Ruchir: Hi, Anandu. Thank you for taking time out and thank you very much for this follow-on session. In the last webinar, we discussed how several, probably, a very large number of global, leading funds based out of Singapore and Mauritius had received notices on two counts. First, challenging the treaty entitlements, and second, disallowing the carry forward of losses from the years of 2013-14, when these funds were taking the benefit of the capital gains benefit under the treaty. I think there has been significant interest subsequently to understand what is this ‘judicial GAAR’ or the examples of sham transactions and what has really given a shot in the arm to the tax department to now open up decade-old cases. There is no definition really of what is a ‘sham’, but it’s probably best understood in context of looking at some of the actual facts and circumstances of those matters which actually went in favour of the tax department. There’s obviously the McDowell case, Aditya Birla, AB Mauritius, and so on. But these are cases only until people understand them in greater depth. I think for us to be able to better understand what is ‘sham’ and whole debate on the morality of taxation that the department has been talking about, it’ll be helpful if you can discuss some of these cases and go into the granular detail on what were the facts of each of these cases that went in favour of the tax department.
Anandu: I think there are a few cases we can definitely identify, but the sort of direct jurisprudence on tax avoidance in the country is always I think you cast your mind back, always starts from McDowell's. In McDowell there was a concurring opinion that went in the great detail about what tax avoidance meant and whether tax planning was permissible? What value old english rulings on tax avoidance had in India? What could be scrutinised what could not be scrutinised? But the sum and substance of it was that at the end of McDowell, it seemed as if all tax planning was impermissible in India. Tax planning was considered to be immoral, illegitimate and something that should absolutely not be condoned by courts, or by the executive/enforcement authorities. That McDowell cloud has sort of influenced how tax officers have looked at suspected cases of tax avoidance over the last 30-40 years of jurisprudence that we've seen. In Vodafone, we got a little bit more understanding of what tax avoidance actually meant. When the Supreme Court clarified what was intended in McDowell. Supreme Court said, not all tax planning is illegitimate but there are boundaries to what can be done and what can't be done. So a colorable device or a sham transaction, which is completely outside of the bounds of law would not be permitted. That being said, it sort of upheld the old Westminster principle that every man is entitled to arrange his affairs so as to reduce the total taxes that he has to pay, so long as this arrangement is legitimate.
Ruchir: Anandu, I think for a lay man … I'm not sure people will understand the Westminster principle and all that. So, I think if we can just keep it very simple, and go to the point that you made on morality of tax avoidance. Give us an example of what was held to be complete sham in the recent cases.
Anandu: I think one case, I think that you can quickly sort of zoom in on is Aditya Birla Nuvo, which is a case not really of sham as much but a case where the Mauritius treaty benefit was denied because the facts were very glaring. There, you had a Mauritian entity that had sold shares of an Indian company and claimed the tax benefit as part of a sort of overall restructuring of overseas operations of a large telecom company. Now, that claim was rejected by the department because it said the Mauritian entity was just sort of a nominee for someone else, it had no rights to the shares themselves. It couldn't control any of the rights attached to those shares. It had no title over the sale proceeds, etc.
Ruchir: So what exactly happened there? Can you can just set out the facts?
Anandu: So there the background became clear when the when the disputes are reached the Bombay High Court and the Bombay High Court realised that you had the AT&T group in the US enter into a joint venture in India with the Birla group to set up a telecom company in India. And the agreement between AT&T group and the Birla group permitted either of the parties to assign all of its sort of rights to a ‘Permitted Transferee’, who would exercise all the rights pertaining to the JV entity. Now AT&T group assigned its rights to a Mauritian subsidiary, a 100% subsidiary, and the terms of the JV between the US entity and the Indian entity said that all the decisions would be taken at the US level, all rights would be excised at the US level, but you would have an intermediate entity sort of as a nominee, so to speak, there's a simpler sort of understanding.
Ruchir: So that is pretty much like you are...destroyed
Anandu: Yeah, it is a case open and shut case because they looked at the facts and they realised the Mauritian entity basically could do nothing without the say so of the US entity. And in fact, the sale consideration was sort of remitted upwards in a back to back payment I believe on the same day or on the very next day when it received payment for the shares. So that's like a classic case.
