Tax Court Rules on “Beneficial Ownership” Test in India-Mauritius Tax Treaty

A recent ruling by the Income Tax Appeal Tribunal (ITAT) has revived the discussion on the Capital Gains Tax Article in the India-Mauritius Tax Treaty (the Tax Treaty) . The ITAT, ruling on a Mauritius-based investor’s appeal against denial of tax treaty benefits due to alleged failure to meet the “beneficial ownership” test, raised a fundamental question as to whether the criterion is in fact a condition precedent to obtaining such advantages.

The taxpayer was Blackstone FP Capital Partners Mauritius V Ltd, a company (a wholly owned subsidiary of a Cayman Islands based entity) incorporated and domiciled for tax purposes in the Republic of Mauritius. It was incorporated on June 8, 2006 and held a global business license issued by the Financial Services Commission of Mauritius. She was also registered as a foreign venture capitalist with the Securities and Exchange Board of India and had received a certificate of tax residency from the Mauritius Revenue Authority.

During the 2015-2016 financial year, the taxpayer sold shares of an Indian company, under its share purchase agreement dated February 16, 2015, realizing long-term capital gains of 9 billion Indian rupees ($115.7 million). While the taxpayer claimed to be protected by Article 13 of the tax treaty, the tax authorities rejected this request for exemption, alleging that the taxpayer was not the beneficial owner of the transferred shares.

In this regard, the taxpayer referred to aspects such as who had administrative control of the taxpayer, the source of the investment in the shares transferred, the trail of transactions for the acquisition of shares and the sale of them. , and the instructions issued to carry out these transactions.

Court decision

During the appeal proceedings, the ITAT first questioned whether the tax administration’s procedure based on this presumption – namely that the beneficial ownership test was an intrinsic requirement to be met by a taxpayer to claim capital gains tax relief under Article 13 of the tax treaty – was actually the right approach. In this regard, the ITAT has noted that, unlike some other articles of the tax treaty, Article 13 does not contain this beneficial ownership test.

From the perspective of the discipline and balance of international tax law, the ITAT noted that unless a condition is specifically set forth in the treaty provision itself, it cannot be inferred. Indeed, the tax provisions of tax treaties are consciously agreed to by two willing partners and therefore cannot be unilaterally overruled based on perceptions of some underlying notions of what would constitute good public policy.

ITA also pointed out that in the context of international tax treaties, compliance with negotiated agreements between contracting states is fundamental to ensuring tax certainty and predictability and to upholding the pacta sunt servanda principle, which is specifically mentioned in article 26 of the Vienna Convention. on the Law of Treaties (Vienna Convention) and which stipulates that “every treaty in force binds the parties and must be performed by them in good faith”.

In light of this, the ITAT ruled that, as a first step, a conscious appeal to the question of whether the requirement of “beneficial ownership” is incorporated into Article 13 is sine qua non before proceeding on this basis. Accordingly, the Court referred the case back to the tax authority to decide the fundamental question of whether the requirement of “beneficial owner” can be read within the framework of Article 13 of the Tax Convention, and it is only if the answer is in the affirmative that the question of the taxpayer’s beneficial ownership of the shares can be considered.

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Article 13 of the tax treaty, which provided that capital gains realized by a Mauritian resident on the transfer of Indian assets were not within the scope of Indian income tax, has been the subject of considerable judicial scrutiny in the past. Although the capital gains tax exemption has been removed for investments made on or after April 1, 2017, cases of denial of treaty relief alleging non-compliance with the beneficial ownership test do not are still not uncommon, despite the fact that circular number 789 dated April 13, 2000, issued by the Central Board of Direct Taxes (the highest body for the administration of direct taxes in India) categorically stated that wherever a certificate of tax residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence to accept the status of residence as well as the beneficial owners for the purposes of the tax treaty accordingly.

ITA has rightly observed that before deciding who has beneficial ownership in such situations, the fundamental question to be addressed is whether this beneficial ownership test is indeed a requirement to be met first. venue. Admittedly, the text of Article 13(4) of the Tax Convention does not include a beneficial ownership requirement. It will be interesting to see what criteria or reasons the tax authorities will apply/attribute in deciding whether the beneficial ownership requirement is incorporated into Article 13(4) of the Tax Treaty.

We remember the famous judgment of the Supreme Court of India in the case of Union of India vs. Azadi Bachao Andolan [2003] 263 RIR 706 (SC), where, in the context of treaty shopping, the Court noted that until provisions dealing with treaty shopping are incorporated into a tax treaty, they cannot be artificially imported into it.

ITA’s acknowledgment that any breach of the Vienna Convention can only come at a huge cost of tax unpredictability is also a welcome remark, as certainty and predictability are among the most important considerations for foreign investors. The investment structure adopted by the taxpayer per se is fairly typical across the industry. Therefore, clarity on “beneficial ownership” will bring a sigh of relief to many foreign investors.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

The opinions of the authors in this article are personal and do not constitute legal/professional advice from Khaitan & Co.

Author Information

Sanjay Sanghvi is a Partner and Raghav Kumar Bajaj is an Advocate, Direct Tax Practice Group at Khaitan & Co., India.

Authors can be contacted at: [email protected]

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