New Delhi, Jan. 27 -- The Supreme Court's decision denying capital gains tax exemption to Tiger Global under the India-Mauritius tax treaty on the sale of shares in Flipkart Singapore, sends a clear signal that access to tax treaty benefits will be evaluated on substance, not merely legal form. The ruling marks a significant shift in the interpretation and application of tax treaties and has materially recalibrated how tax treaty-based positions may be evaluated by Indian tax authorities going forward.
The ruling has also watered down the grandfathering protection under the General Anti-Avoidance Rules (GAAR) applicable for investments undertaken prior to 1 April 2017. This raises significant concern for the investment community that even legacy arrangements could face heightened scrutiny if the authorities consider them to be designed primarily for tax avoidance.
While the dispute arose in the context of an indirect transfer of shares in an Indian company, the ripple effects are likely to extend well beyond such transactions. Treaty benefits for capital gains, dividends and even debt returns may become increasingly contestable in practice, particularly where the investing entity is perceived as a conduit with minimal commercial footprint. Investors, fund managers and deal teams should treat this moment as an inflection point - one that demands a fresh approach to structuring, diligence, documentation, withholding and risk allocation.
Immediate impact
In the near term, the impact will be felt most acutely in live disputes and recently closed transactions.
The most visible impact is expected in the ongoing tax treaty related disputes before the tax authorities, appellate authorities and courts. The findings and observations by the Supreme Court will have a binding impact on the authorities and courts at all levels, placing a higher degree of onus on taxpayers to substantiate their positions.
For the transactions closed in the current and previous financial year (FY), the parties may undertake a fresh review to re-confirm the tax treaty positions and have a strategy in place, in the event of any questioning by the authorities. Under normal course, the transactions closed in FY 2024-25 can be picked up for audit by 30 June 2026 whereas the audit for deals undertaken in current year can be initiated by 30 June 2027.
Potential impact for past years
The transactions completed until 31 March 2019 (FY 2018-19) cannot be re-opened now due to statutory limitations. However, for the interim period i.e. FY 2019-20 to FY 2023-24, re-opening by the authorities is permissible subject to certain checks and balances. These include the requirement that the authority must possess certain new information indicating that any income chargeable to tax has escaped assessment.
This is where market stability becomes a policy concern. If the judgment triggers widescale reopening of past cases, the ecosystem could face significant uncertainty. A measured clarification from the Government confirming that past closed transactions shall not be reopened solely on account of this judgment would go a long way in preventing a Pandora's box scenario and preserving investor confidence.
Taxing times for M&A transactions
The ruling is likely to cause a paradigm shift in the deal dynamics and require parties to adopt a more balanced approach with respect to taxes. In the ongoing secondary transactions, the buyers may prefer to adopt a conservative position and withhold taxes, ignoring the applicability of tax treaty benefit, if any. Sellers could revisit their structures and assess if it passes the muster in view of the findings set out by the Supreme Court to claim a refund of taxes withheld (if any) as well as to avoid prolonged litigation.
Alternatively, buyers may look for stronger contractual protection, including in terms of robust tax indemnities, holdback or an escrow arrangement, subject to regulatory considerations. In the right fact pattern, tax insurance remains a potential tool, with the underwriting being highly focused on substance aspects. If the position is grey, the investors may look at pricing in the tax cost with respect to investment in India and have certainty over the net returns.
How should funds and investors navigate this development?
Proactive assessment of tax treaty eligibility for the existing and proposed structures is the need of the hour. Most tax treaty disputes are lost on narrative. Investment committees, board minutes and structuring memos should clearly articulate the commercial reasons for the chosen structure and how it is operated in practice.
In transactions where tax treaty reliance is necessary, investors may plan early for withholding positions, documentation support and the buyer's expected proposition. The fund managers need to ensure there is clarity on allocation of tax costs and a strategy in place to defend any potential disputes. In certain circumstances, fund managers may need to consider reserves, giveback provisions or other feasible mechanisms to manage contingent tax exposure.
From a structuring standpoint, hedge funds or investors engaged in high frequency trades may consider setting up a GIFT City Fund, which enjoys certain tax benefits under the Indian tax law and does not entail accessing the tax treaties.
Issues that need clarification
The ruling has also raised a few pertinent questions, including (a) whether the grandfathering protection under GAAR can be denied to "investments" undertaken prior to 1 April 2017, by claiming that it forms part of an "arrangement" set up for tax avoidance (b) whether availability of tax treaty benefit is subject to taxation in the resident state and (c) scope of tax treaty coverage for indirect transfers.
Given the wider ramifications, clarifications by the Government on these aspects should address the industry's concerns and restore predictability.
Conclusion
The Tiger Global ruling is a reminder that India's tax treaty landscape must be navigated with more than formal compliance. For global and domestic funds alike, the path forward lies in strengthening substance, tightening documentation, planning withholding outcomes, and allocating risk transparently in transaction documents. In the near term, expect increased scrutiny and a more conservative deal environment. Over the longer term, investors who can demonstrate coherent commercial rationale and economic substance will be best placed to preserve returns while avoiding protracted controversy.
(The writer is a Partner at Khaitan & Co. Views expressed are personal.)
Published by HT Digital Content Services with permission from VC Circle.