Cross-border share sale – Eligibility for Tax Treaty benefit

19 九月 2023

by Harshit Khurana Sonali Bansal


Over the past few years, the Foreign Direct Investments (‘FDI’) in India have been on a steep rise. As per the 2023 edition of the World Investment Report, the total FDI into India soared by 10 percent. Continued attraction of FDI into India has also resulted in many cross-border share sale transactions, wherein the existing foreign investors, as part of their exit strategy, sell their investment in the Indian company to another non-resident/ Indian resident investor.

While the cross-border share sale transaction involves numerous legal, commercial and regulatory implications, one of the most critical aspects which every MNE fret about is the income-tax implications in India.

In some of the tax treaties entered by India with countries such as Mauritius and Singapore, India does not have taxing rights upon sale of shares of an Indian company by non-resident investors if the investments were made before 1 April 2017. In certain other tax treaties such as with Netherlands, the taxing rights have been provided only in case shares derive value principally from non-business immovable property. On the contrary, as per Indian domestic law, sale of shares of Indian company are exigible to tax in the hands of non-resident investors.

Such exemption in tax treaties have made the Tax authorities question as to whether treaty benefits should at all be provided if the non-resident seller does not have much commercial substance? This article seeks to examine said question.

Anti-abuse rules in place

The General Anti Avoidance Rules (‘GAAR’) prevalent in the Indian domestic law as well as the Principal Purpose Test (‘PPT’) introduced via MLI in the tax treaties, seek to deny treaty benefit in cases where the principal purpose or one of the principal purposes of entering into the transaction is to obtain tax treaty benefit. However, both as per GAAR and the PPT, treaty benefit should not be denied if the transaction has sound commercial rationale and providing such a benefit is in accordance with the object and purpose of the tax treaty.

Considering that both GAAR and PPT have been recently enacted, there is not much jurisprudence on the same in India. Accordingly, what may qualify as reasonable commercial rationale and what may be in accordance with the object and purpose of tax treaty is yet to be tested.

To understand the same, it is worthwhile to look at how Courts in different countries have applied GAAR in tax treaty issues and also what Courts in India have held applying judicial anti avoidance test existing prior to introduction of statutory GAAR. 

Key judicial precedents

In the case of Alta Energy Luxembourg S.A.R.L.[1], the taxpayer was incorporated in Luxembourg. A Delaware limited company sold the shares of group company, Alta Canada, to the taxpayer and the taxpayer in turn sold those shares to another company in Canada. The latter sale of shares got tax exempt under the treaty entered into between Canada and Luxembourg. Admittedly, taxpayer did not conduct any other business or held any other investments following the transaction in question. The Revenue invoked GAAR and rejected the treaty benefit in the hands of the taxpayer.

In the above set of facts, the majority bench of Canadian Supreme Court allowed the benefit of Luxembourg- Canada tax treaty to the taxpayer by observing that if the drafters intended to limit the benefit of treaty based on the economic benefit, they would have spelt out their intention. It is noteworthy that the dissenting judges held that the GAAR vests an unusual duty upon the courts to look beyond the words of applicable provisions to determine whether the transactions in question frustrate the underlying rationale. The Court also observed that the taxpayer had no genuine economic connection with Luxembourg as it was a mere conduit interposed to avail the tax exemption which frustrates the rationale of the relevant provisions of the treaty and therefore, should not be allowed treaty benefits.

In another case of NetApp Denmark ApS, TDC A/S[2], the Danish Supreme Court was posed with the similar question of whether treaty benefit should be allowed to an entity which has been demonstrated to have been created with the main object to take benefit under the relevant treaty. In the facts of the case, admittedly, NetApp USA created an entity in NetApp Cyrus to route dividends from NetApp Denmark without any tax withholding. The Hon’ble Court held that NetApp Cyprus was a pass-through entity and since, NetApp USA was the beneficial owner of the dividend income, NetApp Denmark was required to deduct tax at source.

The High Court of Bombay in the case of Bid Services Division (Mauritius) Limited[3] decided upon granting benefit of India-Mauritius tax treaty in the case of transfer of shares. In said case, at the time of acquisition of shares of Indian company, group company of taxpayer was involved in bidding process. However, just two weeks prior to acquisition, the taxpayer was incorporated who purchased shareholding interest in the Indian company. The fact about incorporation and introduction of taxpayer was informed to the government authorities involved in the bid evaluation process.

In said facts, the Court granted treaty benefit to the taxpayer. The Court noted that the concept of denying treaty benefit to shell entity as specified in Limitation of Benefit clause in tax treaty is applicable from 1 April 2017. Accordingly, the same cannot be applied for cases prior to that. Also, the Court observed that where the entire bidding structure as well as the bid has been evaluated by Government authorities, taxpayer cannot be considered as a sham entity. The Court also noted that creation of taxpayer two weeks before the submission of the bid does not appear unusual or suggest that the same was to defraud the revenue or perpetrate any illegal activity especially when Government authority had permitted the use of such SPV.  

Authors’ comments

From the above judgements, it is evident that there is a lot of uncertainty surrounding the applicability of anti-abuse rules to cross border share acquisitions. A lot is left at the mercy of how the Courts look at the facts in a given situation.

In authors’ view, the fact that a SPV (with no other business) invests in an Indian company is not sufficient to hold that treaty benefit should be denied. It is quite common in multinational groups to set-up investment holding companies and invest via said companies. The objective in such cases can be to separate the investing activity from the operational activity of the group, managing investments and obtain benefit of lesser compliances in SPV country. Therefore, there can be good commercial/administrative/regulatory rationale for investing into India via SPV structure. All the factors must be evaluated in totality before concluding on the applicability of anti-abuse provisions.

It is also important to understand the object and purpose of the tax treaty. For instance, if tax treaties provide for specific anti-abuse test, but the case at hand does not attract said provisions, then treaty benefit should be granted. In such cases, it can be reasonably said that the object and purpose of the treaty was to grant the benefit.

One will have to wait and watch as to how the Indian courts will apply GAAR and PPT. The MNEs must prepare themselves for the tussle by ensuring that there exists backup documentation to justify the commercial rationale for an arrangement.

[The authors are Principal Associate and Senior Associate, respectively, in Direct Tax Team at Lakshmikumaran and Sridharan Attorneys, New Delhi]


[1] Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49 (Supreme Court).

[2] Ministry of Taxation v. NetApp Denmark ApS (Case 69/2021); NetApp Denmark ApS v. The Ministry of Taxation (Case 79/2021); TDC A/S v. The Ministry of Taxation (Case 70/2021) [Supreme Court].

[3] Bid Services Division (Mauritius) Limited v. Authority of Advance Ruling (Income Tax) Mumbai Bench, Writ Petition No. 713 of 2021.

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