The issue of whether the grant of a tax residency certificate by the authorities in Mauritius would enable a company situated there to claim the benefit of the double taxation avoidance treaty between India and Mauritius was decided favourably by the Supreme Court in Union of India v. Azadi Bachao Andolan, (2004) 10 SCC 1. This issue resurfaced before the Punjab & Haryana High Court in Serco BPO Private Limited v. Authority for Advance Rulings, where the court after a detailed analysis stayed true to the broader principles laid down in Azadi Bachao Andolan and upheld the sanctity of tax residency certificates issued by the Mauritius authorities.The essential facts of the case are that two Mauritius based companies, i.e. Barclays (H&B) Mauritius Limited (“Barclays”) and Blackstone GPV Capital Partners (Mauritius) V – B Ltd. (“Blackstone”) held nearly 80% shares in an Indian company SKR BPO Services Pvt. Ltd. (“SKR”) after obtaining the necessary regulatory approvals. In 2011, Barclays and Blackstone entered into an agreement with Serco BPO Pvt. Ltd. (“Serco”) for the sale of 66.29% and 12.75% shares respectively to Serco. The core issue pertains to whether Serco is required to deduct tax at source for any capital gains tax payable by Barclays and Blackstone on the sale of their shares to Serco. In this behalf, Serco approached the Authority for Advance Rulings (“AAR”) under section 245-R of the Income Tax Act, 1961 seeking guidance on whether the transaction was taxable in India. To this, the AAR (after considerable delay) found that “the factual scenario projected … clearly establishes that the transaction in question was designed prima facie for avoidance of income tax”. On this basis, the AAR declined to provide a ruling and rejected Serco’s application. Serco then challenged the AAR’s order by way of a writ petition before the Punjab & Haryana High Court, which issued the ruling discussed in this post.The Court’s decision traverses different issues, which are discussed separately below:1. Whether the transaction was designed prima faciefor the avoidance of income tax?Section 245-R(2), proviso (iii) states that the AAR shall not allow an application where the question raised “relates to a transaction or issue which is designed prima facie for the avoidance of income tax …”. This was the ground on which the AAR rejected Serco’s application in the present case. The High Court, however, found no basis for the same, as the AAR’s order did not contain a single finding of fact to support its conclusion. The Court observed (in para. 21) that “[t]here was no indication in the order and there was no indication even before us as to the direction or the nature of the analysis”. On the contrary, the facts suggest that Barclays and Blackstone had intended to acquire and hold the shares, and in fact did so: there was nothing to suggest that the structure was devised merely to profit from the sale of the shares.2. Whether the High Court should decide the matter or remand it to the AAR?The Court found no purpose in remanding the matter given the extensive delays that occurred previously before the AAR. Hence, the Court decided the matter on merits.3. Whether Barclays and Blackstone actually reside in Mauritius for the purpose of the double taxation avoidance treaty?This is the crux of the issue. Here, the Court examined the impact of Azadi Bachao Andolan and various circulars issued under the Income Tax Act. The Court was categorical in its acceptance of the tax residence certificate issued by the Mauritius authority as a method of determining whether the companies are in fact resident in Mauritius. In the Court’s own words:29. … The certificates of residence issued by the Mauritius Authorities, therefore, establish that Blackstone Mauritius and Barclays are residents of Mauritius within the meaning of Article-1.30. In view of the circular, it is incumbent upon the authorities in India to accept the certificates of residence issued by the Mauritian authorities. Circular No. 789 is a statutory circular issued under section 119 of the Act. It is obviously based upon the trust reposed by the Indian authorities in the Mauritian authorities. Once it is accepted that the certificate has been issued by the Mauritian authorities, the validity thereof cannot be questioned by the Indian authorities. This is a convention/treaty entered into between two sovereign States. A refusal to accept the validity of a certificate issued by the contracting States would be contrary to the convention and constitute an erosion of the faith and trust reposed by the contracting States in each other. It is for the Government of India to decide whether or not such a certificate ought to be accepted. Once it is established that it has been issued by the contracting State i.e. Mauritius, a failure to accept the residence certificate issued by the Mauritian authorities would be an indication of break down in the faith reposed by the Government of India in the Government of Mauritius and the Mauritian authorities reiterated in and evidenced by statutory Circulars issued under section 119 of the Act. 31. Consequently, the convention applies to Blackstone Mauritius and Barclays being persons who are residents of one or both the contracting States-India and Mauritius.In arriving at this conclusion, the Court upheld the sanctity of the bilateral nature of the treaty, which would prevent one of the countries’ authorities from acting in a manner that undermines the basic nature of the arrangement. 