The case of AzadiBachao

On 1 April 1983 the Governments of India and Mauritius entered into a

Convention on the Avoidance of Double Taxation.

The object of the Convention was to avoid double taxation and to prevent fiscal
evasion of taxes on income and capital gains and to encourage mutual trade and
investment.

The Convention provided that gains derived by the alienation of shares by a

resident of a contracting state shall be taxable only in that state.

Capital gains derived by a resident of Mauritius on the alienation of shares were

taxable only in Mauritius.

By a circular dated 30 March 1994, CBDT clarified that capital gains derived by
any resident of Mauritius on the alienation of shares of an Indian company shall be
taxable only in Mauritius according to the taxation laws of that country and would
not be liable to tax in India.

Notwithstanding this, the income tax authorities issued notices to show cause in
2000 to Foreign Institutional Investors (FIIs) to explain why they should not be
taxed for profits and dividends which accrued to them in India.

The basis of the notices was that the recipients were shell companies incorporated
in Mauritius whose main purpose was investment of funds in India.

Moreover, it was alleged that those companies were controlled and managed from
countries other than India and Mauritius and not by residents of Mauritius so as to
derive the benefits of the Convention.

Confronted by a withdrawal of funds by FIIs, CBDT issued a circular on 13 April

2000 clarifying that such entities incorporated under the laws of Mauritius would
be considered as residents of Mauritius in accordance with the Convention and that
when a certificate of residence is issued by Mauritian authorities, that shall
constitute sufficient evidence for accepting the status of residence and beneficial
ownership for applying the Convention.
The circular issued by the CBDT was quashed by the Delhi High Court, in public
interest petitions, on the ground inter alia that the circular was ultra vires the
powers of the CBDT insofar as it directed income tax authorities to accept a
certificate of residence issued by the authorities in Mauritius as sufficient evidence
of the residential status of such an entity.

The Delhi High Court held that the Income Tax Officer was entitled to lift the
corporate veil to determine as to whether a company was actually resident in
Mauritius and to find out whether the corporate veil had been adopted to avoid
payment of tax.

The Delhi High Court faulted the circular on