Ruchir: So maybe in the same facts set, it would’ve possibly been decided in favour of the taxpayer, if the Mauritian entity was incorporated first and the entity in turn negotiated the whole contract, and the Mauritian entity then remitted the consideration, etc.
Anandu: That's true.
Anandu: The case that followed this, to my mind was another case called AB Mauritius. And, AB Mauritius is interesting because two two rulings were delivered on the same day by the Authority for Advanced Rulings. The first case, which was titled AB Mauritius In re, was a case where the treaty benefit was denied because the Mauritian entity couldn't demonstrate any substance to claim the treaty benefit...because the revenue looked at the board minutes of the Mauritian entity and, there was no rationale anywhere recorded in the board minutes of why the investment was made. The sale purchase agreement was not purely executed by the Mauritius entity, but also by its parent. There was nothing to show that the Mauritian entity had paid consideration for purchasing the shares. There was nothing to show that the money had gone back to the Mauritius entity. The actual documents were authorised by someone who was not a signatory of the Mauritius entity.
Ruchir: How did the Mauritius entity acquire the Indian asset in this case?
Anandu: So the Mauritius entity was was sort of the named entity in an SPA for acquiring the shares. But the SPA itself was not signed by the Mauritian entity.
Ruchir: So this is close to Aditya Birla, where the entity just came in as a device later on to get the tax benefit. And it's pretty elementary for anyone to be able to read into the fact set and say that the Mauritius entity was actually superimposed, and the reason it was superimposed was only to get tax benefits and nothing else.
Anandu: Yeah, it basically couldn't demonstrate any sort of ownership over the asset or the income, in either way. But I think the reason why me versus interesting was because of the same day another ruling was delivered for the same transaction. So, the parent entity of the entity in question in that group, was a group called the ‘C group’, because the names are all redacted in the document as it was confidential in the rulings). So, the C group two subsidiaries in Mauritius. The first subsidiary – it had a negative ruling where the AAR decided that it couldn't show any ownership over the asset or the income. But the second subsidiary, it was titled AB Holdings – AB Holdings’ case went very differently, because interestingly, it was able to show that all the documents are signed by itself. It had held on to the investment for many years. It had the minutes to substantiate the fact that it had taken the decision to divest. The sale proceeds went into its own name. The documents are signed by its own directors who had substantial presence in Mauritius. So, the contrast between the two cases relating to the same group, the same transaction, is very clear on what went bad and what went good. Because some of these commercial substance factors were examined in great detail, both by the revenue and by the court, which is why one decision went one way or the other when the other.
Ruchir: Got it. And just before we delve into what is really substance … it is always a tricky question. But you're also involved in Tiger and maybe you could just give a little bit of context about Tiger also, what happened because many people believe that Tiger Walmart has actually been the trigger for all these income tax notices.
Anandu: That's true, actually, and I think Tiger has gone down with a bit of a bad reputation in the last last couple of years, because I think a lot of cases, since Tiger have sort of tried to use the same arguments that succeeded in Tiger. But interestingly, there were six applicants in Tiger – three Mauritius based applicants and three Singapore based applicants. All of whom had approached the Authority of Authority for Advanced rulings on a foreign fully overseas transaction. So, you had a foreign company selling shares of an intermediate Singapore company, which ultimately held an Indian entity that was the sort of structure of the transaction, in the Tiger cases which was a case of indirect transfer. And the three Singapore applicants had their cases admitted by the … still pending to the best of my knowledge. But as far as the Mauritian entities were concerned, the department looked at the question of, why did you invest through Mauritius? What is the reason for setting up in Mauritius? And they asked for a lot of documents, all of the underlying minutes, all of the underlying filings, everything that they had in Mauritius all the paperwork and they went into great detail. And for one of the Mauritius entities, in one of their filings, they made a disclosure of beneficial ownership, where, it was disclosed that someone sitting in the US who was part of the ultimate overseas management of the Tiger group was shown as the beneficial owner of the Mauritius companies. So, there you have the smoking gun…
Ruchir: So essentially it's all come out, I think, Chase Coleman was recorded as the beneficial owner, while the other guys did not record anyone as the beneficial owner. I think that’s where the slight procedural challenge that you don't take care while you find documents. And I think that's what got them into trouble seemingly.
