TheLeagle | Indian Eco Law Forum

The Supreme Court recently handed a significant legal victory to the Income Tax Department (‘Revenue’) in The Authority for Advance Rulings (Income-Tax) & Ors v Tiger Global International III Holdings (‘Tiger Global case’). And in the process created a significant shift in our understanding of income tax jurisprudence and tax treaty obligations. But, before we get to what the Supreme Court held, a short prologue.  

Prologue: Underlying Procedural Knot

Justice Mahadevan, in his leading opinion, concluded that the Revenue has proved that transactions in ‘the instant case are impermissible tax-avoidance arrangements, and the evidence prima facie establishes that they do not qualify as lawful.’ (para 50) (emphasis added)  

The above conclusion – lacking adequate basis – is crucial because of procedural backdrop of the case. Tiger Global companies (‘Tiger Global’) had filed an application before Authority for Advance Ruling (‘AAR’) seeking clarity on their obligation to withhold taxes. But, AAR rejected Tiger Global’s application on the ground that its arrangement was for avoidance of tax in India. If a transaction is ‘designed prima facie for the avoidance of income tax’, then AAR is obligated to reject the application under proviso (iii) to Section 245R(2). AAR found the above provision to be ‘squarely applicable’ to the case and rejected the application. The core finding of AAR was that Tiger Global incorporated in Mauritius lacked economic substance and its head and brain were located in the United States of America. Tiger Global, AAR noted, were ‘conduits’ for investments in Singapore and Mauritius.   

Tiger Global impugned AAR’s ruling before the Delhi High Court (‘High Court’). The Revenue contended that AAR had only given a preliminary opinion on chargeability to tax and there was no justification for the High Court to exercise judicial review. The High Court reasoned that reports of both Commissioner of Income Tax and AAR had ‘trappings of finality’ and ‘evident element of resolute decisiveness’. The High Court’s view was fortified by AAR’s observations on treaty eligibility and on chargeability of capital gains. The High Court, convinced that AAR had made substantial findings and not expressed a prima facie view, pronounced a detailed decision on merits. The High Court held that Tiger Global was not liable to tax in India and could avail treaty benefits under the India-Mauritius tax treaty.     

In appeal against the High Court’s decision, the Supreme Court has pronounced a detailed judgment but not gone into merits of the case. A fact that is difficult to come terms with once you read the judgment. Nonetheless, as per the Supreme Court the core question before it was: whether AAR was right in rejecting applications for advance rulings on grounds of maintainability and whether enquiry can be made if capital gains is chargeable.

In view of the above procedural history, the Supreme Court’s conclusion that the Revenue has succeeded in proving that ‘prima facie’ Tiger Global’s arrangements are unlawful is vital. Since the Supreme Court Revenue has ruled in favor of the Revenue, the assessment of Tiger Global will materialize. Tiger Global, if it chooses, can lend quietus to the issue and pay tax or challenge the imminent assessment orders and indulge in another round of legal bout with the Revenue. That is all in the untold future, until then we have the Supreme Court’s judgment to contend with.   

Introduction

Supreme Court’s judgment can be analyzed on various axes: international tax law-domestic law dynamic, application of judicial anti-avoidance rule, prospective and retrospective applicability of amendments, trajectory of India-Mauritius tax treaty, eligibility for tax treaty benefits, relevance of secondary legislation such as circulars issued by the Revenue and norms of judicial propriety. Two crucial threads of the case – in my view – are the relevance of tax residency certificate (‘TRC’) and applicability of GAAR.

In brief, Supreme Court has held that TRC is necessary but not a sufficient condition to claim tax treaty benefits. Tiger Global possessing TRC of Mauritius does not preclude the Revenue from applying the substance over form test and deny assessee tax treaty benefits. In this article, I forsake an exhaustive commentary on the case, to make two narrow claims: 

First, the Supreme Court in holding that TRC is a necessary but not sufficient condition for claiming tax treaty benefits plays fast and lose with strict interpretation of Section 90(4) of the Income Tax Act, 1961 (‘IT Act, 1961’) and instead places greater reliance on legislative history and legislative intent while ignoring binding judicial precedents.

