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May 6, 2011 Tax authorities take E*Trade Mauritius to the Indian Supreme Court The E*Trade Mauritius case is back in focus, this time on account of revenue authorities going right up to the Supreme Court to ask (again) for a denial of Mauritius tax treaty (“Mauritius Treaty”) benefits to E*Trade Mauritius Ltd. (“E*Trade”). We’ve tracked this case and its long haul with respect to availability of Mauritius Treaty benefits, over previous hotlines titled E*Trade and the Mauritius route: Much ado about nothing?, E*Trade Mauritius Uproar - Tax Department’s Findings (An Update) and A Happy End to the E*Trade Mauritius Saga. The last of these alerts promised a happy ending, with the Authority for Advance Rulings (“AAR”) confirming that E*Trade Mauritius would be entitled to Mauritius Treaty benefits and not taxable in India. AAR rulings are non-appealable, and while tax authorities do have the constitutional right to approach the Indian Supreme Court by filing a special leave petition (“SLP”) in the interests of justice, this is required to be done within a limitation period of 90 days from the date of advance ruling. As the AAR ruling came out over a year ago, in March 2010, there was to that extent a level of comfort of the international investor community with respect to finality of the E*Trade case. Spoken too soon, perhaps – tax authorities have now filed an SLP, albeit a little delayed, before the Indian Supreme Court, which has considered the application and directed that E*Trade Mauritius be sent a notice, allowing them to represent why the SLP should not be admitted. Background E*Trade, a wholly owned subsidiary of US-based, E*Trade Financial Corporation (“E*Trade US”) sold its stake in the Indian company, IL&FS Investmart, to Mauritius based HSBC Violet Investments (“HSBC”). The transaction basically involved the transfer of Indian company shares between two Mauritius resident companies. E*Trade sought to obtain a nil withholding certificate from the tax authorities, which was not granted and pursuant to which E*Trade filed a writ petition before the Bombay High Court. The Bombay High Court, did not rule on the merits of the case, but directed E*Trade to file a revision application before the Director of Income Tax (“DIT”), on the basis of the consent of the parties. Meanwhile E*Trade was required to deposit INR 245 million pending the decision of the DIT. The DIT confirmed the position adopted by the ADIT and the amount deposited by E*Trade was released to the Government of India. E*Trade meanwhile approached the AAR for clarity on the Indian tax implications of sale of an Indian company’s shares by a Mauritius company and the applicability of Treaty benefits. The AAR held in favour of E*Trade and reiterated the applicability of the Supreme Court ruling in Azadi Bachao Andolan (263 ITR 706), which ensures Mauritius Treaty benefits to Mauritius companies with a valid tax residency certificate. Available online here is a detailed analysis of the issues examined by the AAR as well as a diagrammatic representation of the E*Trade structure. The SLP is filed by the Indian revenue authorities as a challenge to this AAR ruling. Analysis of the SLP The revenue authorities appear to be challenging the AAR ruling on the basis of factual, procedural and substantive grounds. For example, they have submitted that as per the facts applicable in E*Trade, the US company was controlling the entire activities of the Mauritius company and carrying on business, not as a shareholder of the Mauritius company but as a direct shareholder of the Indian company. On this factual basis, revenue authorities appear to be submitting that the corporate veil of E*Trade must be pierced. The merits of this point would depend on the actual facts presented by the revenue authorities. In general it is relevant to note that India respects form over substance and that Indian courts have supported piercing of the corporate veil only where the transaction appears to be a sham transaction i.e. a fraudulent arrangement without permanent legal effect. A second set of (procedural) grounds pertains to the eligibility of the AAR to examine this arrangement, when the DIT had passed an order requiring E*Trade to pay taxes in India. However, the most important, substantive ground raised by the tax authorities relates to the applicability of the Azadi Bachao Andolan. It has been submitted by the tax authorities that the Mauritius Treaty benefits cannot be made available in situations such as E*Trade, merely on account of a subsidiary being incorporated in Mauritius. They seek to submit that while Azadi Bachao Andolan permits taxpayers to plan their affairs, it does not grant legitimacy to the use of colourable devices for such planning. This ground was also argued by the revenue authorities before the AAR, and an analysis may require a brief background as to the case law on anti-avoidance in India. Position laid down by Azadi Bachao Andolan: Indian anti-avoidance rules are primarily derived from common law. Courts have tended to accept the position laid down by the House of Lords in the case of the Duke of Westminster, where it was held that every person has a right to plan his tax affairs within the framework of the law. This position was subsequently examined by a seven judge bench of the Supreme Court, in the 1987 case of McDowell, where it was held that while tax planning is permissible, taxpayers would not be permitted to use a “colourable device”. In 2004, a two judge bench of the Supreme Court again examined this issue in the context of Mauritius based companies and the availability of tax treaty benefits to entities with a Mauritius tax residency certificate. After a detailed analysis of anti-avoidance case law, tax treaty jurisprudence and the Indian constitution, it was held by the Supreme Court that tax planning is permissible and that revenue authorities would not be entitled to disregard a transaction unless it is considered a sham transaction. Therefore, Azadi Bachao Andolan interpreted “colourable device” as meaning a sham transaction. It has been stated by subsequent High Court rulings in cases such as Akshay Textiles, that the applicable law today is the McDowell rule on “colourable devices” as interpreted and understood by Azadi Bachao Andolan. Implications for E*Trade and other Mauritius investors: In Azadi Bachao Andolan, it was held that the mere availability of tax treaty benefits does not reduce a Mauritius based company to a sham, and that Mauritius based companies with a valid tax residency certificate should be entitled to the benefits of the Mauritius Treaty. Further, as stated in Azadi Bachao Andolan and reiterated by the AAR in the case of E*Trade, the Indian position respects both form over substance and the taxpayers right to plan its affairs, and courts have generally been loathe to disregard corporate structures merely on account of the fact that they may have tax benefits available to them, within the framework of the Indian Income Tax Act or Mauritius Treaty. Therefore, if the Indian Supreme Court considers judicial precedent till date, the determination of the fate of E*Trade may depend on the factual position on whether E*Trade Mauritius can be considered a “sham”, to be disregarded under Indian tax laws. By no means can the dispatch of notice to E*Trade be considered a reversal in the existing Indian position on applicability of tax treaty benefits to Mauritius entities with a tax residency certificate. As far as other Mauritius based investors go, the best approach would perhaps be to wait and watch what happens at the Supreme Court of India in the case of E*Trade. Will the apex court reiterate, once more, the right of Mauritius based entities to tax treaty benefits? Or will it make a complete departure from established precedents to rule differently? Keep watching this space.
- Tax Team You can direct your queries or comments to the authors
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