Tax trouble: The Indian Supreme Court’s Tiger Global judgement could potentially put foreign investors off

The brief facts are as follows. In 2009, Tiger Global, a private equity firm, had invested in the Singapore-based holding company of e-commerce major Flipkart, and then increased its exposure over the next two years to about $1 billion—a 20% stake.

In 2017, it began monetizing its investment by selling part of its holding to SoftBank Group, and in 2018, it sold most of its shares to Walmart. This sale triggered the tax dispute.

The holding structure was complex. It was Tiger Global Mauritius (TGM) that held equity in Flipkart Singapore, which in turn had a stake in Flipkart India, and what was sold to Walmart in 2018 was TGM’s stake in Flipkart Singapore.

As such, this was not a sale of a company in India. In this, it offers a parallel with the Vodafone case; in 2007, Hong Kong-based Hutchison Group had sold its stake in overseas holding firms (including one in Mauritius) that controlled Hutchison Essar in India to UK-based Vodafone.

In TGM’s case, though, the sale was by a Mauritius firm of a Singapore firm valued for e-commerce operations in India.

Article 13 of an India-Mauritius tax treaty offered a capital gains exemption for many years, starting from 1992, till it was amended in 2016 (with effect from 1 April 2017). The historical background matters. In 1991, India had to reform its economic policies after running short of foreign exchange.

New Delhi liberalized rules for foreign investment inflows. Around the same time, India passed the Mauritius Offshore Business Activities Act and struck a tax treaty with Mauritius that gave income tax exemption for sale of shares by companies resident there.

It was obviously designed to attract foreign investment into India via Mauritius, as few could argue that Mauritian businesses were large enough to use this avenue. However, a Tax Residency Certificate (TRC) regime arose that allowed treaty benefits to be claimed simply by showing a TRC.

As Circular No. 682 of the Central Board of Direct Taxes (CBDC) dated 30 March 1994 states: “Any resident of Mauritius deriving income from alienation of shares of Indian companies will be liable to capital gains tax only in Mauritius as per Mauritius tax law and will not have any capital gains tax liability in India."

In August 2016, the India Mauritius treaty was amended with the following insertion of Article 13(3A) and 3B):

“3A) ​Gains from the alienation of shares acquired on or after April 1, 2017 in a company which is resident of a Contracting State may be taxed in that Stage."

“3B) ​However, the tax rate on the gains referred to in Paragraph 3A of this Article and arising during the period beginning on April 1, 2017 and ending on March 31, 2019 shall not exceed 50% of the tax rate applicable on such gains in the State of residence of the company whose shares are being alienated."

It would be obvious that shares acquired upto to 31 March 2017 should get the benefit of the earlier exemption.

Subsequently, the CBDT also issued Circular No. 789 dated 13 April 2000, clarifying that a TRC issued by Mauritius authorities is sufficient evidence for taxpayer residence status. On its basis, in the Azadi Bachao Andolan case of 7 October 2003, the Supreme Court held that if a valid TRC is provided, the treaty benefit cannot be denied. That judgement also stated that the 2000 circular was within the CBDC’s powers to issue.

The Mauritius route clearly had the government’s approval and the TRC had “deemed" substance because the purpose of the treaty was to lure foreign investment. Unfortunately, endless doublespeak over three decades has badly impacted India’s credibility on this matter and acted as a put-off for investors.

One would assume the Supreme Court was acquainted with that context. Unfortunately, it ruled against Tiger Global and its use of tax grandfathering—notably, the transactions under scrutiny were done before 1 April 2017.

The tax department had still pressed for a capital gains levy and the apex court focused on the underlying business being in India to uphold that tax claim.

Without delving further into legal technicalities, here are some larger issues:

First, the government itself wanted foreign investment and used the Mauritius treaty and CBDT circulars to convey its intent of honouring a tax exemption. Yet, the Centre chose to press for taxes.

Second, what are the signals this sends foreign investors? Especially in today’s context, as we face geopolitical headwinds and uneven capital inflows.

All of this raises a question. Should the Supreme Court have overlooked the technical specifics of the case? This ruling has cast a long and dark shadow on the certainty of law, sanctity of tax treaties and the worth of government promises (even if only implied). Overall, it has sent negative signals to foreign investors, particularly to private equity players.

Whilst there may be few other cases of its kind number, the ruling threatens a reopening of deals that have long been concluded. It also casts into uncertainty cases covered by other treaties with a similar provision, such as one with Singapore, as also cases under the India-Dutch treaty, which has its own form of exemption.

One can only hope that some kind of a resolution will emerge and positive signals will be sent by the Centre shortly to mitigate the impact of this judgement.

Sneha Mahnot contributed to this article

The author is founder of Katalyst Advisors Pvt Ltd.