AAR grants Capital Gain exemption under the India-Mauritius Tax Treaty to E*Trade Mauritius – Treaty Shopping permissible within the legal framework

The Authority for Advance Rulings (AAR) in the case of  E*Trade Mauritius Ltd. (AAR No. 826 of 2009) has held that that capital gains arising from the sale of shares in an Indian company would be exempt from tax in India under Article 13(4) of the India-Mauritius Tax Treaty (tax treaty).

The AAR, while relying on the principles laid down by the Supreme Court in the case of Union of India Vs. Azadi Bacho Andolan [2003] 263 ITR 706 (SC) , observed that –

• if a resident of a third country seeks to take advantage of the tax relief and economic benefits under any tax treaty through a conduit entity, the legal transactions entered into by that conduit entity cannot be declared invalid.
• the design of tax avoidance by itself is not objectionable if it is within the framework of law and not prohibited by law.

 Facts of the case

• E*Trade is an indirect subsidiary of E*Trade Financial Corporation, USA (US Co) which sold its stake in IL&FS Investmart Ltd.(IL&FS), an Indian company to HSBC Violet Investments (Mauritius) Ltd. (HSBC), another Mauritius company.
• E*Trade made an application under section 197 of the Income-tax Act, 1961 (the Act) to the tax authorities for issue of a ‘Nil’ withholding certificate authorizing HSBC not to deduct any tax from the sales proceeds payable to E*Trade.
• The tax authorities issued a certificate under section 197 of the Act directing HSBC to deduct tax on the amounts paid to E*Trade. E*Trade filed a writ petition before the Bombay High Court challenging the said certificate.
• With the consent of the parties, the Bombay High Court by its order dated 26 September 2008 disposed of the writ petition directing E*Trade to file a revision application before the Director of Income Tax (International Tax) (DIT). Pending the decision of the DIT, HSBC was also directed to deposit a sum of INR 245 million which would be withheld from the consideration paid to E*Trade. It is important to note that the High Court did not get into the merits of the case.
• Pursuant to the High Court’s order, the DIT, in his revision order confirmed the position taken by the tax authorities regarding withholding of tax by HSBC. Accordingly, the Bombay High Court, in its order dated 23 March 2009 directed the release of INR 243.1 million from the deposited amount to the government and the refund of the balance amount to E*Trade.
• E*Trade thereafter approached the AAR to determine the tax ability of the said transaction under the tax treaty.

Issue before the AAR :- Whether E*Trade is exempt from payment of capital gains tax in India under the tax treaty in respect of the transfer of shares of an Indian company to another Mauritius entity?

Tax department’s contention