Second, I suggest that Tiger Global case unsettles well-entrenched axioms in income tax and tax treaty landscape. The most significant rupture is of the doctrine that tax treaties override domestic law if the former are more beneficial to the assessee. The Supreme Court had no qualms in stating that GAAR contained in a domestic law can be used to deny tax treaty benefits. An observation that appears unblemished, if we look at the underlying provision(s), but holds wider consequences for India’s tax treaty obligations.   

I conclude that the sub-par reasoning of the Supreme Court is attributable to its half-baked idea of tax sovereignty. The concurring opinion of Justice Pardiwala invokes tax sovereignty expressly while the leading opinion of Justice Mahadevan relies on it impliedly. In Tiger Global case, Indian Supreme Court has couched tax sovereignty in legal sophistry, without articulating it in any meaningful manner. In fact, the Supreme Court has exhibited a shallow view of international law – and by extension tax treaty – obligations by viewing them as dispensable and permitted unilateral actions by the Revenue in the name of tax sovereignty.     

I make the above claims fully cognizant of the fact that the Supreme Court’s judgment is, technically, not on merits of the case. But the Supreme Court’s observations are sufficiently detailed and such judicial observations deserve a scrutiny irrespective of narrowing framing of the issue. 

Factual Background 

The brief facts of the case are that Tiger Global acquired shares in Flipkart Singapore before 1 April 2017. The value of shares of Flipkart Singapore was primarily due to the assets the company held in India. In simpler terms, Tiger Global held some shares in holding company of Flipkart – Flipkart Singapore – which in turn controlled subsidiary Indian companies. And the value of shares of Flipkart Singapore was derived from the business and assets owned by its Indian subsidiaries. In August 2018, Tiger Global sold the shares as part of the larger restructuring wherein Walmart acquired majority shareholding in Flipkart Singapore. 

The sale of shares was an ‘indirect transfer’ because sale of shares of Flipkart Singapore indirectly transferred control of Flipkart’s Indian companies and business to Walmart. The sale, as per the Revenue was chargeable to tax under IT Act, 1961. Since the value of shares in Flipkart Singapore was primarily due to the assets it held in India, the legal fiction under Explanation 5, Section 9 was applicable as it deems such shares as located in India. Tiger Global contended that it was a resident of Mauritius, it had acquired the shares before 1 April 2017, and as per the India-Mauritius tax treaty it was liable to pay tax only in Mauritius.    

Tiger Global was riding on two major factors: firstly, that under the India-Mauritius treaty all investments made by residents of Mauritius before 1 April 2017 were grandfathered and were liable to tax only in Mauritius; secondly, if an assessee is resident of India’s tax treaty partner the IT Act, 1961 will only apply if it is more beneficial to the assessee. Thus, as per Tiger Global even if the transaction was liable to tax under Section 9, IT Act, 1961 the India-Mauritius tax treaty exempted it from tax in India and the treaty should override the statute. Widely held views amongst lawyers backed the former claim, decades of jurisprudence the latter.  

The Supreme Court rejected the arguments of Tiger Global and wrote a judgment premised on fanciful ideas of tax sovereignty and autonomy.    

Tax Residency Certificate: Necessary but not Sufficient  

In April 2000, the Revenue had issued Circular No. 789 to address the anxieties about tax liabilities of FIIs and other investment funds which operated from Mauritius and were incorporated there. The relevant portion of the Circular stated that: 

It is hereby clarified that wherever a Certificate of Residence is issued by the Mauritian Authorities, such Certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly. (emphasis added)

In October 2003, the validity of Circular No. 789 was upheld by a Division Bench of the Supreme Court in Union of India v Azadi Bachao Andolan and Anr. The Supreme Court in upholding the Revenue’s power to issue Circular No. 789 endorsed its contents and the Revenue’s interpretation of the India-Mauritius tax treaty. In Tiger Global case, the Supreme Court instead of accepting this unequivocal position of law and engaging with it a meaningful manner, pursued the tangent of legislative history and amendment of Section 90 to conclude that TRC is not sufficient evidence of residence. The legislative history was the amendments made to IT Act, 1961 in 2012 and 2013 to primarily undo the effect of Supreme Court’s judgment in the Vodafone case.    

