Foreign Direct Investment (FDI) in India has greatly increased in the past decade, particularly after the pandemic. This has led to more cross-border transactions in which foreign investors transfer their company holdings as a planned exit strategy. Offshore reorganisations with changes in ownership have triggered off-market deals in listed securities. However, cross-border securities transactions face legal, regulatory and commercial challenges, particularly for income tax liability.
Some tax treaties, such as those with Mauritius and Singapore, have ceded taxing rights on the sale of securities of Indian companies by non-resident investors before 1 April 2017. Tax treaties with the Netherlands include rights where the shares derive value from non-business immovable property. Domestic law, however, taxes the sale of shares in Indian companies to non-resident investors. The differences in treatment have raised concern.
Domestic law general anti-avoidance rules (GAAR) and the tax treaty principal purpose test (PPT) deny treaty benefits where the purpose of the transaction is to obtain such benefits. However, domestic and treaty benefits are granted if transactions are for sound commercial reasons and such benefits are consistent with treaty objects and purposes. The application of the GAAR and the PPT has not yet been tested in the courts. Guidance may be derived from the approaches of courts in other jurisdictions and from the application by Indian courts of anti-avoidance provisions before the introduction of the GAAR.
In the landmark 2023 Alta Energy Luxembourg case in Canada, a Delaware limited company sold the shares of a group company, Alta Canada, to the Luxembourg-incorporated taxpayer that in turn sold them to another company in Canada. The latter sale was claimed as tax exempt under the Canada-Luxembourg treaty. The taxpayer had no other business nor held any other investments. Canadian tax authorities, invoking the GAAR denied the treaty benefit, labelling it a tax avoidance scheme.
The Supreme Court allowed the benefit of the tax treaty, observing that if the drafters had intended to limit the benefit, they would have set this out in the treaty. Although the taxpayer had no economic connection with Luxembourg, the treaty exemptions were to encourage businesses to invest in Canada and this the Luxembourg company had done. The court found no abusive tax avoidance.
In NetApp Denmark ApS, TDC A/S, the High Court in Denmark dealt with two cases in which dividends were distributed through complex parent company structures. In one, the court held that one of the intermediary companies could not claim a treaty benefit as it was never the beneficial owner. However, the ultimate recipient, a US company, was the beneficial owner and could have received the dividends without the conduit of the intermediary company. Treaty benefits were allowed. In the second case, the taxpayer company provided no evidence of the beneficial owners. Tax exemptions were therefore denied.
In the recent case of Bid Services Division (Mauritius) Limited v Authority for Advance Ruling (Income Tax) and Ors, the Bombay High Court allowed the benefit of the India-Mauritius tax treaty on a transfer of shares. A group company was involved in bidding for shares in an Indian company. Two weeks before the acquisition the taxpayer company was incorporated and eventually purchased the shareholding interest in the Indian company. The tax authorities failed because the purchase and transfer were before the cut-off date of 1 April 2017. The court also found that merely because a tax vehicle was exempt from liability that did not make it a shell or sham entity. The court distinguished tax efficiency from tax avoidance.
Anti-abuse rules are inconsistently applied in cross-border divestiture. A special-purpose vehicle with no other business investing in an Indian company should not be denied treaty benefits on those grounds alone. Multinational groups often set up investment holding companies and the Supreme Court recognised their legitimacy in the landmark Vodafone case.
Tax treaty objects and purposes are important. If a tax treaty provides a specific anti-abuse test but a specific case is not caught by it, treaty benefits should apply. It can be argued that the object and purpose of the treaty is to grant such benefits.