The happy to help pug and the company with amazing advertising ideas seem to have chosen the wrong pieces in their tax jigsaw. The latest judgment relating to the Indo-Mauritius Double Taxation Avoidance Agreement (DTAA) in the Aditya Birla Nuvo Limited (FKA Indian Rayon & Industries Limited) and Tata Industries Limited case, more popularly known as the “Idea Cellular matter” is a pointer to first getting the plot right and then putting in the pieces.

The issue pertains to the eligibility of Mauritius resident entities to claim exemption from capital gains tax in India under the provisions of the DTAA. Contrary to first impressions, the judgment does not in any manner change the status quo and the decision of the Supreme Court in Azadi Bachao Andolan still holds good. The case highlights the need for more comprehensive approach by lawyers, accountants and advisors in cross border M&A transactions.

Drafters have to keep in mind an increasing tendency by the revenue authorities and the judiciary to apply treaty provisions in a strict and narrow manner to deny benefits to those where structures and documentation do not strictly comply with treaty provisions.

Facts of the case

The founders Birla Group’s Grasim Industries and AT&T Wireless USA (AT&T USA) entered into a joint venture agreement (JVA) in 1995 for carrying out the wireless telecommunication service in India through their joint venture company (JVC) Birla Communications Limited (BCL).

As per the JVA 51 per cent equity shares of the JVC were to be subscribed and owned by the Birla Group and 49 per cent equity shares of the JVC were to be subscribed and owned by AT&T USA. The control of the JVC was with the founders, who were also called “party shareholders”. The founders could hold the shares in their own name or through a 100 per cent subsidiary ('permitted transferee') and they were jointly and severally liable for the performance of the obligations of the permitted transferee. The founders exercised all rights of the shareholders under the JVA such as appointment of the directors, affirmative voting rights and rights of first refusal. Even notices under the JVA were to go to the founders.

AT&T Mauritius was designated as the “permitted transferee” and held shares in its name but was neither a party to the JVA nor was it obliged to pay any amount under the JVA to hold the equity shares of ICL as a permitted transferee of AT&T USA.

A Shareholders Agreement (SHA) was entered into between AT&T USA, Birla Group and Tata Industries Limited in December 2000 whereby Tata Cellular Limited (TCL) would merge with BCL (now renamed BACL) and the respective share holdings of the three groups in BACL after restructuring would approximately be 33 per cent each.

The SHA reiterated that AT&T USA (signatory to the JVA dated 5 December 1995) is operating cellular services in Maharashtra and Gujarat through its wholly owned subsidiary AT&T Mauritius and that the joint venture partner AT&T USA would represent the AT&T Wireless Group. AT&T USA’s power to appoint directors as per the JVA was reduced from four to three to accommodate the directors to be appointed by the Tata Group. The other clauses in the shareholders agreement remained the same as in the JVA dated 5 December 1995. BACL’s name was later changed to Idea Cellular Limited (ICL).

Later on Cingular Wireless LLC acquired shares of AT&T USA and renamed it as New Cingular Wireless Services Inc, USA (NCWS). In July 2005, NCWS offered its shares in ICL to Birla Group and the Tata Group and the offer was accepted by both of them. Indian Rayon bought shares in ICL from AT&T Mauritius/NCWS while Tata Industries Limited acquired the entire issued and paid up share capital of AT&T Mauritius from NCWS and MMM Holdings LLC who were holding 100 per cent shares of AT&T Mauritius.

Case before the court:

Both transactions were questioned by the tax department through show cause notices and zero capital gains available through the DTAA with Mauritius was denied. Both Idea and Tata filed writs in the Bombay High Court, which dismissed the petitions by holding that the beneficial ownership of the shares vested in NCCW and not in AT&T Mauritius and hence the benefits of Indo-Mauritius Treaty were not available to them.

The manner in which the transaction was structured and the drafting of the clauses in the JVA, shareholders agreement and the share purchase agreement led the court to conclude that the JVA was with AT&T USA and not AT&T Mauritius and all rights, title and interest in the shares vested in the founders.

