The Impact of Tiger Global on Treaty Protection and Exit Strategies in India

[Amritanshu and Shreya are students at National Law University Odisha.]

The India-Mauritius Double Taxation Avoidance Agreement (DTAA) gave rise to what became known as the “Mauritius Route”. While this treaty boosted foreign capital inflows, there were mounting concerns that entities were being incorporated in Mauritius purely for the purpose of tax avoidance.

The Supreme Court’s (SC) judgment in Authority for Advance Rulings (Income Tax) v. Tiger Global International II Holdings (Tiger Global) is a significant development for the future of DTAA. In this case, the SC denied capital gains tax exemption claimed by Tiger Global International. The SC was of the view that Tiger Global International was utilising an impermissible tax avoidance structure. Tiger Global is significant because the SC denied treaty benefits to Tiger Global even in the presence of a tax residency certificate (TRC). This ruling will certainly have severe implications on the DTAA while also affecting exit strategies adopted by private equity and venture capital (PE/VC) funds. The judgment also raises questions on the status of treaty protection given to the taxpayers.

In this piece, the authors analyse the evolution of the DTAA, the Tiger Global judgment, its implications on PE/VC exit strategies, and the collapse of grandfathering assurance.

The Evolution of the DTAA

Article 13 of the DTAA provides the framework for Capital Gains Taxation. Article 13(4) provides that capital gains from the alienation of shares are taxable “only in the resident jurisdiction”. In the context of Mauritius-based investments in India, this meant that the capital gains were only taxable in Mauritius. But since Mauritius’s domestic policy exempted capital gains from share transfers from taxation, this effectively made the gains free from tax. This created a significant tax arbitrage opportunity. 

However, in the year 2000, Indian tax authorities denied the benefit of Article 13(4) of the DTAA to certain foreign institutional investors (FIIs) on the ground that their beneficial ownership was outside both India and Mauritius. The Finance Ministry clarified that this was only a case-specific instance, rather than a shift in India’s trade policy with Mauritius. Subsequently, the Central Board of Direct Taxes issued Circular Number 789 reaffirming that FIIs and investment funds operating from Mauritius were liable to tax in Mauritius. This circular was challenged by way of a public interest litigation in Union of India v. Azadi Bachao Andolan, where the Supreme Court upheld its validity and ruled that Article 13(4) of the DTAA “did not require the control or beneficial ownership of shares to be within India or Mauritius”. The SC further clarified that it is sufficient if an entity is liable under Mauritian law, even if Mauritius does not actually levy capital gains tax. Accordingly, FIIs and investment funds operating from Mauritius were treated as eligible for treaty benefits.

The next major shift in the DTAA came via a case which did not even concern the DTAA directly. The Supreme Court in Vodafone International Holdings BV v. Union of India (Vodafone) was called upon to interpret the scope of Section 9(1)(i) of the Income Tax Act 1961 (Act), which deals with income deemed to accrue or arise in India. Section 9(1)(i) deems income to accrue or arise in India if it is derived either directly or indirectly through the transfer of a capital asset situated in India. The provision thus determines when India can tax cross-border transactions involving Indian assets. The SC held that indirect share transfers such as the Vodafone–HEL transaction are not covered under Section 9(1)(i) of the Act. Vodafone was significant because the SC reaffirmed the validity of the Mauritius Route. By refusing to read anti-avoidance principles into Section 9(1)(i) in the absence of a legislative mandate, it increased investor confidence in offshore investment routes.

After the fallout from Vodafone, the Government reacted promptly to nullify the implications of the judgment by removing its basis and addressing tax avoidance concerns via the Finance Act 2012. Section 9 was now amended to make gains from the transfer of shares or interests in a foreign entity deriving substantial value from assets located in India taxable in India, codifying the principle of source-based taxation. The General Anti-Avoidance Rules (GAAR) were introduced as a comprehensive rule to deter “tax evasion under the guise of FII investments” by companies misusing the DTAA with the Mauritian Government. 

To address the concerns of treaty abuse, the DTAA was finally amended in 2016. Both countries signed a protocol which shifted capital gains taxation from a residence-based to a source-based regime for shares acquired on or after 1 April 2017. At the same time, the protocol expressly grandfathered investments pre-2017 under Article 13(3A) of the DTAA. The introduction of a limitation of benefits clause marked a decisive move to address treaty abuse within the treaty framework itself. Further, the CBDT released a clarification that GAAR would apply only prospectively and would not unsettle grandfathered investments. Together, these measures balanced anti-avoidance concerns with treaty certainty, forming the legal backdrop for Tiger Global.

What the SC Said in Tiger Global

The issue for determination in this case was whether the gains arising to Tiger Global International from the sale of shares held by them would be chargeable to tax in India under the Act, in light of the DTAA. 