Finance Act, 2012 amended Section 90(4), IT Act, 1961 to state that an assessee is not entitled to claim relief under a tax treaty unless he obtains a certificate of being residence. In 2013, Finance Bill, 2013 proposed to introduce Section 90(5) in IT Act, 1961 to state that: 

The certificate of being a resident in a country outside India or specified territory outside India, as the case may be, referred to in sub-section (4), shall be necessary but not a sufficient condition for claiming any relief under the agreement referred to therein.

Due to backlash and concerns about the effect of proposed sub-section(5) on the Mauritius route, Finance Act, 2013 dropped the above version and instead introduced the current Section 90(5) which states that an assessee referred to in sub-section(4) shall also provide ‘such other documents and information’ as may be required.

Presuming the legislative history of Section 90 is relevant to adjudicate the issue in Tiger Global case, it is possible to derive two possible views from the above developments. One, adopted by the Delhi High Court was that:

issuance of a TRC constitutes a mechanism adopted by the Contracting States  themselves so as to dispel any speculation with respect to the fiscal residence of an entity. It therefore can neither be cursorily ignored nor would the Revenue be justified in doubting the presumption of validity which stands attached to that certificate bearing in mind the position taken by the Union itself of it constituting ―sufficient evidence‖ of lawful and bona fide residence. (para 199)

The High Court cited the Vodafone case to note that the Revenue’s power to investigate despite a TRC was confined only to cases of tax fraud, sham transactions or where an entity has no vestige of economic substance. 

The Supreme Court pointed the needle in other direction. The Supreme Court referred to the Explanatory Memorandum of Finance Bill, 2012 to observe that intent of amending Section 90(4) was that TRC is necessary but not sufficient evidence of residence. Reliance on supporting sources instead of interpreting the provisions is a curious approach and even the High Court traversed this path for no clear reason. 

The Supreme Court noted that while the legal position – that TRC is necessary but not sufficient – could not be codified due to withdrawal of previous version of Section 90(5), introduction of current version of Section 90(5) still introduced ambiguity if TRC was sufficient. But the Finance Ministry issued a clarification in 2013 that the Revenue ‘will not go behind the TRC’ and Circular No. 789 continues to be in force. And yet, the Supreme Court’s conclusion seems at odds with the clarification issued by the Finance Ministry. The Supreme Court concluded that: 

Section 90(4) of the Act only speaks of the TRC as an “eligibility condition”. It does not state that a TRC is “sufficient” evidence of residency, which is a slightly higher threshold. The TRC is not binding on any statutory authority or Court unless the authority or Court enquires into it and comes to its own independent conclusion. The TRC relied upon by the applicant is non- decisive, ambiguous and ambulatory, merely recording futuristic assertions without any independent verification. Thus, the TRC lacks the qualities of a binding order issued by an authority. (para 37)

The legislative intent in amending Section 90(4) was that TRC is necessary but not sufficient to claim treaty benefits. But such an unambiguous position never found its way in the statute. Instead, the Revenue to clarify the import of amendments to Section 90 stated – via the Finance Ministry – that Circular No. 789 is still in force. But the Supreme Court, relied on legislative intent and observed that TRC has ‘limited evidentiary value’ because of the statutory amendments that govern the field. Failing to note that the Finance Ministry issued its clarification in March 2013 – after the amendments.  

The import and of Section 90(5) was understood by the Supreme Court in following words: 

Section 90(5) mandated that the assessee shall also provide such other documents and information, implying that the existence of a TRC alone need not be treated as sufficient to avoid taxation under the domestic law. (para 12.24) (emphasis added)

Even if legislative history is relevant, the failure to engage with a binding judicial precedent – Azadi Bachao Andolan case – is indefensible. Supreme Court’s refuge was that amendments to IT Act, 1961 have changed the law. In stating so, it refused to acknowledge jurisprudence that High Courts have developed jurisprudence on TRC even after the amendments and the judicial view has largely been consistent with Azadi Bachao Andolan case. Perhaps engagement with the reasoning of High Court judgments and expressing better reasons for disagreement could have lent some credibility and weight to Supreme Court’s conclusions. And as the Revenue itself argued, Vodafone was not a treaty case, it involved interpretation of statutory provisions. Amendments to IT Act, 1961 in 2012 and 2013 to undo Vodafone cannot be used to bypass treaty obligations.  

