From UPSC perspective, the following things are important :
Prelims level : Treaty with Mauritius
Mains level : Paper 3- Tiger Global case
Through this story, we will explore how investment fund companies exploit the tax agreements between the two countries. This story involves the famous case of investment by Walmart in Flipkart. So, let’s see what was involved in the case and what argument was made by the investment fund involved in the case.
Tax avoidance is the use of legal methods to minimize the amount of income tax owed by an individual or a business. This is generally accomplished by claiming as many deductions and credits as is allowable. It may also be achieved by prioritizing investments that have tax advantages, such as buying municipal bonds.
First, let’s understand why Mauritius is favourite among investors?
- Mauritius and India do have a tax treaty to start with.
- Suppose an investment company based out of (why not based in?) Mauritius made a lot of money selling shares of an Indian company.
- Now, Indian authorities won’t tax the gains you made via the transaction.
- Instead, you’ll be taxed in Mauritius.
- But since Mauritius does not tax capital gains, you get away without paying capital gain tax.
- So you got the answer to why Mauritius.
- Obviously, foreign corporations lapped up this opportunity until 2016 — when the government finally decided to plug the gaps.
- They made amendments to the treaty.
The story of Tiger Global’s investment into Flipkart
- Tiger Global was one of the earliest investors in Flipkart.
- They held 22% of the company until 2018 when they sold about 17% to Walmart’s Luxembourg entity FIT Holdings.
- This transaction was valued at over INR 14,500 Cr.
- But Tiger Global had made its investments through funds based out of Mauritius.
- Since Tiger Global had made most of its investments during the first half of the decade (obviously before 2016).
- So the amendment to the treaty wasn’t really applicable to them.
- So when they made all that money selling their stake in Flipkart, they figured they wouldn’t have to pay any tax.
- And at first sight, this argument seems legit.
Let’s dig deeper into the case by going through 3 arguments
- The funds were operating out of Mauritius.
- The directors were discharging their duties in Mauritius.
- All in all, everything was firmly placed in Mauritius.
- But if you peel back the layers, you’ll see that these funds are ultimately owned by Tiger Global Management LLC, USA — albeit through a maze of holding companies.
- So, the tax authorities argued that Tiger Global had in fact set up the Mauritius based entity for the sole purpose of avoiding taxes.
- And therefore contested that they shouldn’t be exempt from paying tax on gains they made through the Flipkart Transaction.
- Tiger Global, miffed with the taxmen, took the matter to a quasi-judicial body — The Authority for Advance Rulings (AAR).
And the case begins.
Let’s look into three arguments.
1. Focus on transaction, not on the entity that involved in the transaction
- Tiger Global investment fund counsel had the following argument to make:
- “It must be proven that the transaction [the final sale of shares] itself was designed to avoid taxes.”
- And proving that the structure of the entity undertaking the transaction was designed for the avoidance of income-tax should not be necessary here.
- So, the Revenue (the Income Tax Department) had failed to discharge its burden of proof. But AAR didn’t agree with this argument.
2. So, what’s AAR’s argument?
- AAR said that you don’t just compute taxes by looking at the final transaction.
- Instead, you look at the transaction as a whole —When were the shares bought? What was the purchase price? What happened in between? Who’s the primary executioner? What’s the appreciation in value? You look at everything.
- More importantly, the “head and brains” executing the transaction resided elsewhere.
- Tax authorities had shown rather conclusively that a certain Mr. Charles P. Coleman (operating out of a U.S based entity) was the beneficial owner of the fund.
- And that “he” was primarily responsible for most management decisions.
- So the AAR hit back with the following observation:
In our opinion, it is not the holding structure only that would be relevant. The holding structure coupled with prima facie management and control of the holding structure, including the management and control of the applicants, would be relevant factors for determining the design for avoidance of tax. The applicant companies were only a “see-through entity” to avail the benefits of India-Mauritius DTAA [Double Taxation Avoidance Agreements]
But wait… what about the past judgements?
- Tiger Global had another weapon in its arsenal — Past judgements on the matter.
- Specifically, a particular ruling in the case of Moody’s Analytics Inc.
- AAR in this case conceded that capital gains accruing to a Mauritius based entity from the transfer of shares of an Indian company shouldn’t ideally be taxed.
3. Flipkart is a Singaporean company. So, pay the taxes!
- The AAR said that “In this particular case, gains were made by transferring shares of a Singaporean company. Not an Indian company.”
- That’s right. Flipkart is based out of Singapore.
- Flipkart Singapore is the strategic shareholder of Flipkart India.
- Flipkart India is the entity that owns most of the capital assets.
- The shares that were sold to Walmart — that’s Flipkart Singapore, not Flipkart India.
- But the India-Mauritius tax treaty agreement is only applicable to the transfer of shares of Indian companies.
Consider the question “Examine the basis used by the Authority for Advance Rulings (AAR) that led it to rule in favour of tax authorities.”
AAR concluded that there was no doubt that Tiger Global had set up the Mauritius based entity to avoid paying taxes and therefore should be liable to pay what the Income Tax authorities deem fit.
Back2Basics: Vodafone tax
Can India tax the gains made by selling the shares of Singaporean company?
- According to Section 9(1)(i), (popularly known as the Vodafone tax), any income accruing or arising, whether directly or indirectly (through multiple layers), inter-alia, through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India.”
- So Indian tax laws are pretty clear about where the gains ought to be taxed.
- But the India-Mauritius treaty doesn’t say anything about this matter.
- That’s why the AAR ruled the way it did.