Mauritius Route, Not 'Objectionable Treaty Shopping': Recent Advance Ruling
Confirming the Mauritius route for the fifth time in the recent past,1 the Authority for Advance Rulings (“AAR”) has held that gains arising from the transfer of shares of an Indian company by a Mauritian resident should not be taxable in India under the India-Mauritius tax treaty (“Treaty”).2 While rejecting the Revenue’s attempts to disregard the Mauritian entity on grounds of substance, the AAR has made interesting comments on issues such as tax avoidance, beneficial ownership and the validity of treaty shopping.
The taxpayer, Ardex Investments Mauritius Limited (“AIML”) was incorporated in Mauritius in 1998 and is held by Ardex Holdings U.K. Ltd (“Ardex Holdings”), a UK based company engaged in the business of manufacturing construction material. AIML is a resident of Mauritius and possesses a tax residency certificate issued by the Mauritian tax authorities. It currently holds 50% of the shareholding in Ardex Endura (India) Pvt. Ltd (“AEIPL”), an Indian company engaged in the business of manufacturing flooring adhesives.
AIML proposes to sell its entire stake in the Indian company to Ardex Beteiligungs GmbH (“ABG”), a German group company, at fair market value. It sought an advance ruling on whether capital gains on the proposed sale would be chargeable to tax in India having regard to the provisions of the Treaty.
Taxman Disregards Mauritius
The Revenue argued that AIML was brought into existence as a façade to make investments in India on behalf of Ardex Holdings UK, just to take advantage of the India-Mauritius Tax Treaty and thereby avoid being taxed under the India-UK tax treaty. It was argued that the assets of AIML comprised only the investment in AEIPL and that AIML did not earn any income in the year prior to the proposed transfer. The Revenue also proposed that the beneficial ownership of the shares of the Indian company vested with Ardex Holdings since the funds for purchase of such shares were sourced from the parent company. It was also alleged that the decision to sell the shares in AEIPL was taken by Ardex Holdings, which AIML followed, being its subsidiary. On this basis, the Revenue sought to disregard the corporate veil of the Mauritian entity and bring the transaction to tax.
Treaty Shopping Not Taboo
The AAR did not agree with the Revenue’s submissions. It noted that the shareholding in AEIPL was acquired over a period a period of 10 years and did not come to existence all of a sudden. It also noted that although the formation of AIML was with an eye on the Mauritius Treaty, it cannot be viewed as objectionable treaty-shopping.
Relying on the landmark Mauritius case3, the AAR held that there is nothing taboo about treaty shopping.4 In the Mauritius case, the Indian Supreme Court held that treaty shopping is a legitimate exercise of tax planning and taxpayers cannot be denied benefits of the Mauritius Treaty in the absence of express treaty provisions limiting such benefits.
Considering that the shares were held by AIML for a considerable period of time and are proposed to be sold at fair market value, the AAR did not view the arrangement as a tax avoidance scheme. It also did not consider the theory of beneficial ownership to be relevant for deciding whether Ardex Holdings is the holder of the shares of the Indian company. Beneficial ownership is an anti-avoidance tool used in tax treaties aimed at restricting the availability of lower withholding tax rates to persons who exercise real and complete ownership rights over specific streams of income such as dividends, interest, royalty and fees for technical services. Interestingly, in an earlier case,5 the AAR had noted that the concept of beneficial ownership may not be relevant for the purpose of capital gains, since treaties generally do not use this expression in the clause dealing with capital gains income.
Mauritius: It’s Not Only About Tax
The Mauritius saga - a story of irony and suspense – continues to capture the attention of professionals, foreign investors and policy makers.
For almost a decade, the Mauritius case has provided a good degree of certainty to taxpayers investing through Mauritius. They have been reassured of their right to structure their affairs in a legitimate manner that minimizes the incidence of tax. For instance, US investors are able to avoid double taxation in India and the US on capital gains earned from the sale of shares of Indian companies. It is therefore not surprising that over 40% of India’s FDI is invested through Mauritius.
Ironically, in the Mauritius case it was the Indian Government which defended the Mauritius route and convinced the Supreme Court that treaty shopping is legitimate and that the Mauritius Treaty does not exclude shell holding companies investing into India.
In the recent past, however, the tax department has been actively challenging offshore holding structures and Mauritius residents’ entitlement to tax treaty benefits. Cases such as Vodafone, Aditya Birla Nuvo and E*Trade Mauritius reflect the sudden volte face in the Government’s approach.6 These cases are currently before the Supreme Court. Today, there is much suspense on the fate of the Mauritius route and whether the Supreme Court will qualify its decision in the Mauritius case. This has created quite a bit of uncertainty for cross-border mergers and acquisitions.
Of course, the important question is whether the final conclusion to the Mauritius saga is a matter of judicial interpretation or one of Government policy. In the Mauritius case, the Supreme Court was of the view that ‘treaty shopping’ is essentially a policy issue and Courts may only look at whether it is expressly prohibited by the treaty. It also observed that such policy choices are influenced by the state of a country’s development and other economic and political considerations.
From a broader policy perspective, the ostensible loss of revenue on account of treaty shopping using the Mauritius route may not be as significant as:
While developing its policy for Mauritius, it is necessary for the Government to recognize these macro considerations and take a reasonable, stable and balanced view in the interest of the nation.
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1 Earlier cases decided in 2010 and 2011: E* Trade Mauritius Ltd. v. DIT,  324 ITR 1 (AAR); Praxair Pacific Limited v. DIT,  326 ITR 276 (AAR); D.B. Zwirn Mauritius Trading No. 2 Limited v. DIT, (2011) 240 CTR (AAR) 6; D.B. Zwirn Mauritius Trading No. 3 Limited v. DIT,  333 ITR 32 (AAR).
2 Ardex Investments Mauritius Limited, AAR No. 886/2010, decision dated November 14, 2011.
3 Azadi Bachao Andolan, 263 ITR 706 (SC).
4 The AAR also noted that the earlier McDowell case, AIR 1986 SC 649 did not address issues of treaty shopping and was hence not relevant. In the Mc Dowell case, the Supreme Court held that colorable devices and subterfuges do not constitute legitimate tax planning.
5 KSPG Netherlands Holding B.V. v. DIT,  322 ITR 696 (AAR).
6 Our earlier hotlines providing insights on these cases are available at: Vodafone decision: All is not lost, perhaps nothing, Taxing a Permitted Transferee: Any IDEAs? and A Happy End to the E*Trade Mauritius Saga.