Grandfathering in this instance refers to allowing an entity's actions during a certain period to be subject to provisions that existed at the time.

The New York-based investment firm had moved the Delhi High Court in 2020 against the quasi-judicial body's ruling, insisting there was enough substance and decision-making in the deal structure to avail benefits under the India-Mauritius treaty.

The high court's decision bodes well for India's startup and corporate ecosystem as it sends a favourable signal to foreign investors about the country's investment landscape.

Mint spoke to taxation lawyers and other industry stakeholders to decipher what happened and the implications of the ruling.

What's the origin of the dispute?

In May 2018, global retailer Walmart acquired a 77% stake in Flipkart for about $16 billion, becoming the e-commerce firm's largest shareholder. Some of Flipkart's early investors, including Tiger Global Management, sold their shares as part of the Walmart-Flipkart deal, gaining bumper returns.

But the Authority for Advance Rulings rejected Tiger Global's petition for exemption from tax on capital gains from the stake sale. Tiger Global had claimed nil withholding tax on the capital gains since its entities that had invested in Flipkart were based in Mauritius and established before 2017. 

But the authority rejected the petition suspecting that Tiger Global was abusing the tax treaty to avoid tax.

The AAR is a legally constituted body under the Goods and Services Tax (GST) Council and can issue a binding ruling to an applicant that is a registered taxable person or is liable to be registered. Its purpose is to provide certainty in tax liability in advance and reduce potential litigation.

How does the tax treaty work?

A DTAA is a pact signed between two nations to prevent double taxation and encourage capital investments and maintain cordial economic relations. The India-Mauritius DTAA was signed in 1982 to prevent evasion of income taxes in the two countries. It protects investments from Mauritius into Indian companies before 2017 from being taxed in India.

Tiger Global's Mauritius entities had sold their stakes in Flipkart Singapore to Walmart's Luxembourg-based company for over ₹14,500 crore, and, subsequently, sought an advance ruling for zero withholding tax. India's tax authorities objected to this, deciding that the transaction was purely for tax evasion. 

The AAR accepted its view, arguing that the Mauritian funds were shell entities and thus ineligible for DTAA benefits, despite holding a Tax Residency Certificate. (A TRC is a document issued by tax authorities to non-resident investors that mentions the jurisdiction where the fund is based, and acts like a proof for availing DTAA benefits.)

Thereafter, Tiger Global filed an appeal in the Delhi High Court seeking injunction against the AAR's order.

Has this happened before?

Tiger Global isn't alone. The Indian tax department's aggressive stance on TRCs has evoked concerns among other offshore investors as well. In January, the Supreme Court stayed a Delhi High Court ruling in favour of Blackstone Partners, stating that TRCs are sufficient for availing benefits under double tax avoidance agreements.

Tax authorities have been trying their best to collect taxes from foreign investors investing through tax-friendly jurisdictions such as Mauritius, Singapore and Cyprus, alleging that such entities are typically set up with the sole objective of claiming tax benefits, according to S.R. Patnaik, partner and head of taxation at law firm Cyril Amarchand Mangaldas.

What did the Delhi High Court say?

The Delhi High Court in its ruling on Wednesday disagreed with the ARR's position, affirming that a TRC is sufficient to establish tax residency.

This means that Tiger Global will not have to pay any tax on the capital gains earned by it from the sale of Flipkart shares to Walmart.

"The (ARR's) stance was criticised as being highly subjective and, to some extent, arbitrary. This created challenges for Indian companies in raising funds from foreign investors, who were cautious due to the Revenue authorities' aggressive approach," said Ankit Jain, partner at Ved Jain and Associates, a tax consultancy.

What does this mean for startups?

The high court's ruling affirms that TRCs are inviolable, which could enhance foreign investors' trust in the Indian taxation system and encourage further investment in the Indian ecosystem, according to Pallav Pradyumn Narang, partner at CNK & Associates.

"This ruling sets a favourable precedent for global investors by reinforcing the sanctity of TRCs, potentially making India a more attractive destination for investment without undue tax concerns," Narang told Mint.

The ruling also underscores the legitimacy of offshore holdings and arrangements when used for valid commercial reasons and lawful tax planning, Rahul Charka, partner at Economic Law Practice, said.

Moreover, the mere act of setting up a subsidiary or holding company in an offshore jurisdiction does not automatically imply tax evasion or any criminal intent. "A lower tax bill for the investors in turn means higher (internal rate of return, or IRR) and easing a bit of the performance burden for the investee startup," Charka said.

Cyril Amarchand Mangaldas's Patnaik added that the order reiterates India's position as a well-regulated democracy with an independent judiciary, and a nation that can be regarded as an attractive destination not only for startups but also for mature industries to make investments.

What's next?

There is a possibility that the tax authorities may challenge the decision of the Delhi High Court before the Supreme Court. 

However, considering the well-drafted and reasoned 224-page order passed by the high court, it will be extremely difficult for the Supreme Court to overrule it, according to Patnaik.

Moreover, the decision to be made in the Blackstone case may put the seal of finality on the legitimacy of foreign investors investing through a tax friendly jurisdiction to avail the benefits, Patnaik added.