Anandu: Yeah, their, sort of, corporate hygiene could have been better, so to speak.
Ruchir: Which is exactly what happened, in fact, even in the Vodafone case. We remember that even though it was a Cayman to Cayman transaction, the entire documentation was hinged on the fact that you get FIPP approval, and the Indian publicity and all that. And anyone who picked up the document could easily say, and that's what happened, because in the FIPP approval process, there is one person from the revenue who sits and looked at everything, he said,look, these are two Cayman companies but, essentially, the whole deal is based on the Indian asset. So, this is really an Indian deal…So I think, quite honestly, in many ways, I feel that if you don't do things right, then just by standing on the principles of form over substance doesn't really work. You also need to meet the optical test. If it looks so hideous optically, I think it's very difficult then to stand and say that look, legally, I am on sound ground. I think that is what has happened across in Tiger or in AB Mauritius or Aditya Birla Nuvo.
Ruchir: So, I think, Anandu, just if we get back to this from a tax litigation perspective, and, you've been doing enough of this, what do you think, and I think there are possibly two ways to look at it, two buckets, in which we could sort of compartmentalise this. One is what has happened and now what do these people do? And second is, what is it that people should do in the future, to ensure such demands do not come? Because this clearly is happening, not under GAAR. But this is happening under what you just mentioned, as ‘sham’, people are calling as judicial GAAR. So, naturally, if without GAAR, you can challenge the substance, that I think within GAAR or after GAAR has been applicable since 2017, the tax authorities will definitely be more aggressive – it's only a matter of time. So what exactly can be the different strategies now for the people who have actually got these notices? What exactly can they go on and say, to the department?
Anandu: If you've already gotten a notice, the path is pretty clear. You have to challenge those notices, before they achieve finality. And there's a sort of litigation pathway that you take – either go through the appellate mechanism in the income tax regime, which has its own upsides and downsides. Or you can, if you have a good facts set, which supports your case, you have substance in Mauritius, that you can tangibly demonstrate based on filings there, presence there and documents, then, you can approach a jurisdictional High Court and sort of ask for relief by quashing those notices. But I think the more important question here is, what happens if you're an existing investor, you have a grandfathered structure, and you see these notices and you're wondering what you can do. So it's good to look at the systems that you can sort of put in place to prevent this kind of scrutiny. And based on our experience in the field, we know that, the tax department looks for several factors. They have a sort of checklist that they go in with when they try and figure out that the entity in an overseas jurisdiction is just put up there to claim treaty benefits. And some of the things they look at I think are common and it's something that we discussed in our webinar or in our Article too. We looked at the basis for funding in Indian investments, whether it’s through shareholder funds, external borrowing, or is it several layers of back to back funding from an ultimate beneficiary. We look at fiscal independence, which is whether the Mauritian or the Singapore entity has full independent control over its bank accounts, whether it has the discretion to utilise the money without asking approval from anyone else. We look at what it did with the exit proceeds. So, was that retained in its own bank account? Was that immediately upstreamed? Did they have any contractual obligations and legal obligations to give that money to someone else? We look at how long an entity has been in operation in a treaty state. We look at, have activities continued beyond the sale, have investments only been made in one company, in one country. We look at decision making – decision making is something I think that we keep focusing on the fact that decisions have to be taken from the country in which you claim a treaty benefit. So, you have to identify who the actual people in control are. Where do they reside? What are their qualifications? Where did the board meetings take place? What was discussed in the board meetings? What was minuted? Did the minutes have substantial information where the board was briefed on why an investment or a divestment was taking place? What part of the board's responsibility was delegated to someone else? What role did the immediate parent or the ultimate parents have in managing the entity's affairs? We look at various material presence thresholds, on what kind of employees you have, what kind of expenditure you have, whether you have other kinds of activities that you carry on in the jurisdiction. And you also look at certain claims, certain other things like where your accounts are maintained, whether your corporate law records are maintained, whether you have the basic obvious ones – the TRC, the Form 10-F, or if you are from Singapore, you have your IRAS clearance, if you have an MAS approval. These are the sorts of things I think typically that the Income Tax department looks at these days, when they examine this claim of substance.
