Tax Hotline April 29, 2009

E*Trade Mauritius Uproar - Tax Department's Findings (An Update)

In our earlier hotline, we analyzed the decision of the Bombay High Court in E*Trade Mauritius Limited v. ADIT & Ors.1, and whether the recent stir created by this decision is warranted. We now go on to analyze the revisional order passed by the Director of Income Tax (“DIT”) refusing to grant a nil withholding certificate for the sale of an Indian company’s shares between two Mauritian companies.

While the key issue, i.e., whether the sale of an Indian company’s shares between two Mauritian companies would be subject to tax in India will be decided only upon the conclusion of assessment proceedings, an understanding of the DIT’s order would still be useful. Particularly as the DIT’s observations are indicative of the revenue’s stand on the applicability of treaty benefits when using intermediary jurisdictions for investing in India.


E*Trade Mauritius Ltd. (“ETM”) is a wholly owned subsidiary of US based Converging Arrows Inc (“CAI”), which is in turn a wholly owned subsidiary of E*Trade Financial Corporation (“ETFC”), also a US company. ETM had sold its stake in IL&FS Investmart (“IL&FS”, an Indian company to HSBC Violet Investments (“HSBC”), also based in Mauritius.


In connection with the sale, ETM sought a certificate from the tax authorities (“AO”) under section 197 of the Income Tax Act, 1961 (“ITA”) authorizing payment of consideration by HSBC sans any withholding of tax.

As the AO refused to grant the nil withholding tax certificate, a writ petition was filed before the Bombay High Court. On the basis of the consent of the parties, the High Court directed ETM to file a revision application before the DIT and disposed the writ in September 2008.

The DIT in its revisional order, upheld the order of the AO in not granting a nil withholding certificate. We have provided below our analysis of the factors that were considered by the DIT to question the already settled legitimacy of the India-Mauritius route.

DIT’s Order

In its order, on the basis of the facts and circumstances of this case, the DIT after examining various documents and filings made by ETFC and its subsidiaries as well as by IL&FS chose to disregard ETM as an intermediate shareholder company and conclude that the investment was in actual fact held and sold by ETFC.

ETFC's Control Over IL&FS

First, the DIT has closely examined the members of the board of directors of ETFC, CAI, ETM and IL&FS prior to the sale of ETM’s stake in IL&FS. Some directors were found to be common between ETFC and IL&FS. Further, the DIT ascertained that the former Vice President of ETFC was serving as the CEO and Managing Director of IL&FS finding this to be a significant link between ETFC and IL&FS. Additionally, several personnel of ETFC were being deputed to IL&FS. Thus, the DIT was of the view that ETFC was exercising rights directly in IL&FS not only through appointment of directors but also through the deputation of managerial and senior executives. In this regard, the DIT even went so far as to conclude that ETFC has a ‘permanent establishment’ in India under the India-US Tax Treaty.

Source of Funding

The DIT also scrutinized the source of ETM’s funds for its periodic acquisitions in IL&FS. It was found that only when funds were infused in ETM by either ETFC or CAI did ETM acquire shares in IL&FS. ETFC’s funding of acquisitions in IL&FS was yet another reason for the DIT to believe that it was ETFC acquiring shares in IL&FS and not ETM.

Additionally, certain undertakings provided by IL&FS under the shareholders agreement with ETM and other shareholders of IL&FS were also analyzed. The undertakings to furnish information and statements to facilitate ETFC’s compliance with US tax requirements (i.e., ‘Passive Foreign Investment Corporation’ norms) were factored in to bridge the link between ETFC and IL&FS.

Public Disclosures & Filings

As in the Vodafone controversy, in this case as well, several non tax declarations and regulatory filings (i.e. prospectus, offer letter, annual reports etc) were also studied. As examples:

  • The ‘Public Announcement’ filed by ETM under the SEBI Takeover Code while setting out the reasons for the open offer also stated that ETFC’s resources will be deployed to India allowing IL&FS to leverage ETFC’s expertise to achieve growth and efficiency.

  • The extracts of the Annual Report of IL&FS state that IL&FS had inducted ETFC as a strategic partner being one of the largest retail broking and banking entity with ETM holding shares on behalf of ETFC in India.

All these documents were analyzed to support the DIT’s contention that the shares of IL&FS were truly held by ETFC and not ETM.


Despite what the DIT believed to be ‘overwhelming facts indicative of the ownership of shares resting with the US Company’, the key question of whether the India-Mauritius Tax Treaty or the India-US Tax Treaty would be applicable was ultimately not answered by the DIT. The DIT was instead of the view that such a finding can only be made in the assessment proceedings upon a greater analysis of further facts and circumstances.


The DIT, in its order, appears to have kept the option of challenging the validity of Circular 789 (the circular issued by the tax authorities which allows Mauritian companies having tax residency certificates to benefit from the India-Mauritius tax treaty) open. This stems from the judgment of the Supreme Court in Central Excise v. Ratan Melting & Wire Industries Ratan2 which gives the revenue the right to challenge their own circulars.

The DIT has clearly gone to great lengths (in terms of factual enquiries and analysis) to disregard an intermediate shareholding company. However, the fact remains that as the law stands today in light of decision of the Supreme Court of India in Union of India v. Azadi Bachao Andolan3 which had upheld the validity of Circular No. 789, the sale of shares of an Indian company by a Mauritian company should not attract capital gains tax in India. Further, there are settled principles of law when it comes to lifting the corporate veil and the circumstances under which it may be lifted. Looking through corporate entities purely to bring transactions to tax is not one of them.


Learning from the hard line approach being taken by the revenue in recent times, be it with Vodafone or E*Trade, the deal documentation should be carefully drafted from an Indian tax perspective so as to avoid being unreasonably hauled up by the Indian tax authorities. Similarly, due care should be taken when making any declaration or filing (for regulatory and other purposes) in connection with the transaction.

The story does not end here. As highlighted above, this is not a final determination of the taxability of the transaction but is only a provisional determination of tax for withholding tax purposes. Interestingly, the High Court has not gone into the merits of the case since the parties had consented to approach the DIT for a revisional order. Thus, the chargeability of such transactions to tax in India is yet to stand the test of judicial scrutiny.


Archana Rajaram & Rajesh Simhan




1. WP. No. 2134 of 2008
2. 2008 (13) SCC 1
3. 263 ITR 706 (SC)

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