As published on law360.com/tax-authority, Monday 15 June, 2020.
An Indian rulings body recently denied a withholding tax exemption tied to Walmart's $16 billion purchase of online retailer Flipkart after finding a tax treaty didn't apply — a decision that could signal increased scrutiny for companies claiming similar benefits.
The Authority for Advance Rulings, or AAR, in New Delhi concluded that New York-based investment firm Tiger Global Management didn't have sufficient connections to Mauritius, an island nation in the Indian Ocean, to qualify for benefits under the Indian-Mauritius tax treaty. Accordingly, the AAR upheld a withholding tax on capital gains that Tiger Global realized when selling its Flipkart shares as part of a larger transaction for Walmart to ultimately pick up a majority stake in Flipkart, the Indian e-commerce company.
Specialists say the AAR's ruling comes as Indian revenue authorities have already been putting companies' structures under a microscope to determine whether they're routing affiliates through certain jurisdictions, such as Mauritius, solely for the treaty benefits. The denial of a ruling for Flipkart bolsters the case for that scrutiny, according to Rajeshree Sabnavis and Nikky Shah of accounting firm Rajeshree Sabnavis & Associates in Mumbai.
"This decision of AAR will definitely give impetus to tax officers to go beyond the legal form of the entity to assess the management and control aspect of holding structures," they said in an email to Law360.
In the underlying transaction, Tiger Global's Mauritian affiliates sold their shares in Flipkart, which was registered in Singapore, to a Luxembourg entity, Fit Holdings SARL, for about 145 billion rupees ($1.9 billion). These transfers were undertaken as part of a broader deal involving Walmart's $16 billion majority acquisition of Flipkart from several shareholders, including Tiger Global, according to the AAR.
Shortly before the share transfer took place, Indian tax authorities in August 2018 denied Tiger Global's request for a withholding tax exemption under the Indian-Mauritius double taxation avoidance agreement, or DTAA.
In upholding the revenue department's decision, the AAR found that "the head and brain" of Tiger Global was situated in the U.S., not Mauritius, according to the ruling, issued March 26 and publicly released June 5. The AAR concluded that Tiger Global's Mauritian affiliates "were only a 'see-through entity' to avail the benefits of the Indian-Mauritius DTAA."
The AAR's decision could influence how Indian tax authorities approach similar requests for treaty benefits, according to Paul de Haan, a former partner with PwC who's currently an independent tax adviser with CapaBuild, a nonprofit organization that provides tax training in developing countries.
"The message is: Have your act 100% together or you do not get [the] benefit of treaty protection," he said.
De Haan added that "from a distance, the legal structure involved did not have that much flesh on the bones."
The Flipkart deal involved offshore indirect transfers, or OITs, which are stock transactions that companies carry out in jurisdictions separate from those holding the underlying assets. A previous high-profile OIT involved U.K.-based Vodafone and an Indian mobile phone company — and in that case, the Supreme Court of India found that the Indian-Mauritius tax treaty applied.
In that transaction, in 2007, Vodafone picked up shares in a Cayman Islands subsidiary that held interest in the Indian phone company. The shares had belonged to a Hong-Kong based multinational with affiliates in Mauritius. The nearly $11 billion deal "took place entirely outside India, between two nonresident companies," according to recent U.N. guidance designed to help countries draft tax legislation for OITs.
The issue wound its way to the Supreme Court, which held in 2012 that the India-Mauritius treaty didn't restrict benefits to companies whose shareholders weren't residents of the island nation. If Indian tax authorities "insist that the investment would directly come from Mauritius and Mauritius alone, then the Indo-Mauritius treaty would be dead letter," according to the decision.
Later that year, the Indian government changed the law with retroactive effect so that the transaction could be taxed, and related arbitration of the case is ongoing. Meanwhile, India's Ministry of Finance in January 2017 announced a general anti-avoidance rule that would apply to investments beginning that year.
"Ever since the Vodafone ruling, Indian tax authorities in recent years are increasingly looking at such transactions and evaluating whether treaty benefits can be granted," said Rajesh Gandhi, a partner at Deloitte Haskins & Sells LLP in Mumbai.
In light of the AAR decision in the Flipkart case, "tax authorities could use the observations in this ruling to scrutinize Mauritius structures," he said.
In its decision, the AAR went beyond concluding that the India-Mauritius treaty didn't apply to the Flipkart transaction. The tribunal also found that the treaty was never intended to allow capital gains exemptions for transfers of assets in a company that wasn't based in India — a finding that appears to ignore the treaty's preamble, according to Sabnavis and Shah of Sabnavis & Associates.
"This interpretation will cast an element of doubt in the minds of foreign investors on whether India-Mauritius tax treaty benefits [are] at all available in cases of indirect transfer transactions," they said.
Sabnavis and Shah added that this doubt will be there "even in a scenario where a Mauritius company satisfies the substance test."
But while the AAR's ruling could add to tax authorities' momentum in assessing certain requests for treaty benefits, the decision could ultimately be an outlier.
The ruling may lead to certain additional factors becoming more relevant in tax proceedings — such as the objective behind the structure and bank account signatories, according to Hitesh D. Gajaria, head of tax and partner at KPMG India.
He added, however, that "the conclusions reached in this case are fact specific and should not lead to an automatic denial of tax treaty benefit claims in other cases."
The "unusual facets" in the AAR's ruling, including its brief reasoning for denying treaty benefits for indirect transfers, could lead to a challenge before the high court, Gajaria said.
As de Haan at CapaBuild saw it, the AAR's ruling wasn't surprising because India has long been determined to effectuate its right to tax Indian-sourced gains.
The problem, he said, "was that up till some time ago, its domestic law and treaties were not really backing that desire."