In Tiger Global Case, Supreme Court Explains Distinction Between 'Tax Planning' & 'Tax Evasion'

The Supreme Court has held that while an assessee is permitted in law to plan transactions to avoid tax, such planning must strictly conform to the framework of the Income Tax Act, the applicable rules, and notifications. The Court said that once a transaction structure is found to be illegal, sham, or lacking commercial substance, it ceases to be permissible tax avoidance and becomes impermissible avoidance or tax evasion, entitling the Revenue to closely examine and tax the transaction.“Though it is permissible in law for an assessee to plan his transaction so as to avoid the levy of tax, the mechanism must be permissible and in conformity with the parameters contemplated under the provisions of the Act, rules, or notifications. Once the mechanism is found to be illegal or sham, it ceases to be “a permissible avoidance” and becomes “an impermissible avoidance” or “evasion”. The Revenue is, therefore, entitled to enquire into the transaction to determine whether the claim of the assessees for exemption is lawful”, the Court held.A bench of Justice JB Pardiwala and Justice R Mahadevan made these observations while deciding appeals arising from the capital gains tax dispute linked to the sale of shares connected with Flipkart, where non-resident assessees had claimed exemption under the India–Mauritius Double Taxation Avoidance Agreement. The Court said that the object of a tax treaty is to prevent double taxation and not to facilitate tax avoidance or evasion.The Court noted that the applicability of treaty benefits depends on Article 4 of the DTAA, which defines a “resident of a Contracting State” as a person liable to taxation in that State by reason of domicile, residence, place of management, or similar criteria. Where a person other than an individual is treated as a resident of both Contracting States, the DTAA deems such person to be a resident of the State in which its place of effective management is situated.The Court observed that treaty protection under Article 13(4) of the DTAA is available only where the resident entity directly holds the shares or movable property that is transferred. Indirect transfers of shares do not, at the threshold, qualify for treaty protection. In such cases, the capital gains are taxable in India if they arise from the disposition of assets that derive their value substantially from India.The Court relied on its earlier Constitution Bench ruling in McDowell & Company Ltd v. Commercial Tax Officer in which it was held that that tax planning is legitimate only if it is within the confines of law, and colourable devices cannot form part of tax planning and that courts should not encourage the belief that avoiding tax through dubious methods is acceptable. The Court had underlined that every citizen has an obligation to pay taxes honestly, without resorting to subterfuges.The Court noted that Parliament has, over time, strengthened anti-avoidance measures to deal with sophisticated structures designed to escape tax. The introduction of Chapter X-A of the Income Tax Act, dealing with the General Anti-Avoidance Rule, and amendments to treaty provisions were intended to empower tax authorities to pierce artificial arrangements and deny benefits where the main purpose of the transaction is to obtain a tax benefit, the court said.A taxpayer seeking treaty protection must therefore establish that the income in question is taxable in the State of residence. The Court observed that amendments to the DTAA and to domestic law were introduced to prevent revenue loss caused by abuse of treaty provisions, particularly through structures designed to shift taxing rights away from the source State.“Therefore, for the treaty to be applicable, the assessee must prove that the transaction is taxable in its State of residence. The amendments to the Agreement as discussed above, were introduced precisely to prevent revenue loss to the State where the gains actually arise, by abuse of the Treaty. The assessee, hence, has to establish that it is a resident of the Contracting State covered by the DTAA by producing all relevant documents.”The Court then outlined the analytical framework for deciding treaty eligibility in cases of indirect transfers. The first step is to determine whether the income is taxable under domestic law, particularly Section 9(1)(i) of the Income-tax Act, which deems income arising from the transfer of a capital asset situated in India to accrue in India. Explanation 5 to this provision extends the deeming fiction to shares of a foreign company if such shares derive their value substantially from assets located in India. Once domestic taxability is established, the second step, the Court said, is to examine whether such taxability is curtailed by the DTAA, which requires an assessment of residence, the applicability of Article 13, and the operation of the limitation of benefits clause.The Court noted that, after the statutory amendments, assessing officers are empowered...

In Tiger Global Case, Supreme Court Explains Distinction Between 'Tax Planning' & 'Tax Evasion'

Amisha Shrivastava

Tags