In a recent ruling¹, the Income Tax Appellate Tribunal, Delhi (“Tribunal”) recognized and upheld the importance of the Tax Residency Certificate (“TRC”) and held that a Mauritius-based Collective Investment Vehicle (“CIV”) registered as a Foreign Portfolio Investor (“FPI”) by the Securities and Exchange Board of India (“SEBI”) is entitled to the benefits provided under the Double Taxation Avoidance Agreement between India and Mauritius. (“DTAA”).

Background

The taxpayer, a non-resident incorporated under the laws of Mauritius (“Taxpayer”) had a valid TRC issued by the Mauritian tax authorities. The Taxpayer operates as a Collective Investment Scheme, authorized and is regulated by the Financial Service Commission in Mauritius. Additionally, the Taxpayer is registered with the SEBI as an FPI. The Taxpayer is managed by Sapien Capital (Mauritius) Limited, an investment management company (“SCML”).

Furthermore, neither the Taxpayer nor SCML overseeing the fund has a Permanent Establishment in India. All significant operational activities and functions pertaining to the fund and management company are conducted and situated outside India. This includes the decision-making process, approvals, control, and overall management associated with it.

The Taxpayer’s operations in India are limited to specific activities, namely investing in Government Securities (Bonds) and Exchange Traded Cash Equities, as well as engaging in trades involving Exchange Traded Derivatives, Equities, and Currencies (Futures & Options).

For the year in question, the Taxpayer filed its return of income showing income as exempt as it took benefit of the DTAA. While the case was chosen for scrutiny assessment, the Assessing Officer (“AO”) accepted the returned income as filed by the Taxpayer. However, the first appellate authority i.e. the Commissioner of Income Tax (Appeals) (“CIT”) determined that during the assessment proceedings for the relevant year, the AO failed to acquire sufficient information regarding the nature of income claimed as exempt. The CIT ruled that the AO did not seek any clarification or obtain any explanation to establish the Taxpayer’s argument that such income is not taxable.

Upon examination of the provided details and explanation by the Taxpayer, the CIT concluded that the Taxpayer is ineligible to avail the benefits conferred by Article 11 of the DTAA (that provides for taxability of Interest). As a result, the CIT held that the income would be subject to taxation in India on a gross basis, applying the tax rate specified under section 115A of the Act. The CIT based its decision basis the following:

1. The Taxpayer in Mauritius is liable to tax, albeit with an 80% exemption as per domestic laws. However, when considering liability to tax for treaty purposes, it refers to full or comprehensive liability rather than a limited liability under domestic laws of the contracting state. Therefore, in this case, the criteria of “liable to tax” is not met. Consequently, the Taxpayer cannot be considered a tax resident for the purpose of applying the DTAA;
2. The scheme of arrangement employed by the Taxpayer is nothing but tax avoidance through treaty shopping mechanism as the fund is controlled by individuals who are residents of the UK. Therefore, the presence of the Taxpayer in Mauritius lacks legitimate commercial rationale as the commercial outcomes would be identical irrespective of location of funds;
3. The Taxpayer is just a conduit and the real owner is the shareholders/investors who are tax residents of different countries. Within the CIV, there are approximately 21 investors who are not tax residents of Mauritius. The CIV operates for a limited duration, and once investments are sold, the proceeds are disbursed to investors based on their contributions. The primary intention is to pass on all income to the investors after deducting fund management expenses, establishing a back-to-back arrangement;
4. The Taxpayer is also not a beneficial owner of income as control and dominion of fund is not with the company; and
5. TRC is not sufficient to establish the tax residency if the substance establishes otherwise. The CIT opined that post-Base Erosion and Profit Shifting (“BEPS”), tax residents utilizing treaty shopping to avoid paying legitimate taxes are no longer entitled to tax treaty benefits, CIT stated. This was supported by Article 6 of the Multilateral Instrument (“MLI”), which emphasizes the intention to prevent non-taxation or reduced taxation through tax evasion or avoidance, and Article 7, which focuses on the prevention of treaty abuse. Both India and Mauritius have signed the MLI and ratified their tax treaties, incorporating Article 6 of the MLI. Consequently, it was concluded that arrangements aimed at evading taxes, such as treaty shopping or conduit companies, do not qualify for the benefits of the DTAA, as they are considered improper use of treaties.

Therefore, aggrieved by the order of the CIT, the Taxpayer filed an appeal before the Tribunal.

