The tax haven of Mauritius has been a steady source of foreign investments to India, which over the decades have topped $180 billion. However, the Supreme Court ruling against Tiger Global, saying that its $1.6 billion stake sale in Flipkart to Walmart in 2018 should be taxed, upends years of tax planning and investment routes created by foreign investors to make use of an effective no-tax regime. Till now, share sales in India by Mauritius-based investors were only subject to taxes in the tiny island nation, where the rate was nil. An updated India-Mauritius treaty in 2017 had ended the tax-free system but said all pre-2017 investments would continue to enjoy the previous benefits under a so-called grandfathering clause. But the court has now held the view that treaty provisions cannot be interpreted so as to facilitate abuse. Small wonder then that the court ruling is spooking investors, as it could potentially reshape the M&A and investment landscape by strengthening the government’s hand against alleged tax evasion.
The decision has major implications for private equity funds that have set up shell entities in the offshore haven to channel investments into India. That includes Blackstone Inc, KKR & Co and Warburg Pincus. Indian firms such as Kedaara Capital Investment Managers and ChrysCapital Management also have investment vehicles there. The ruling could now impact ongoing cases related to private equity exits and investment vehicles there. Even if investors demonstrate more substance and control within the same jurisdiction to claim treaty benefits, what is the guarantee that tax authorities will listen?
The judges, in their ruling, said the prosecution had proved that Tiger Global's deal used its Mauritius units, which were ‘conduit’ firms, in a bid to make use of an ‘impermissible tax-avoidance arrangement’. Tiger Global had denied the allegations as well as India's depiction of its structures, saying it had correctly used available tax benefits under the India-Mauritius bilateral treaty. The ruling will give sweeping powers to India to lift the lid on corporate deals. The government contends that domestic law will now allow tax officials to override any treaty benefit being incorrectly claimed via the use of sham business structures. It believes that the notion that the ruling will impact investments is ‘nothing but a distraction’, adding that such deals are made on the basis of several factors and not just capital-gains tax.
Signed in 1982, the India-Mauritius treaty played a key role in boosting investments into India, as, thanks to the tax benefits it entailed, investors set up units in Mauritius to route money to India. Though the treaty was often litigated in courts, the investments kept flowing. After the SC ruling, lawyers are already fielding nervous investor calls from Europe and the US, as they decode the landmark 152-page ruling, which also risks increased scrutiny of past deals, where treaty benefits were used.
In the Tiger Global ruling, the Supreme Court said merely having so-called tax residency certificates from Mauritius was not enough proof of having a legitimate business there, and inspectors could challenge the deal by proving funds were routed via Mauritius only to avoid tax, as they were in Tiger Global's case. The judges ruled, however, that India's strict anti-tax-evasion law GAAR can “pierce the structure and deny treaty benefits where the transaction lacks genuine commercial substance”. Clearly, the grandfathering protection has gone for a toss and on past investments made, investors will hold their breath on how their exits pan out.
As one of the world's fastest-growing economies and its most populous nation, India has been a darling of foreign investors. But tax uncertainty has often been a sore point, be it about the interpretation of treaties, the scrutiny of imports or prolonged litigation. For instance, Volkswagen is challenging the demand for back taxes running into a record $1.4 billion, which came after 12 years of scrutiny over alleged improper import declarations. In another high-profile tax saga, Vodafone won its case against a $2 billion retrospective tax demand in 2020, after more than a decade of legal battles, including international arbitration at the Hague.
As tax lawyers now believe, the court ruling has given more teeth to an already aggressive tax administration. What investors are looking for is certainty. The SC itself talks about predictability based on past judgments of the court. But the ruling will only shake the confidence of investors.