Khaitan & Co has won a landmark order from the Authority for Advance Rulings (AAR) for the firm's client E*trade Mauritius (ETM) to obtain tax exemptions under the India-Mauritius Tax Treaty on capital gains accrued from a sale of shares it held in an IL&FS investment.

The AAR held: "Though it looks odd that the Indian tax authorities are not in a position to levy the capital gains tax on the transfer of shares in an Indian company, this is an inevitable effect of the peculiar provision in India-Mauritius DTAA, the Circular issued by CBDT and the law laid down by Supreme Court in Azadi Bachao case.

"Whether the policy considerations underlying the crucial Treaty provisions and the spirit of the Circular issued by the CBDT would still be relevant and expedient in the present day fiscal scenario is a debatable point and it is not for us to express any view in this behalf."

Khaitan & Co tax partner Sanjay Sanghvi said: "AAR has given a very fair and pragmatic ruling.

"The importance of this ruling is that it will clear all doubts. The law was already laid down by the Supreme Court in 2003 in the Azadi Bachao Andolan judgement; it is reinforced after six years after this advance ruling. The ruling is dealing with other finer aspects like the lifting of the corporate veil.

"Second, it will give tremendous comfort to the international investor community by giving more certainty and clarity on tax obligations. It's a very positive ruling.     

"In summary AAR has followed the law of the land which is Azadi Bachao Andolan, and held the treaty and the Circular applicable. It's a policy matter and if at all they have to levy tax, the Government will first have to amend the law."

"As a citizen of this country I may feel that perhaps the treaty shopping is not fair because my government is losing crores of Rupees in tax revenues. But the Government has to see from a larger perspective, that the country is receiving huge foreign capital which helps the country in various in different ways."  

Case History:
E Trade Mauritius Limited (ETM) was a Mauritius entity and had invested in shares in an IL&FS entity. In September 2008 it divested its entire 43 per cent stake in this Indian entity and realised capital gains in India.

But it claimed that under Article 13(4) of the India Mauritius treaty it was exempt from paying tax in India, which states that capital gains realised by a resident of Mauritius are taxable only in Mauritius and not in India.

ETM filed for a withholding tax certificate (TDS) before the tax authorities, which was rejected and the income tax department ordered ETM to pay 20 per cent withholding tax and said that treaty did not apply to the present case.

ETM filed an ultimately unsuccessful writ petition in the Bombay High Court.

In August 2009 Khaitan & Co filed an application before the AAR asking whether capital gains realised by ETM on the sale of its shares of an Indian company are exempt from tax in India under India-Mauritius Treaty. Secondly, Khaitan & Co asked whether ETM would be eligible to a concessional tax rate of 10 per cent, which is also available to a foreign company, in case it was held to be taxable in India on those gains.

In an unrelated case, mobile operator Vodafone has finalised its submissions in its dispute with the Income Tax Department over why its acquisition of Hutchison Essar should not attract taxes, which could run into $2bn.  Vodafone argued that the acquisition took place from a Cayman Islands registered entity and did not take place in India.

The AAR's E*Trade order can be downloaded here.