Capital gain on sale of unlisted equity shares transferred pursuant to an arrangement impermissible under law, not entitled to exemption under DTAA – SC
In a recent judgment, Hon’ble Supreme Court has held that capital gain on sale of unlisted equity shares which were transferred pursuant to an arrangement impermissible under law, not entitled to exemption under DTAA.
ABCAUS Case Law Citation:
4995 (2026) (01) abcaus.in SC
In the instant case, the Income Tax Department had challenged the order passed by Delhi High Court setting aside ruling of AAR rejecting the application of the respondent companies and holding that transfer of shares were prima facie designed for the avoidance of income tax.
The respondent assessee/companies were private companies incorporated under the laws of Mauritius with the primary objective of undertaking investment activities to earn long-term capital appreciation and investment income. They also held valid Permanent Account Numbers issued by the Indian income tax authorities.
The assessees sold shares of Flipkart Private Limited (the Singapore Company) and approached the Indian tax authorities by filing applications under Section 197 of the Income Tax Act, 19619, seeking certification of nil withholding prior to consummation of the transfer.
The tax authorities informed that the assessees would not be eligible to avail the benefits under the DTAA on the ground that they were not independent in their decision-making and that control over the decision- making relating to the purchase and sale of shares did not lie with them.
Hence, the assessees approached the Authority for Advance Rulings (AAR) by filing applications under Section 245Q(1) of the Income Tax Act 1961, seeking an advance ruling.
The AAR observed that the respondent companies were part of a USA based company and were held through its affiliates via a web of entities based in the Cayman Islands and Mauritius. On facts, the AAR found that the overall control and management of the respondent companies did not lie with their Board of Directors in Mauritius, and that the authority to operate bank accounts for transactions above USD 2,50,000 was vested with person who was not based at Mauritius and he was also declared as the beneficial owner. Although the principal bank account of the respondents was maintained in Mauritius, no local person based in Mauritius was authorised to sign cheques on behalf of the Directors.
AAR found that real control over transactions exceeding USD 2,50,000 was exercised by said person through a non-resident Director. On this basis, it was held that the “head and brain” of the companies, was not in Mauritius and, therefore, their control and management were situated outside Mauritius, in the USA. Referring to the financial statements filed with the applications, the AAR found that the respondents had made no investment other than in the shares of Flipkart, and therefore concluded that the real intention behind obtaining the Tax residency Certificates (TRCs) was to avail the benefit of the DTAA.
AAR came to the conclusion that the applications preferred by the assessees relate to a transaction or issue which is prima facie designed for the avoidance of income tax and therefore, rejected the same as being hit by the threshold jurisdictional bar to maintainability, as enshrined in proviso (iii) to Section 245R(2).
However, the High Court held that the assessees were entitled to treaty benefits and that their income would not be chargeable to tax in India.
The Hon’ble Supreme Court noted that for the benefit under Article 13(4) of the DTAA, the person claiming treaty protection must not only qualify as a “resident” of the other State i.e., Mauritius, but also establish that the movable property or shares forming the subject matter of the transaction are directly held by such resident entity. In all other cases, the transaction is taxable in India, where the capital gains arise out of the disposition of movable property, including movable property forming part of the business property held by a permanent establishment in India. Thus, an indirect sale of shares would not, at the threshold, fall within the treaty protection contemplated under Article 13.
The Hon’ble Supreme Court further observed that after the amendment to Chapter IX, the insertion of Chapter XA, the amendments to Rule 10U, there can be no doubt whatsoever that a TRC alone is not sufficient to avail the benefits under the DTAA, and reliance upon earlier judgments dealing with circulars issued in the preamendment regime cannot ipso facto come to the aid of the respondents. Rather, the facts will have to be independently analysed to decide on the applicability of Chapter XA.
The Hon’ble Supreme Court further observed that given the settled anti-avoidance principles, Parliament has statutorily empowered the AAR to reject applications at the threshold where the transaction appears prima facie tax-avoidant. Section 245R(2) of the Income-tax Act.
The Hon’ble Supreme Court further noted that the use of the term “prima facie” in Section 245R(2) implies that it is sufficient if the AAR, on an initial examination of the documents, is satisfied that the transaction is for avoidance of income tax and can reject the application. The provision is couched in such a way that the burden lies on the person claiming a particular fact, and such prima facie opinion is sufficient to reject the application. The level of satisfaction required to arrive at a prima facie conclusion is much less when compared to a case where a fact has to be proved.
The Hon’ble Supreme Court further opined that all that is required for the AAR, in the case of an application by a non-resident, is to see whether the contents of the application and the documents disclose a transaction by which an attempt is made to avoid payment of tax, if it is otherwise taxable under law. The language of the provision has to be read in tandem with the object of the respective provisions of the Income-tax Act and the Rules as applicable to the facts of the case.
The Hon’ble Supreme Court opined that the High Court, was not right in observing that since the appellants have been in existence from 2011 onwards, such a presumption cannot be made by relying upon the judgments of this Court which were rendered prior to the amendment of the provisions, wherein, by necessary amendment, the mere existence of a TRC is now held to be insufficient to establish the resident status of the applicant in the other State.
The Hon’ble Supreme Court noted that Chapter XA is made applicable to any arrangement, irrespective of the date on which it was entered into, in respect of a tax benefit obtained from such arrangement on or after 01.04.2017. It prima facie appeared as if the assessees acquired the capital gains before the cut-off date, i.e., 01.04.2017. However, the Revenue invoked the JAAR, grounded in the doctrine of substance over form, consistently recognised in Indian jurisprudence.
The Hon’ble Supreme Court observed that 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 Hon’ble Supreme Court observed that the Revenue had proved that the transactions in the instant case were impermissible tax-avoidance arrangements, and the evidence prima facie established that they did not qualify as lawful. Consequently, Chapter X-A becomes applicable.
The Hon’ble Supreme Court held that the applications preferred by the assessees relate to a transaction designed prima facie for tax avoidance and were rightly rejected as being hit by the threshold jurisdictional bar to maintainability, as enshrined in proviso (iii) to Section 245R(2). Accordingly, capital gains arising from the transfers effected after the cut-off date, i.e., 01.04.2017, were taxable in India under the Income Tax Act read with the applicable provisions of the DTAA.
Accordingly, the judgment of the High Court was set aside.
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