Ruchir: That's a lot of stuff… But tell me if there is no GAAR, right? And what is the basis? I mean, unless it's a sham, on the face of it. Does the Income Tax department really have the power because I'm sure a lot of people would have taken back to back financing. Funds would not have remained in Mauritius. A lot of board meetings would have happened, honestly, just through teleconference, but is that sufficient ground for tax department to deny these tax treaty benefits? How do you see this playing up? Because, we know how Mauritius as a jurisdiction has functioned, so how do you see this playing up for those people who haven't done all of this? Do you think they're really on tricky ground or do you think a challenge at the High Court level, obviously, not at the assessing officer or the ITAT level, maybe but at the High Court, Supreme Court level, even without doing all these things, they may still have a good chance of winning?
Anandu: So, I think the lesson for existing investors is, they should be ready to buckle in for the long haul. Because this might take a while. We know that the likelihood of a successful income-tax appeal is extremely high. Because, you outline the Income Tax Department loses 90% of the cases that they bring. But most of those taxpayer successes happen only at a higher level – at the High Court and the Supreme Court. And everything that's playing out now is really just a redo of everything that played out 20 years ago when Azadi Bachao Andalon happened, when where they said pretty much the exact same things that they say now that these funds have no substance in Mauritius, they've literally been set up there just to claim a treaty benefit. What they're doing is colorable. They're trying to look at the language that was used in McDowell, and I think what telling is what they don't rely on, right, what the tax authorities don't rely on. They don't make any references to Azadi Bachao Andolan. They don't make any references to the majority opinion in McDowell. They don't make any references whatsoever to Vodafone and if they do, it's only a minority opinion of Justice Radhakrishnan in Vodafone. They only look at documents that selectively support their side of the case or their facts. They only look at recent AAR rulings that have supported them and I think this is part of a very typical playbook. And I'm sorry to say this but the typical playbook that the revenue has, in sort of prosecuting these cases. But like I said, we know the numbers, we know that, we have fair grounds to stand on but that might take some time before relief is obtained.
Ruchir: Correct. So essentially, this has all happened, what you're saying is, it's a playbook, it's happened, they may have waited a certain level but ultimately, I think the principles were very clearly set up that if you have a TRC, then really, at least in the pre-GAAR sort of realm, it will be difficult for them to prevail over. No matter what ammunition they have by saying that was back to back financing on board minutes all that. But tell me, just one question what is ‘judicial GAAR’? What is judicial GAAR which people keep referring to?
Anandu: I would say, judicial anti avoidance is sort of an umbrella term for principles that have been distilled from several cases in the past, right, these cases where we discuss tax avoidance, what is permissible, what is not permissible, to cast your mind back to McDowell and Justice Chinnappa Reddy's opinion there. He laid out several things which he said, both the courts and the legislature and the executive should frown upon. He said, it's time we look past principles of tax planning, we have a moral obligation to contribute to nation building and therefore we should not condone schemes where people pay less than they are supposed to, not less than what they are legally required to, I think the distinction is important. So, these principles that have been evolved from these cases have this umbrella term of judicial anti-avoidance, and even though strictly speaking, the Income-tax Act, which is the statutory framework, which governs what the tax authorities can do and can't do. That framework gives no powers apart from GAAR, to the authorities to examine cases based on a suspicion of a false motive, because motive is absolutely irrelevant. If you come down to brass tacks, it’s absolutely irrelevant. Tax is never applied through intent. Our tax measure can never be applied through equity. It either applies proprio vigore or it does not, which means it either applies on the literal bare text of the enactment or it does not. So, you cannot impose a tax because of some suspected motive of tax avoidance. That is categoric that is clear, and that is unconstitutional.
