Expert Zone

(The views expressed in this column are the authors’ own and do not represent those of Reuters)

Over the years, Mauritius has been considered as one of the preferred route by foreign investors for making investments into India, given the potential tax exemption on exit under Double Tax Avoidance Agreement entered into between India and Mauritius (‘the Tax Treaty’) which exempts capital gains tax arising on sale of shares of an Indian company.

The Indian Revenue have in the past questioned the eligibility of capital gains tax exemption under the Tax Treaty on the ground that the Mauritian Company has no real commercial substance and it has been merely set-up for Treaty Shopping.

This approach has resulted in significant long-drawn litigation in a number of cases involving investments in India through Mauritius. In fact, in one of such renowned judicial case, the Supreme Court of India after perusing the Treaty provisions and the CBDT Circulars No. 682 dated 30 March 1994 and 789 dated 13 April, 2000, upheld the position that Mauritius Company can claim the Tax Treaty benefits if it has obtained a ‘Tax Residency Certificate’ (‘TRC’) from the Mauritian tax authorities.

Based on the ruling of the Supreme Court, entities holding a valid TRC should be eligible to claim Treaty benefits. However, the debate is not yet settled down despite the Apex Court ruling and the tax authorities have been examining investments from Mauritius and have sought to deny the Treaty benefits under the pretext of Treaty Shopping.

Recently, the Authority for Advance Rulings (‘AAR’) has reaffirmed that capital gains on sale of Indian shares held by a Mauritius resident company are liable to be taxed only in Mauritius, in the case of D B Zwirn Mauritius Trading No. 2 Ltd (‘D B Zwirn’) (2011-TII-04-ARA-INTL).

The applicant in this case sold its entire stake in Quippo Telecom Infrastructure to another Mauritius based Company. The conclusion of the AAR was based on the Supreme Court decision in the case of Azadi Bachao Andolan.

It seems that an application on a similar issue has been filed by the UK-based telecommunications giant – Vodafone with the AAR. It has sought AAR’s opinion on whether it is liable to deduct tax on payment made to Essar Group as part of its endeavour to buy additional 33% stake in the Indian joint venture company – Vodafone Essar Limited (‘VEL’).

The $5-billion deal between Vodafone and Essar Group is structured in two parts. Essar Group holds 33% stake in VEL out of which 22% is heldthrough two Mauritius based entities and the balance 11% is held directly through an Indian entity. Vodafone’s stance seems to be that it is notliable to withhold taxes on payments to Mauritius based companies due to the benefit provided under the Tax Treaty.

It would be interesting to watch whether the AAR would look upon Vodafone’s case differently or would continue to apply the principles laid down in Azadi Bachao Andolan and followed recently in case of D B Zwirn.

Most likely the principles adopted by the AAR in case of D B Zwirn and the past rulings should apply equally. However, the Mauritius Tax Treaty benefit is certainly up for being tested again in a high profile matter.