In this regard, the SC noted that in order to determine the taxability of income from transfer of capital assets one must check whether it is accrued in India. Once it is established that the income is domestically taxable, it must then be checked whether the DTAA would cover such transactions, curtailing taxability. Further, under Section 245R (2) of the Act, the Authority for Advance Rulings (AAR) can refuse to grant tax exemptions to transactions that seem prima facie tax avoidant. In this case, the exemption was declined due to the conclusion that the effective control and management of Tiger Global International was not in Mauritius but rather in the USA. 

The SC also noted that the TRC provided by Tiger Global International as an evidentiary document to establish residence in proceedings under Section 245R (2) is non-decisive, ambiguous, ambulatory and merely records futuristic assertions without any independent verifications. In doing this, the SC has held that mere residentiary proofs do not hold much significance when the locus of decision-making is clearly situated elsewhere. Relying on Section 96(2) of the Act, the SC clearly declared that the onus to disprove the presumption of tax avoidance lies on the taxpayer, which in this case has not been discharged. 

Tiger Global gains significance not only due to its impact on the taxation landscape and investment aspects, but also due to its attempt to protect the sovereignty of the country. The judgment emphasized on the known fact that taxation is one of the powers that any sovereign nation holds and protects without compromise. The judicial view on global politics was perfectly summed up by Justice Pardiwala when he mentioned that “The golden rule of international diplomacy is how best to secure Nation’s interest and yet be part of the togetherness and reflect the genuine feeling of belonging.”

Tiger Global International had also taken the defence of Article 13(A) of the DTAA, which maintained that capital gains from transfer of shares before 1 April 2017 would not be subject to source-based taxation. Similarly, Rule 10U(1)(d) of the Income Tax Rules 1962 mentioned that the GAAR Rules shall not apply to gains from the transfer of investments before 1 April 2017. However, Rule 10U(2) ensured that this grandfathering provision could not be misused. Thus, it was concluded that while the pre-existing investments were protected, “arrangements” that led to tax benefits after the cut-off date would be subject to GAAR.

Structural Impact on PE/VC Exit Strategies

The judgment not only translates to a novel interpretation of the Act and DTAA, but rather marks a doctrinal shift from seeing capital gains individually to seeing them as arrangements of continuing nature. For a long time, offshore holding structures based in Mauritius, Singapore, Netherlands were preferred modes of investment due to the tax discounts or exemptions they were entitled to, given the existing treaties and ties between the nations. This stability, although challenged by the later amendments, remained largely intact due to the grandfathering provisions which protected past transactions from retrospective scrutiny. Tiger Global appears to be a harbinger of chaos, seeing these exit requests being given a high level of scrutiny if entered into after the cut-off period. The situation appears to be difficult and in a state of disheartenment for PE/VC Funds, owing to the GAAR that is staring them in the face. 

Predictability of Exit Taxation and the Collapse of Grandfathering Assurance

One of the consequences of the judgment is its impact on the predictability of exit transactions due to the waning comfort of the grandfathering provisions. These provisions were introduced to act as a shield for transaction that were done prior to the statutory amendments. They ensured that the new regulations do not retrospectively apply to the transaction which were done in a completely different set of circumstances. Such assurances often become the main factor influencing decision making in areas like capital markets. In cross-border PE investments, exit taxation is factored into valuation models at the time of entry. Where grandfathering operates as a clear and automatic protection, investors can price risk with certainty. Any dilution of that assurance therefore directly affects investment structuring, pricing, and fund-level return projections.

However, the court’s reading of “arrangements” as a larger system of investments turns the grandfathering provision into a conditional relief which would be granted only after passing high levels of scrutiny. This takes away the predictability and structural stability that investors, especially offshore structures relied on. Under the new regime, capital may have entered in a free, open market, but its exit is now bound to be in a scrutiny prone and tightly regulated market.

Conclusion

The SC did not see the issue in Tiger Global as an isolated dispute over taxation. It viewed the issue against the broader backdrop of treaty interpretation and the play of sovereign powers. The judgment is a declaration of the judicial approach to prioritize the state’s interest over treaty commitments that go against it. The judgment also gives power to GAAR and other anti-avoidance rules, expanding the scope of their application. Additionally, the ruling reiterates that AAR is empowered to refuse exemptions based on prima facie positions, thereby negating the exemptions from such anti-avoidance rules merely on the basis that prima facie a certain transaction is deemed to be a form of avoidance. Such an onus would rest on the affected taxpayers to disprove. To sum up, the ruling therefore appears to mark a shift in approach from one based on treaty positions to a regulated approach that is consistent with exemptions under principles related to global best practices on avoidance.