A ruling from India has confirmed that treaty shopping is not taboo and should not warrant enquiry from the authorities.
The decision from the Authority for Advance Rulings (AAR) reiterates the principle laid down by the country's Supreme Court in Azadi Bachao Andolan.
In the case of Ardex Investments Mauritius, the AAR held that capital gains arising on the sales of shares held in an Indian company to another non-resident group company are not taxable in India under the provisions of the tax treaty between India and Mauritius.
The AAR observed that the formation of the Mauritius subsidiary might be an attempt to take advantage of the treaty. But by itself it cannot be viewed or characterised as objectionable treaty shopping.
It was further held that the applicant will have to file the tax return in India for capital gains purposes.
"The ruling is of great importance to foreign investors investing into India, especially through Mauritius," said an alert from PwC.
"This decision also shows how easy it is to go treaty shopping in India," said an Indian tax director who asked to be kept anonymous. "The understanding of treaty shopping with the country's assessing officers is pathetic and so taxpayers are able to use treaty shopping to their advantage."
Facts of the case
Ardex, a tax resident of Mauritius, held 6.5 million equity shares (50%) of Ardex Endura (India), a flooring adhesive manufacturer.
Ardex intends to sell its entire holding in Ardex India to another non-resident group company, Ardex Beteiligungs (Germany) at fair market value.
The key issue was whether capital gains arising to the applicant on the sale of shares of the Indian company are tax exempt under the treaty.
Ardex Mauritius claimed that it is a separate entity and is the beneficial owner of the shares, placing heavy reliance on the 2003 Supreme Court decision in Azadi Bachao Andolan and in the AAR decision of E-Trade Mauritius.
The tax authorities argued that the company set up the structure for treaty shopping purposes. In piercing the corporate veil, the department claimed the capital gains were attributable to Ardex UK, the holding company of the applicant company.
"Preparing the correct documentation and supportive material is vital if you are to obtain treaty benefits," said Ravishankar Raghavan, of Majmudar & Co.
Decision
The AAR ruled that capital gains on the proposed sale of shares by the applicant to its group company are not liable to tax under article 13(4) of the tax treaty and so the applicant can receive the proceeds without any tax withholding.
"The irony is that the authorities are very suspicious of all taxpayers, yet they don't have a grip on treaty shopping," said R Mani, head of India tax at Tata. "Everyone is doing it and the officials don't even realise."
The ruling affirms relatively uncertain position of claiming tax treaty benefits on fulfillment of ancillary factors such as duration of holding, value of shares disposed and satisfaction of tax residency certificate ought not to be considered as a tax avoidance arrangement, for exiting investors even though planned as treaty-shopping through a treaty protected country.
"The ruling draws a fine line between permissible treaty shopping vs. tax avoidance," said Shailendra Sharma of Deloitte.
