The decision against Tiger Global could change the way in which foreign investors choose to invest in India from Mauritius. Funds must now show “substance” in these jurisdictions, or they will be subject to Indian taxation. The verdict may also affect other treaty-based investments and indirect share transfers in Indian companies.
Author : Akshita Jain | EQmint | Finance News
The Supreme Court’s decision on Thursday to support the Rs 14,500-crore ($1.7 billion) tax demand on Tiger Global has significant financial implications for the US-based investment firm, but the decision may have more profound implications for a wide range of venture capital and private equity investors who, for decades, have invested in Indian companies through Mauritius-registered firms.
Lawyers and investors, as well as chartered accountants, speculated that the impact on other funds will not be uniform but will depend on their investment vehicles and whether they invest directly or indirectly in Indian companies.
Mauritius Treaty Benefits Face Scrutiny
“Substance is now the test, and if the real decision-making or control is outside of Mauritius, then the benefits of the treaty cannot be denied,” said one investor. “The risk of being scrutinised is greater if the Mauritius vehicle is only on paper, and decisions are made in India, the US or Singapore” “Outside of tax avoidance, firms also set up Mauritius or Cayman Island companies to pool global capital if they have limited partners from across countries such as the US, Europe, Singapore and the Middle East,” he explained.
But those funds that used the DTAA with Mauritius to build vehicles in the country could be scrutinized by the tax department, they said.
“For years, the only door to Indian equity markets was Mauritius, not Mumbai. Foreign Investors chose Mauritius because it offered them the treaty advantages of a favorable capital gains regime, says Siddarth Pai, partner at 3one4 Capital.
Funds based in Mauritius often had to face a long tax battle over the substance of their activities in Mauritius and where the decisions were made. This meant that the funds’ partners and managers were to reside in Mauritius, and that investments and divestment decisions were made there,” he said, adding that the biggest question for investors with Mauritius structures is whether previous exits will be thoroughly scrutinised.
One of the chief financial officers of a large venture capital firm, which employed the Mauritius-structure, said that when India amended its DTAA with the country in 2017, “the government made clear that tax on any deal must be paid in India.”
We had some investments we held prior to 2017 that we sold after 2017. But we paid the full tax in India,” he said under anonymity.
“VC firms that invest in low tax jurisdictions will have to show substance, which is a core financial or commercial purpose, for opening their offices in such low tax jurisdictions. Without that, their transactions could be examined more closely and taxed in India,” said Pallav Narang, partner of chartered accountancy firm CNK & Associates.
Broader impacts
Besides that, lawyers expressed concerns that the Tiger Global case ruling might set a precedent for other cases in which treaties have been misused. Besides that, the effect could be seen in foreign portfolio investors participating in the high-risk derivatives trading market, according to tax experts.
“The judgment will be used in other treaty cases as well, not limited to only capital gain cases. The determination that tax treaties are not meant to apply to indirect share transfers will also introduce uncertainty for investments made from a number of other jurisdictions,” said Abhishek Goenka, partner of Aeka Advisors, a firm focusing on tax matters and regulations.
Indirect transfers mean operations of companies that are located outside India but get a major part of their business from India, like in the situation of Flipkart. The e-commerce company owned by Walmart, although its operations are based in Bengaluru, has its parent company located in Singapore. During the 2018 deal, Tiger Global’s Mauritius entity sold shares in Flipkart’s Singapore parent to a Walmart-affiliated entity that was also located outside India.
“The Supreme Court’s argument is based on a “threshold” logic: in order to win any benefit under the India-Mauritius treaty, an entity must first prove itself to be a legitimate “resident” with independent commercial substance. By labeling the Tiger Global Mauritius entities as “fronts” or “conduits” for their US-based parent, the court concluded that they were “respectively non-residents to treaty purposes”, said Ankit Jain, partner at New Delhi-based accounting firm Ved Jain & Associates.
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