Taxpayers Can Plan Legally, But Sham Transactions Denied Exemption: SC

(MENAFN- KNN India) ** New Delhi, Jan 19 (KNN)** In Tiger Global case, the Supreme Court held that taxpayers can plan transactions to reduce tax only if they comply with the Income Tax Act and related rules. Transactions that are illegal, sham, or lack commercial substance are not allowed and may be taxed.

A bench of Justices JB Pardiwala and R. Mahadevan made these remarks in appeals concerning a capital gains tax dispute over the sale of Flipkart shares, in which non-resident taxpayers claimed exemption under the India–Mauritius Double Taxation Avoidance Agreement (DTAA).

The Court stressed that tax treaties prevent double taxation, not enable tax avoidance. Under Article 4 of the DTAA, a resident is determined by place of effective management if dual-resident, and Article 13(4) protects only direct share or asset holdings. Indirect transfers deriving value from India remain taxable domestically.

** Legal Framework, Precedents and Framework**

Citing the Supreme Court in McDowell & Co., the Court reiterated that tax planning must stay within legal limits and avoid ‘colourable devices.’ Parliament has reinforced anti-avoidance through GAAR (Chapter X-A) and treaty amendments denying benefits for transactions aimed mainly at tax advantage.

The Court laid out a two-step test for treaty benefits in indirect transfers. First, it assessed whether the income is taxable under Indian law, particularly Section 9(1)(i), which covers gains from transferring capital assets in India, including shares of foreign companies deriving significant value from Indian assets.

Second, it examined whether the DTAA restricts taxation based on residence, Article 13, and the Limitation of Benefits (LOB) provisions. The Court highlighted that Tax Residency Certificates alone are insufficient to claim treaty benefits, authorities may scrutinise the place of effective management, control, and commercial substance.

** Impact of Post-2017 Amendments**

The 2016 India–Mauritius DTAA Protocol introduced an LOB clause, making capital gains on shares acquired after April 1, 2017, taxable in India, with transitional relief for LOB-compliant cases. Pre-2017 investments may still be subject to GAAR if post-2017 arrangements yield tax benefits.

Although the shares were acquired before April 1, 2017, their transfer under the Share Purchase Agreement with Walmart in May 2018 fell under the post-2017 regime. The Court upheld the Revenue’s view that the transaction lacked genuine commercial substance, noting that superficial compliance could not override substantive scrutiny.

** Burden of Proof on Taxpayers**

The Court held that taxpayers must disprove presumptions of tax avoidance, noting that transactions aimed chiefly at tax benefits can be taxed in India. It found the respondents’ claim of exemption under Indian and Mauritian law inconsistent with the DTAA’s purpose, justifying denial of treaty benefits.

The Supreme Court ruled that while legitimate tax planning is allowed, sham arrangements amount to evasion. It found the Flipkart share sale was structured to avoid Indian tax, denying the assesses exemption under the India–Mauritius DTAA.

** (KNN Bureau)**

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