- TRC alone no longer guarantees treaty protection.
- Commercial substance will be scrutinized for every offshore holding.
- Legacy PE exits via Mauritius, Singapore, Cyprus face fresh tax exposure.
- Derivative‑trading FPIs could see treaty benefits questioned.
- Investors must reassess structuring, documentation, and exit timing.
You thought a simple tax residency certificate shielded your returns—think again.
The Supreme Court’s verdict in the Tiger Global‑Flipkart share‑sale dispute has sent a clear signal: India’s tax authorities can now probe the economic reality behind every offshore vehicle that claims treaty relief. For foreign portfolio investors (FPIs) and private‑equity funds, the ruling tears down the long‑standing comfort that a valid Tax Residency Certificate (TRC) is a silver bullet. Below we unpack the decision, place it in a broader fiscal landscape, and give you a playbook to safeguard your portfolio.
What the Supreme Court Ruling Means for DTAA Benefits
The Court held that a TRC is merely a prerequisite, not a guarantee. Tax officials may examine the commercial substance of an overseas structure before granting Double Taxation Avoidance Agreement (DTAA) relief. This applies even to investments made before the April 1, 2017 rollout of India’s General Anti‑Avoidance Rule (GAAR). In plain terms, if the offshore entity is a shell with no real employees, offices, or business activity, the treaty shield can be stripped away.
Decoding the Jargon: DTAA, Commercial Substance, and GAAR
DTAA – A bilateral treaty that allocates taxing rights between two countries, preventing the same income from being taxed twice. India has DTAA treaties with Mauritius, Singapore, Cyprus and many other jurisdictions.
Commercial Substance – The requirement that an entity must conduct genuine business operations (staff, premises, decision‑making) in the country where it claims tax residence. Purely conduit or “paper” companies fail this test.
GAAR – India’s anti‑avoidance framework introduced in 2017. It empowers the tax department to deny treaty benefits if a structure is designed principally for tax avoidance rather than commercial purpose.
Historical Context: From Residence‑Based to Source‑Based Taxation
Before 2016, the India‑Mauritius DTAA followed a residence‑based model: capital gains were taxed only in the investor’s country of residence. Since Mauritius levied no capital‑gains tax, foreign investors enjoyed de‑facto tax‑free exits.
The 2016 amendment flipped the regime to source‑based taxation, meaning gains realized on Indian assets became taxable in India. To protect existing investors, the amendment grandfathered investments made before April 1, 2017, preserving their tax‑free status.
Now, the Supreme Court adds a third layer—substance scrutiny—irrespective of the grandfathering carve‑out. Even a pre‑2017 vehicle could lose treaty relief if the tax authority deems it lacking real economic activity.
Sector‑Wide Ripple Effects: Who’s Feeling the Heat?
The ruling reverberates across three key segments:
- Private‑Equity Exits – Funds that routed returns through Mauritius, Singapore or Cyprus must revisit the substance of their holding companies. A denied treaty claim could translate into a 10‑30% effective tax uplift on exit proceeds.
- Derivatives‑Trading FPIs – While the India‑Mauritius and India‑Singapore DTAA amendments exempt futures‑and‑options (F&O) earnings from capital‑gains tax, the Supreme Court’s emphasis on substance may prompt authorities to challenge the legitimacy of the underlying conduit.
- Direct Equity FPIs – For investors holding listed shares, post‑2017 rules already tax capital gains in India. The ruling does not alter that baseline but reinforces that any attempt to use a shell to claim treaty relief will be scrutinised.
Competitors such as Tata Capital and Adani’s investment arms, which have increasingly built on‑ground operations in Mauritius and Singapore, may be better insulated. Their “substance‑first” approach—maintaining staff, office leases, and local decision‑making—aligns with the Court’s expectations.
Technical Implications for Your Portfolio
1. Documentation Upgrade – Every offshore vehicle must retain robust proof of substance: payroll records, board minutes, lease agreements, and local banking activity.
2. Re‑Structuring Opportunities – Consider moving capital to jurisdictions with stronger substance requirements (e.g., Ireland, Netherlands) where the tax treaty framework is similarly favourable but the substance bar is already embedded.
3. Timing of Exits – For pre‑2017 holdings, evaluate the cost‑benefit of an early exit versus a potential retroactive tax claim. A modest tax hit now may be preferable to a larger, uncertain liability later.
Investor Playbook: Bull vs. Bear Scenarios
Bull Case
- Funds that have already built genuine operational bases in offshore hubs will retain DTAA benefits, preserving high post‑tax returns.
- Investors can capitalize on the market’s muted reaction, buying Indian equities at a discount while the tax uncertainty resolves.
- Strategic re‑allocation to “substance‑rich” structures can unlock new treaty avenues without additional tax drag.
Bear Case
- Legacy PE exits that rely on shell entities face a sudden 15‑25% effective tax increase, eroding IRR targets.
- FPIs with thinly‑documented derivative conduits may see delayed profit distributions as tax disputes unfold.
- Uncertainty could trigger capital‑flight from Indian markets, pressuring valuations in the short term.
Action Steps – Conduct a substance audit of all offshore holdings, shore up documentation, and, where gaps exist, consider restructuring into jurisdictions with established substance requirements. Engage a tax adviser now; the cost of compliance today is far lower than a retroactive tax bill.