The non-engagement with Azadi Bachao is what led Supreme Court to say that since the object of a tax treaty is to prevent double taxation, ‘for the treaty to be applicable, the assessee must prove that the transaction is taxable in its State of residence.’ (para 19) How damaging is this statement, we will only know in due time. For now, it suffices to say that it flies in the face of settled law on treaty interpretation that to avail a treaty benefit, a resident must only be liable to tax in another jurisdiction. Liability to tax cannot be equated to actual payment of tax. 

Also, interpreting tax statutes based on implication is a rare approach. Courts, including the Indian Supreme Court, have repeatedly exhorted that tax statutes need to be interpreted strictly. Adherence to strict interpretation is a sine qua non that courts only abandon in the face of ambiguity in a provision. In Tiger Global case, the Supreme Court seemed comfortable relying on legislative intent – revealed by Explanatory Memorandum – and dismissing binding judicial precedents and valid circulars by pointing at statutory amendments. 

Cumulatively, Supreme Court’s observations on TRC fall foul of strict interpretation of tax laws, disrespect judicial precedents, allow the Revenue to conveniently sidestep its own binding circulars and bring into question legitimacy of documents issued by India’s treaty partners. A stirred cocktail of tax misgovernance.   

Tax Treaty Overrides Domestic Law, GAAR is an Exemption  

The Revenue’s argument was that TRC only constitutes prima facie evidence of residence and cannot override substance over form. Even if TRC was not considered as sufficient, the Revenue had to rely on anti-tax abuse rules to claim that Tiger Global was a sham or a conduit. But the Limitation of Benefits clause (‘LOB clause’) in the India-Mauritius treaty was inapplicable to the transaction. So? GAAR came to the rescue. But the Supreme Court had to jump a few interpretive hoops to allow the Revenue to apply GAAR.  

Section 90(2) states that where the Union has entered a tax treaty with another State or jurisdiction that provisions of IT Act, 1961 shall apply to the extent they are more beneficial to the assessee. The import of this provision is that if a tax treaty is more beneficial it shall apply even if it is at variance with the IT Act, 1961. In successive decisions courts have upheld the above legal position and held that charge of income tax and determination of scope of income under sections 4 and 5 of IT Act, 1961 are subject to tax treaties. An uncontroversial position until 2012.   

In 2012, the Finance Act added sub-section (2A) to section 90 which states that: 

Notwithstanding anything contained in sub-section (2), the provisions of Chapter X-A of the Act shall apply to the assessee even if such provisions are not beneficial to him.

Chapter X-A contains provisions relating to General Anti-Avoidance Rule, also introduced via the Finance Act, 2012. Section 90(2A) empowers the Revenue to apply a statutory anti-tax abuse rule to assessees who are covered by tax treaties. The exception in subsection (2A) then ensures that if the LOB clause of a tax treaty is not sufficient, GAAR can be invoked to address tax avoidance strategies.  

The Supreme Court took cognizance of the above provision, interpreted it strictly and noted that GAAR can apply to assessees covered by tax treaties. On the touchstone of strict interpretation, the Supreme Court was right in observing that GAAR can apply to assessees covered by tax treaties. But Supreme Court’s failure to engage to engage with decades of judicial precedents stating that domestic tax law cannot override tax treaties remains a fatal flaw of the judgment. Unless tax treaty provides that GAAR can apply in the absence/insufficiency of a LOB clause, Section 90(2A) amounts to a unilateral amendment of tax treaties. And the Supreme Court seems to have endorsed it.   