Ruchir: And I think that's a very important point that you make on proprio vigore because I think most of the regulatory statutes actually go back to the intent of a person. But tax law, on the other hand, as you're saying, is really strict interpretation. So don't go into my motive so long as the tax law permits me, I can do that.
Anandu: I think the approach that we're seeing from the tax department right now, the only sort of parallel I can think of is very similar to what happens when SEBI, the securities regulator tries to examine cases of insider trading, where they try and rely on circumstantial evidence. So that's sort of the advice…
Ruchir: That's where the mistake is happening because people look the tax department and SEBI and somewhere tend to believe that oh, if SEBI can ask you these kind of questions, and can penalise you even tax department can. But I think we tend to forget that SEBI's mandate is different or any regulator for that matter, CCI or someone, because you can't really twist and turn, the regulation in a way that's convenient for you and abuse, the whole purpose of the regulation. But I think that purposive interpretation, or defining what is the purpose of a particular provision doesn't apply in context of tax where I think you generally have the permission to do something, so long as it's legit, and so long as it's permitted....But tell me this where does this debate of morality and ethics last, because they will keep on doing this, and has the issue of morality of paying taxes been legitimised by GAAR now? Because now, at least the substance test has been legitimised? So, the question is on a going forward basis now, because going forward, the tax department will actually have the power to say, why were you doing this. And if this was done only with a tax purpose, or the purpose of saving taxes, I think they can disregard the entire structure. So, I think the pointers that you mentioned, is it only fair to say that if all these cases are happened post 2017 then would your analysis change, that the tax department has a great case and that the taxpayer might lose on those counts now?
Anandu: Well, I think it's less about the tax department having a great case and more about the tax department having a great weapon to go after people now. Because, what GAAR did is, GAAR gave the department teeth to ask questions, and it is now bearing that teeth and asked me those questions. So, I think the two punch sort of combo of GAAR in the Income-tax Act and, the increasing introduction of LOB clauses in treaties in Singapore, Mauritius and I think in some of the more newer treaties that India has signed, there are categorical references to how GAAR will override treaty benefits. So you are increasingly going to see more questions being asked, and less successful grounds for challenging the basis for questioning. The answers to the questions, of course will determine how successful the invocation of GAAR is, but we can hope on the fact that there are certain sorts of judicial safeguards built into the application of GAAR that we hope will prevent its misuse and misapplication.
Ruchir: This is one more aspect, I think, which has been rather intriguing in the tax departments notices, I think what they've said is that the carry forward of losses has been disallowed and their argument has been that look, you cannot take an argument that the gains were never taxable because of the India-Mauritious tax treaty. But if you had a loss you carried forward. So, they're saying if gains are not taxable, naturally, corresponding losses also should not be carried forward and then disallowed all of those carried forward losses as well. Again, morally seems right but you tell us legally, where's the stand?
Anandu: Which surprises me right … Because I mean, the one thing I think that you learn about tax law, in your experience as a lawyer is that there is no logic to tax law. So the if this, then that logic that the department is applying seems quite misguided in my application, because unlike I think in the case of logic in equity, I can absolutely have my cake and eat it too, when it comes to tax, because carry forward of losses is completely delinked from whether or not I am eligible to claim a treaty relief, because they know it comes into a completely separate part of the code. It has its own conditions, and as long as I satisfy those conditions, I should be entitled to claim carry forward of losses. But again, these are issues that are only being resolved at the higher appellate level. In the past, we've seen cases which carry forward losses have been denied on the most outrageous of grounds, and they have all been successfully overturned at higher appellate level. So we will have to wait and see how that goes. But to answer your question, I think the tax department maybe on the losing ground on this one.
Ruchir: I think these are two separate legislations. My carry forward losses are under the Income-tax Act and I claim treaty benefits under the treaty.
Anandu: It's apples and oranges. So, they have the no connection between the two of them.
Ruchir: The assessee can choose what’s beneficial for them … Okay, so, this is great. Thank you very much Anandu.
Anandu: My pleasure.
Ruchir: All right. Thank you very much.
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