The obligation to pay for the equity shares of the JVC was on AT&T USA. AT&T Mauritius was only a permitted transferee and could not independently exercise any rights in the shares allotted in its name.

The shareholders agreement was also executed by AT&T USA and not AT&T Mauritius and stated that AT&T USA is carrying on telecommunication business in India through its wholly owned subsidiary AT&T Mauritius. The sale and purchase agreement was also entered into jointly with AT&T Mauritius and NCWS and not solely with AT&T Mauritius.

The argument that NCWS became a party to the sale and purchase agreement on account of the warranties given by NCWS was rejected by the court as under the JVA and the SHA, shares of the JVC allotted in the name of AT&T Mauritius could not be sold by AT&T Mauritius without the consent of AT&T USA (now NCWS).

In view of the above facts, the court concluded that the investment in BCL (now ICL) was made by AT&T USA and not by AT&T Mauritius and hence there was no question of looking into the Indo-Mauritius Treaty, the circulars or the Azadi Bachao Andolan judgment as AT&T USA was an American company.

The case clearly turned on the finding that AT&T USA, being the signatory to the joint venture, shareholders and share purchase agreements, was the real owner.

The drafting/structuring error evidently occurred at the JVA stage itself where for some reason the parent company AT&T USA (and not the Mauritian subsidiary) was made a party. Strangely, the terms “permitted transferee” and “party shareholders” were coined with all the rights under the JVA reserved in favour of the party shareholder, i.e. AT&T USA.

By contrast, in most transactions either the Mauritian subsidiary itself enters into the JV Agreement or even if the agreement is entered into with a non-Mauritian parent, the mechanism used is transfer/assignment to affiliate companies. The affiliate companies then step into the shoes of the parent company upon transfer and are entitled to all the rights and liabilities of the JV shareholder.

How the structuring should have been done?

If AT&T Mauritius had been incorporated prior to the entering into of the JVA then the JVA should have been entered into with AT&T Mauritius. As a parent company AT&T USA could have given the requisite guarantee for performance of the obligations of the subsidiary AT&T Mauritius.

If AT&T Mauritius had not been incorporated prior to the entering into of the JVA, AT&T USA could have executed the JVA and instead of permitted transfer to permitted transferees with all rights of shareholders retained by the party shareholder (ie AT&T USA). The agreement ought to have provided that the rights and obligations of AT&T USA would stand assigned to a group company, which would thereafter be liable to subscribe and pay for the shares, appoint directors, ensure compliance with the terms of the JVA, be subject to the restrictions on transfers of shares, etc.

The drafting and structuring errors were compounded at the shareholders agreement drafting stage when the Tatas became shareholders, although to be fair to the drafters of this document much of the ground had already been set at the JVA stage.

The court highlighted these clauses to conclude that the shares vested in AT&T USA and not AT&T Mauritius. Surely it was possible to have AT&T Mauritius enter into the SHA and AT&T USA at the most could have been a guarantor for the obligations of AT&T Mauritius?

Bright ideas:

Structuring / drafting “ideas” that emerge from this case are:

• As far as possible, have your special purpose vehicles’ (SPV’s) ready before you sign agreements.
• Pay full attention to the recitals and “miscellaneous clauses” (such as notices, arbitration etc.) and make sure these do not conflict with the intended structuring.
• Be mindful of the fact that taxation authorities will examine documents with a microscope, so try a simulated “microscopic test” of the structure / documents if time permits. If not, run the simulation post signing and then novate documents, if some discrepancies are found.
• It is good for the structure to have flexibility but try to balance the benefits with the potential taxation risks.
• The structure and documents should be dynamic and changeable to bring them in line with the ever developing case laws.

Once these boxes are ticked the bulb will light up and the colour will invariably be green.

Naveen Goel is the managing partner of Naveen Goel Law Offices in Delhi