The other hurdle was grandfathering. Rule 10U(1)(d), Income Tax Rules, 1962 states that Chapter X-A containing GAAR shall not apply to income accrued or arisen from investments made before 1 April 2017. Tiger Global argued against application of GAAR citing the grandfathering contemplated in the domestic provisions. But the Revenue relied on Rule 10U(2) which states that: 

Without prejudice to the provisions of clause (d) of sub-rule (1), the provisions of Chapter X-A shall apply to any arrangement, irrespective of the date on which it has been entered into, in respect of the tax benefit obtained from the arrangement on or after the ⁵⁵[1st day of April, 2017]. (emphasis added) 

Rule 10U(2), on first glance, negates the grandfathering contemplated by Rule 10U(1)(d). The Revenue made a similar argument. The High Court had refused to interpret ‘without prejudice’ to mean that GAAR could be applied to income from arrangements entered before 1 April 2017. The High Court noted that it should ‘eschew from’ interpreting a provision in a domestic statute that conflicts with a treaty provision. And concluded that accepting the Revenue’s argument would mean:

A subordinate legislation would thus stand elevated to a status over and above a treaty entered into by two nations in exercise of their sovereign power itself. (para 230)

The Supreme Court did not have similar qualms  as the High Court and accepted the fine distinction made by the Revenue. The distinction was that Rule 10U(1)(d) only grandfathered investments, while Rule 10U(2) uses the word ‘arrangement’ and thus the grandfathering benefit can only extend to investments and not tax avoidance arrangements, even if the latter were entered into before 1 April 2017. A strict interpretation of both Rules – supported by observations of the Shome Committee – will place Supreme Court’s conclusion in a defensible category. But what does it mean for India’s tax treaty obligations?   

A two-pronged thorn emerges: 

First, tax treaty override over domestic law will no longer be exhaustive by virtue of Section 90(2); Revenue can apply GAAR if LOB clause of tax treaty is insufficient by invoking Section 90(2A) read with Rule 10U. Domestic law, specifically, GAAR will act as a backstop to prevent tax avoidance. A legal position that the Supreme Court has accepted in Tiger Global case but flies in the face of decades of jurisprudence on income tax law and tax treaty interpretation.  

Second, relevant provisions of the India-Mauritius tax treaty refer to ‘gains’ not to investments or arrangements. Can domestic laws – including secondary legislation – now determine the scope of taxability and allocation of rights agreed upon tax treaties? The High Court said a categorical no, the Supreme Court said yes. The Supreme Court took refuge in the fact that amendments of IT Act, 1961  – specifically Section 90 – had changed legal landscape. Domestic landscape, yes. Treaty obligations, not. But, I guess, we are a sovereign country that can act independently and if need be in flagrant disregard of our treaty obligations.   

Conclusion

Tiger Global case is an attempt by Indian Supreme Court to flex tax sovereignty, without truly understanding it. The concurring opinion of Justice Pardiwala exemplifies this lack of understanding. He lauds India’s unilateral revocation of Bilateral Investment Treaties in 2016 and adds that an assertion of tax sovereignty is the power to make unilateral moves. What is being termed as tax sovereignty is polite speak for reneging on tax treaty commitments if revenue demands are not accepted unconditionally. Such prescriptions appeal to baser instincts of the State and do not aspire to tax governance founded on rule of law. Justice Pardiwala perfunctorily adds that India should negotiate tax treaties by including certain safeguards such as: GAAR should override tax treaty benefits. Another example of how he misunderstands manifestation of tax sovereignty. Is the assumption here that India’s treaty partners will simply agree to such clauses and not extract similar concessions for themselves. Justice Pardiwala not only exceeds his remit by providing policy prescriptions but provides them based on a shallow understanding of treaty dynamics and negotiations.    

To book end this article, Justice Mahadevan’s conclusion cited at the beginning where he concludes that the transactions of Tiger Global are impermissible anti-avoidance arrangements is based on facts that seem only privy to him and the Revenue. There is nothing in both the leading opinion and the concurring opinion to even provide a glimpse of reasons as to why the transactions and arrangements are impermissible anti-avoidance arrangements. If only Supreme Court judgments on tax issues were to provide us less tax history lessons, fewer policy prescriptions and substitute them with better reasoning, sound analysis of facts and accurate application of law.