India’s derivative market ecosystem could take a major hit as a result of the Supreme Court Verdict in the Tiger Global matter, say tax experts. Several foreign portfolio investors (FPIs) created Mauritius and Singapore structures to invest into India since both the jurisdictions continue to offer zero tax on gains made through derivatives trading in India. While the main trading desks of these companies are often in Europe, they maintain skeletal staff in Mauritius and Singapore.
The verdict could impact over 500 foreign F&O active traders in India, market estimates suggest. FPIs contribute about 15 percent of the total derivative market volumes in India, data showed.
On Thursday, the Supreme Court ruled that Tiger Global is liable for capital gains tax on its 2018 Flipkart stake sale. The Court held the Mauritius structure used by Tiger was an impermissible tax avoidance arrangement lacking commercial substance. Hence Tiger was not allowed to claim treaty benefits.
Until now, the interpretation of these funds, based on previous Supreme Court verdicts, was that having a tax residency certificate (TRC) was sufficient to avail treaty benefits. But the apex court in the case of Tiger Global held on Thursday while TRCs prove residency, they are not sufficient to avail treaty benefits. The court further observed, one needs to look into commercial substance that the entity has in the jurisdiction and also where the actual control of the fund resides.
One of the key amendments India brought into its double tax avoidance agreements (DTAAs) with Mauritius and Singapore in 2017 was to introduce source based taxation for capital gains on shares meaning if the source of capital gains was an Indian company, then it is taxable in India. However, derivative income for both this countries continues to be residency based, meaning funds holding TRCs in Mauritius and Singapore will be subject to tax in those countries for Indian F&O Trades.
“While the Tiger Global ruling is factually anchored in offshore share transfers, its reasoning has broader implications for capital market participants operating under the residual capital gains clauses of India’s tax treaties. By extending a substance-centric test into treaty access itself, the Supreme Court judgment introduces a degree of uncertainty into an area where jurisprudence and market practice had evolved around predictability,” said Binoy Parikh, partner, Katalyst Advisors.
In the coming days, India may witness heightened tax litigation between FPIs and tax department due to the verdict, say tax experts. Based on this judgement, tax authorities can question treaty benefits claimed by Mauritius and Singapore FPIs, say tax experts.
“FPI have been trading in the F&O derivative segment and treating their income as exempt under the respective DTAA. All such cases may now need to satisfy the new threshold being set by the Hon’ble Supreme Court in this case. The tax certainty and the overriding validity of the TRC, which the Courts have upheld all these years, is no longer available,” said Hemen Asher, partner at Bhuta Shah & Co. LLP.
Experts said FPIs should now focus on creating commercial substance to justify their presence in a jurisdiction.
“FPI need to maintain contemporaneous documentation of decision-making, expenditure and staffing in treaty jurisdictions, and clear business purpose beyond tax. Else they could face heightened audit risk, denial of treaty benefits, and potentially punitive tax and interest," said Suresh Swamy, Partner, Price Waterhouse & Co LLP.
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