an eligibility condition and other documents may be prescribed to sufficiently establish residence. Further, the Court found that Section 90(2A) curtails treaty benefits while Sections 95-97 “took away the unlimited right to avoid tax under the domestic law by production of a TRC.”

Protection under Article 13

Article 13 of the DTAA specifies which of the two contracting states may tax different types of capital gains. Article 13(4), a residuary provision, provides that gains derived by an entity from the sale of property “other than those mentioned” in clause (1), (2) and (3) shall be taxable only in the resident state of that entity. The respondents claimed that their transaction was covered under Article 13(4) and thus subject to tax only in the resident state of Mauritius. 

However, upon a combined reading of the clauses, the Court found that Article 13(3A) and (3B) only cover direct transfers and not indirect transfers. Consequently, in addition to residence, the entity must also establish that the subject matter of the transaction (in this case, the Flipkart shares) are directly held by the resident entity. In other words, it held that an indirect transfer would not be included among residual matters under Article 13(4). 

The Court also observed that the LoB applies only to transactions covered under Article 13(3B) and cannot be invoked to bar the respondents from treaty protection.

The “grandfathering” clause

Domestic taxability, sufficiency of the TRCs and exclusion of indirect transfers from Article 13 were all determined based on amendments to the DTAA and Indian domestic law that were initiated in 2012. The amendments also introduced the General Anti Avoidance Rule (GAAR) through insertion of Chapter XA in the IT Act. These came into force on 1 April 2017.

Tiger Global and the Mauritius entities contended that their 2018 transaction was exempt from these amendments as the shares were “grandfathered” under Article 13(3A). The clause effectively extends application of the old legal regime to investments made prior to 1 April 2017, protecting them from the amendments. They sought similar protection from domestic law under Rule 10U(1)(d) of Chapter XA. 

The Court reiterated that Article 13(3A) only applies to direct transfers and not indirect ones. On domestic law, it upheld the appellants’ submission regarding the distinction between investments and arrangements. It found that while Rule 10U(1)(d) extends limited protection to investments, Rule 10U(2) expressly states that irrespective of date on which the arrangement was entered into, GAAR provisions will apply if tax benefits of more than ₹3 crores are obtained from the arrangement on or after 1 April 2017.

Anti-avoidance principles

Coming to the last limb of the analysis, the Court held that even assuming Article 13(4) applied, the transaction would remain subject to anti-avoidance scrutiny. GAAR provisions expressly define impermissible avoidance arrangements that lack commercial substance, codifying the principle of substance over form to prevent treaty abuse. The Court observed that even prior to GAAR, these principles were recognised through precedent as Judicial Anti Avoidance Rules and re-interpreted Azadi and Vodafone to clarify that TRCs are subject to scrutiny of substance over form.

Final holding

Ultimately, the Court set aside the High Court’s decision and held that capital gains arising from the 2018 transaction are not protected by the DTAA and remain taxable under Indian domestic law. 

It clarified that the AAR acted within its jurisdiction under Section 245R(2) and had a limited task of evaluating evidence on a prima facie basis deemed sufficient for rejection of the tax exemption applications at the threshold. The High Court had erred by interfering with this decision and adjudicating on merits.

In conclusion, Justice Pardiwala emphasised the importance of preserving source-based taxation, GAAR override, LoB clauses and mechanisms for review and monitoring of tax treaties.