4. Whether recent reform proposals to the Income Tax Act clarify the nature of the previous position?Attention was drawn to proposed amendments to section 90 of the Income Tax Act in 2013 which indicates that the tax residency certificates issued by other countries was a “necessary but not sufficient condition for claiming any relied” under the treaty. However, this amendment did not materialise. This and a subsequent clarification issued by the Ministry of Finance were seen by the Court to “establish beyond doubt that the Residence Certificate issued by the Mauritius authorities must be accepted provided of course it is established that it has been issued by the appropriate Mauritius Authorities”. 5. Whether the treaty benefits can be availed of by the sellers even though Mauritius does not impose capital gains tax on the sale of shares? The Revenue’s argument surrounded the fact that while the double taxation avoidance treaty does not require sellers to pay capital gains tax in India, they are able to benefit from the fact that Mauritius does not levy any tax on capital gains. The Court found this to be irrelevant, since that is precisely the reason why several companies invest into India through Mauritius. This was based on an interpretation of the treaty, where the Court observed as follows: 39. Article 4 provides that for the purpose of the Convention, the term “resident of a Contracting State” means any person, who, under the laws of that State, is liable to taxation therein by reason inter-alia of his domicile residence, place of management or any other criterion of similar nature. The words “is liable to taxation” mean that the income of the person may be liable to taxation and not that he is actually taxed or pays tax. The words mean that the Government is entitled to tax the person and not whether under the laws he actually pays the tax. A person liable to pay tax may not be required to pay tax for variety of reasons. For instance, his income may not be within the taxable bracket. There may be a special provision exempting the payment of the taxes by him. Even such a person is liable to taxation. This is clear from the words “any person who, under the laws of that State” which immediately precede the words “liable to taxation therein”. Had it been otherwise, Article 4 would have been worded differently. A view to the contrary would make the DTAC unworkable and erode the basis thereof. 6. Whether the situs of the property in the form of shares is relevant in the determination of whether tax on capital gains is to be levied in India or Mauritius? Article 13(4) of the treaty between India and Mauritius provides that gains derived by a resident of a contracting state from the alienation of property (other than those dealt with in other provisions of the article) shall be taxable only in that state. The question arose as to whether the situs of the shares is relevant to the determination of which country it is taxable in. The Court found that for the purpose of article 13(4), which covers shares, the situs of the property is irrelevant. This stands in contrast with other provisions of the article such as immovable property, ships, aircraft, etc. where the situs of the property is relevant. Hence, the Court found that capital gains tax on sale of shares (although situated in India) could only be taxed in Mauritius.7. Whether this is a case of treaty shopping? On this question, the Court relied heavily on Azadi Bachao Andolan, which had answered the question in the negative in a similar case. Further, in this case, the Court noted: 49. The Supreme Court also dealt with the interpretation of treaties with respect to ‘treaty shopping’ in considerable detail. It is sufficient to note only a few observations. It was observed that many developed countries tolerate or encourage treaty shopping, even if it is unintended, improper or unjustified, for other non-tax reasons unless it leads to a significant loss of tax revenues. Several countries allow use of their treaty network to attract foreign enterprises and offshore activities. In developed countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital or technology. The countries take a holistic view keeping in mind the fiscal necessity and political compulsions. The Supreme Court observed that it could not judge the legality of treating shopping merely because one section of thought considers it improper. We would only add that entering into a treaty and terms and conditions thereof are the sovereign functions involving important aspects of policy. Such decisions must be left to the policy makers who are best equipped and have been entrusted with the responsibility of negotiating the treaty to the greatest advantage and good of the country. Consequently, the High Court quashed the order of the AAR and declared that no capital gains tax is payable by Barclays and Blackstone in respect of the sale of their shares in SKR BPO, due to which there was no requirement on the part of Serco (as the purchaser) to withhold tax.At one level, this decision may be considered to be a reiteration of the principles laid down by the Supreme Court in Azadi Bachao Andolan. But, at the same time, it reinforces the use of the double taxation avoidance treaty between India and Mauritius, and particularly the reliance upon tax residency certificates issued by the Mauritius authorities as a means to claim the treaty benefits. It is also evident from the High Court’s decision that any change to the legal position can only be brought about through executive action by renegotiating the treaty. This is a broader issue that has been in the news lately, but until then the current position is likely to ensue.