In its recent decision in Blackstone Capital Partners (Singapore) VI FDI Three Pte Ltd vs ACIT the High Court of Delhi reaffirmed the position that the Indian tax authorities can’t go behind a valid tax residency certificate to deny capital gains tax exemption as provided under Article 13(4A) of the India-Singapore double taxation avoidance agreement. This decision was in a context where the taxpayer complied with the limitation of benefit clause in the India-Singapore DTAA and such compliance hadn’t been questioned earlier by the tax authorities.
The High Court recognized that the test of “beneficial ownership,” unless such test is expressly stated in the DTAA, shouldn’t be a relevant criterion for the purposes of taking advantage of the capital gains tax exemption under the DTAA.
The domestic tax law requires that benefits under a DTAA would only be available to a nonresident that furnishes a valid tax residency certificate issued by a competent authority of the country of residence. In Blackstone, the tax authorities sought to deny the capital gains tax exemption, claimed by Blackstone’s subsidiary in Singapore on account of sale of grandfathered shares (acquired before April 1, 2017) of an Indian company, by going behind the tax residency certificate issued by the Singaporean authorities and claiming that Blackstone Singapore wasn’t the beneficial owner of the capital gains income arising to it.
The High Court, relying on circulars issued by the tax department and earlier decisions, ruled in favor of Blackstone Singapore, and held that a tax residency certificate is sufficient evidence to claim treaty eligibility, residential status and legal ownership. The court refused to read in the requirement of beneficial ownership that wasn’t specifically provided for claiming capital gains tax exemption under the India-Singapore DTAA.
The decision is also instructive on the point that positions negotiated between two countries under a tax treaty need to be respected.
The High Court’s reading of the India-Singapore DTAA in this case is also in line with the good faith principle of treaty interpretation, given that the underlying thrust of the ruling is on respecting the negotiated bargain, without reading in conditions that aren’t expressly provided for in a DTAA.
The court’s decision also follows a purist reading of the tax treaty, as was the case in a recent ruling of the Canadian Supreme Court in the case of Alta Energy. In that case it was held that sufficient substantive economic connection test not included in the Canada-Luxembourg DTAA couldn’t be read into the provisions of the DTAA, as negotiations between contracting states to a tax treaty must be respected when interpreting the provisions of such treaty.
The court’s decision in Blackstone brings the focus back on certainty regarding tax outcomes that foreign investors were assured of earlier, through circulars and court decisions that reaffirmed a tax residency certificate as being a key document for treaty eligibility. Given that this ruling leaves the tax authorities with little wiggle room to deny treaty benefits, it is likely that the tax authorities will challenge the ruling before the Indian Supreme Court.
In the present case, since the investments were made prior to April 1, 2017, provisions of domestic general anti-avoidance rule—GAAR—couldn’t have been invoked, as there is a specific carve out provided under the GAAR provisions for investments made prior to April 1, 2017. Going forward, with the introduction of domestic GAAR, principal purpose test and specific anti-avoidance rules—SAAR—contained in various tax treaties, the threshold for claiming treaty benefits will change.
However, even in those changed circumstances, as a starting point the principles laid down in Blackstone with respect to a tax residency certificate would be helpful, given that holding a valid certificate would keep the burden of proof for denying treaty benefit with the tax authorities.
It is expected that the inherent safeguards provided under the domestic GAAR provisions should also act as a deterrent against potential invocation of such provisions to deny treaty benefits. The issue that may still be open is whether principal purpose test or SAAR provisions would operate outside the procedural safeguards provided under domestic GAAR provisions. As a matter of procedural fairness, it should be good practice to ensure that the safeguards provided under domestic GAAR provisions are also extended to nonresidents at the time of invoking principal purpose test or SAAR provisions.
At a broader level, this is a positive ruling as it focuses on certainty in tax and respects tax outcomes presented to foreign investors based on positions negotiated under DTAAs.