Ruling

The Tribunal ruling in favour of the Taxpayer held that it is eligible for benefits under the DTAA. The Tribunal came to this conclusion on the basis of the following reasons:

• The CIT’s observation that the Taxpayer is ineligible for benefits, under DTAA, as a non-resident due to the non-fulfilment of the “liable to tax” criterion is factually incorrect. The provision of tax exemption by the Taxpayer’s resident country does not automatically grant the revenue authorities the right to impose taxes on the income in the contracting state.
• Choosing to establish a fund in Mauritius is a commercial decision influenced by various factors, independent of any incidental tax benefits associated with the jurisdiction. Mauritius offers a comprehensive range of financial products, including treasury/investment/asset management, investment funds (such as closed-end and open-ended funds), retailed funds, as well as services like protected cell companies, captive insurance, family offices, and trusts. This diverse ecosystem provides fund managers with efficient structuring options for their businesses. Furthermore, Mauritius is a prominent financial centre for global fund management. It emphasized the presence of skilled managers and administrators who offer cost-effective services compared to those available in the UK. Therefore, the decision of establishing fund in Mauritius was driven by other commercial reasons, as stated above. Hence, the principal purpose of establishing the fund in Mauritius was not tax avoidance.
• The tribunal disagreed with the CIT’s observation that the Taxpayer, having approximately 21 non-tax resident investors from Mauritius, merely acted as a conduit. The tribunal further noted that: what holds significance is whether the Taxpayer company itself is subject to taxation in Mauritius or not.
• The Tax Residence Certificate (TRC) holds conclusive evidentiary value, as determined by various Supreme Court judgments, Circular and Press Note. The following key points were highlighted by the Tribunal:

1. 1. CBDT Circular 789 dated 13th April 2000: This circular provides clarification that Foreign Institutional Investors and other investment funds operating from Mauritius are typically incorporated in Mauritius itself. These entities are subject to taxation under the Mauritius Tax law, establishing their residency in Mauritius. The circular further emphasizes that a Certificate of Residence issued by the Mauritian Authorities serves as sufficient evidence for confirming both the residency status and beneficial ownership. The Tribunal also notes that the Supreme Court, in the case of Azadi Bachao Andolan v. Union of India², upheld the constitutional validity of this circular.
   2. Finance Ministry’s Clarification on Tax Residence Certificate (TRC) Press Release, dated 1-3-2013: This clarification, that came after proposed amendment (that the TRC containing prescribed particulars is a necessary but not sufficient condition for availing benefits of the DTAA) in section 90 of the Act as stated in the explanatory memorandum to the Finance Act, 2012, emphasizes that when a resident of a contracting state presents a Tax Residency Certificate, it should be considered valid evidence of their residency in that specific contracting state. The clarification also affirms that the Income Tax Authorities in India are obligated to accept the TRC without questioning the individual’s resident status.
   3. The tribunal relied on the case of Blackstone Capital Partners (Singapore) VI FDI Three Pte. Ltd. v. ACIT³, which dealt with the taxability of capital gains. In this case, the court held that the revenue cannot question the TRC issued by another tax jurisdiction, as it serves as sufficient evidence for claiming eligibility for Double Taxation Avoidance Agreement (DTAA) benefits. The tribunal emphasized that the TRC is the sole statutory evidence required to qualify for benefits under the DTAA. Any attempt by the revenue to undermine the validity of the TRC was seen as contradicting the consistent policy of the Government of India and its repeated assurances to foreign investors.

• It was argued by the Taxpayer that the CIT has made an error by asserting that both India and Mauritius have signed MLI and ratified their tax treaties to include Article 6 of the MLI. However, it should be noted that Mauritius has not designated its tax treaty with India as a “covered tax agreement” in its submission to the OECD for the implementation of MLI. Furthermore, fund in question is currently active and has not ceased operations since the amended protocol came into effect. Therefore, it cut downs the very argument that the fund was established solely to exploit the pre-amendment provisions of the treaty.

Analysis

The Tribunal’s ruling reaffirms the long-standing and well-established principle that a TRC issued by another tax jurisdiction is a valid and sufficient evidence for claiming eligibility for DTAA benefits. Despite the clear substance and settled position on this matter, the revenue authorities persistently raise objections related to treaty shopping.

In order to foster a trust-based tax system that supports the economy, it is crucial for tax authorities to respect and adhere to the principles and decisions that have been repeatedly reaffirmed by the Courts and Government. The repetitive challenges on settled matters not only create unnecessary disputes but also undermine the confidence of foreign investors.

This ruling serves as a timely reminder of the importance of consistency and adherence to established principles when assessing tax residency status and treaty benefits. It provides much-needed clarity and guidance for foreign investors engaging in cross-border investments in India, allowing them to have a better understanding of their entitlement to treaty benefits and avoiding potential tax disputes.

By reiterating the significance of TRCs and dismissing revenue’s contentions related to treaty shopping and conduit status, the Tribunal’s ruling contributes to a more stable and predictable investment environment. It emphasizes the need for tax authorities to focus their efforts on substantive issues rather than rehashing settled matters, ensuring a fair and efficient tax administration system.

-Krishna Agarwal & Ashish Sodhani

1. TS-308-ITAT-2023(DEL)
2. [2003] 263 ITR 706 (SC)
3. TS-41-HC-2023(DEL)