Can the AAR reject an advance ruling application as prima facie tax-avoidance under Section 245R(2) despite a TRC?

Summary

Practical Impact

What’s New / What Lawyers Should Note

• TRC under Section 90(4) is necessary but not conclusive to claim DTAA relief; AAR and tax authorities may probe actual residency.
• AAR’s jurisdictional bar under Section 245R(2)(iii) permits rejection of applications when a transaction is prima facie an impermissible avoidance arrangement.
• GAAR (Chapter XA) overrides treaty benefits even for pre-2017 investments if tax benefits accrue on or after 01.04.2017 (Rule 10U(2)).
• Section 9(1)(i) “through” and “indirect transfer” amendments extend source-state taxation to shares deriving substantial value from Indian assets.
• Circular Nos. 682/789 and earlier authorities are superseded by statutory GAAR and post-Vodafone/DTAA amendments.

Summary of Legal Reasoning

1. Sovereign right to tax and DTAA context: Article 265, Sections 4–5 ITA and Article 13 DTAA.
2. Indirect transfer provisions (Section 9(1)(i)): Explanations 4–5 codify “by reason of” and “substantial value” tests.
3. Residency and TRC requirements (Section 90(4)–(5)): TRC is necessary but ADMISSIBLE, not AUTOMATIC, proof of DTAA eligibility.
4. AAR’s jurisdiction under Section 245R(2)(iii): Prima facie power to reject avoidance-designed applications.
5. GAAR and Rule 10U – scope and grandfathering: Chapter XA applies to tax benefits on or after 01.04.2017 (Rule 10U(2)); limited exclusion for small-value and bona fide pre-2017 “investments” (Rule 10U(1)(d)).
6. Precedents:
   • Vodafone: “look at” test, business purpose, judicial anti-avoidance rule.
   • Azadi Bachao: TRC binding until strong evidence of abuse.
7. DTAA Protocol (2016): Article 13(3A/B): source-based capital gains post-2017 with transitional 50% rate, grandfathering of pre-2017 investments.
8. Conclusion: AAR rightly rejected; Supreme Court reverses High Court.

Arguments by the Parties

Petitioner (Revenue):

• Section 197/TDS certificate under 01.04.1962 amendment is provisional, not final.
• Article 4(1) DTAA allows India to test residency under Mauritian law, but India retains source-state tax authority (Section 9).
• TRC is only prima facie, not conclusive—“substance over form” and POEM apply.
• GAAR (Chapter XA) overrides DTAA benefits for impermissible avoidance arrangements on or after 01.04.2017 (Sec 95–100, Rule 10U).
• LOB in DTAA applies only to direct transfers (Art 13(3A/B)), not indirect transfers (Art 13(4)).
• Circular 789 aimed at FIIs/NRIs, not GBL-I licensees; cannot override GAAR or Section 90(2A).

Respondent (Tiger Global entities):

• Article 4(1) DTAA defines residency exclusively by Mauritius law; TRC binding under Section 90(4)–(5).
• Circular 789 continues in force; binding precedent (Azadi Bachao and Vodafone).
• GAAR applies prospectively only to post-2017 investment INSTRUMENTS, not arrangements; Rule 10U(1)(d) grandfathering applies.
• AAR’s threshold bar under Section 245R(2)(iii) not triggered; no prima facie avoidance.
• Vodafone reaffirmed that TRC cannot be pierced absent fraud or sham.

Factual Background

Tiger Global International II, III & IV Holdings (“applicants”) are Mauritian GBL-I entities that held shares in Flipkart Singapore. They sold those shares in 2018 to a Luxembourg buyer for US $2.08 billion, generating substantial capital gains. They obtained Mauritian TRCs and applied under Section 197 for nil withholding, but the tax authorities prescribed TDS rates (6–8.5%). They then sought advance rulings from the AAR under Section 245Q(1) on DTAA-based exemption. The AAR dismissed their applications under the proviso to Section 245R(2)(iii) as prima facie tax-avoidance. The Delhi High Court quashed the AAR order, but the Supreme Court has now reversed that judgment.

Statutory Analysis

• Section 9(1)(i) ITA (post-2012 amendment & Explanations 4–5): indirect transfer of foreign shares deriving value from Indian assets deemed to accrue in India.
• Section 90 ITA: DTAA override—two limbs:
  • Sec 90(2): treaty prevails over domestic law if more beneficial.
  • Sec 90(2A): GAAR overrides treaty benefits for avoidance arrangements.
  • Sec 90(4): TRC is necessary condition; Sec 90(5): additional prescribed documents.
• Section 245R(2)(iii): AAR must reject advance-ruling applications on transactions prima facie designed for tax avoidance.
• Chapter XA (Sections 95–102): GAAR—impermissible avoidance arrangements, lack of commercial substance, outcomes (re-characterization, denial of benefits).
• Rule 10U: GAAR exclusions and grandfathering:
  • 10U(1)(d): income from transfer of pre-01.04.2017 investments excluded.
  • 10U(2): GAAR applies to any arrangement (regardless of date) once tax benefit arises on or after 01.04.2017.
• DTAA Article 13 (pre- and post-2016 Protocol):
  • 13(3A/B): source-based taxation of capital gains on shares acquired on or after 01.04.2017, transitional 50% rate.
  • 13(4): residuary rule—gains on other property taxable only in residence State.
  • Article 27A LOB: denies transitional rate if primary purpose is treaty avoidance or if entity is a shell/conduit.

Dissenting / Concurring Opinion Summary

• Emphasizes economic sovereignty and the imperative of protecting tax sovereignty in an era of geo-economic uncertainty.
• Highlights global trend toward pooled VAT regimes but absence of uniform direct-tax conventions, stressing India’s need to retain discretion in bilateral treaties.
• Warns against undue compromise of sovereign taxing rights through treaties, urging robust LOB, GAAR overrides, exit clauses, periodic reviews, and stakeholder consultations.
• Notes unilateral legislative power to amend or override precedents and circulars when treaty or domestic law is misused.
• Concludes that retention and assertive exercise of tax sovereignty is critical for India’s long-term strategic and security interests.

Procedural Innovations

• Empowerment of AAR to reject applications at threshold if prima facie tax avoidance is established (Section 245R(2)(iii)).
• Two-tier GAAR approval process: Principal CIT → Approving Panel headed by High Court judge (Section 101 and Rules 10U-10UC).
• Grandfathering carve-out for bona fide pre-2017 investments but subject to subsequent benefit-based scrutiny (Rule 10U(2)).

Alert Indicators

• 🚨 Breaking Precedent – Delhi High Court quash of AAR reversed by Supreme Court
• ✔ Precedent Followed – Vodafone, Azadi Bachao Andolan
• ⚖️ Split Verdict – Separate concurring observations on tax sovereignty
• 🔄 Conflicting Decisions – Overturns High Court’s interpretation of Circular 789 and TRC sufficiency