Taxation Law

Union of India v. Azadi Bachao Andolan

(2004) 10 SCC 1; (2003) 263 ITR 706

Facts

The India–Mauritius Double Taxation Avoidance Convention allocated certain capital gains on shares to the country of residence of the transferor.
Mauritius did not impose capital-gains tax on such share transfers.
Consequently, foreign investors frequently incorporated investment companies in Mauritius and invested in Indian companies through those entities.
Indian assessing officers began questioning whether some Mauritius companies were merely shell or conduit companies actually controlled from third countries.
This uncertainty led to withdrawal of foreign investment.
The CBDT issued Circular No. 789 on 13 April 2000.
The Circular stated that a certificate of residence issued by Mauritius would constitute sufficient evidence of:
Mauritius residence;
beneficial ownership;
eligibility for treaty treatment.
It also clarified that Mauritius-resident investors were not taxable in India on capital gains covered by Article 13.
Public-interest petitions challenged the Circular as facilitating treaty shopping and tax avoidance.
The Delhi High Court quashed the Circular, after which the Union of India appealed to the Supreme Court.

Whether Circular No. 789 was valid and binding.
Whether the India–Mauritius DTAA could override inconsistent provisions of the Income-tax Act where it was more beneficial.
Whether incorporation in Mauritius to obtain treaty benefits was necessarily an unlawful or colourable tax-avoidance device.
Whether McDowell had eliminated the taxpayer’s freedom to undertake lawful tax planning.

A DTAA entered into under section 90 can modify, reduce or eliminate a liability that would otherwise arise under domestic tax law.
Where the treaty is more beneficial, it prevails to that extent.
CBDT circulars issued within statutory authority are binding upon tax authorities.
A genuine transaction is not invalid merely because:
it has been structured to obtain a tax advantage;
the taxpayer selected a favourable treaty jurisdiction;
tax saving was an important motive.
McDowell prohibits colourable devices, sham transactions and dubious methods.
It does not prohibit every legally permissible arrangement which reduces tax.
Whether treaty shopping should be restricted is principally a matter for:
treaty negotiation;
legislation;
executive tax policy, rather than judicial moral disapproval.

The Court held that section 90 expressly permitted the Government to enter into treaties departing from ordinary domestic tax rules.
The fact that the treaty benefit resulted in little or no tax in either country did not make the treaty invalid.
The treaty had also been intended to encourage mutual trade and investment.
The Court recognised that routing investment through Mauritius could attract foreign capital into India.
It refused to declare that policy illegal merely because critics described it as treaty shopping.
Circular No. 789 did not amend the treaty.
It provided administrative guidance on how Mauritius residence was to be evidenced.
The CBDT had statutory authority to issue such general instructions.
The Court rejected the argument that McDowell required every tax-motivated structure to be ignored.
It distinguished between:
an actual corporate structure producing genuine legal consequences; and
a sham or colourable structure existing only on paper.
Tax motivation was not sufficient to convert the former into the latter.
The Court also rejected an unlimited judicial power to lift the corporate veil merely because an investment originated in a third country.
Without a specific limitation-of-benefits or anti-abuse clause, the Court would not add restrictions which the contracting states had not negotiated.
It considered treaty-shopping policy to involve economic and diplomatic considerations better handled by the executive.

The Supreme Court set aside the Delhi High Court judgment.
Circular No. 789 was declared valid and effective.
A Mauritius residence certificate was accepted as sufficient evidence under the Circular for obtaining the treaty benefit.
The judgment affirmed that legitimate tax planning remained permissible after McDowell.
The existence of a tax-saving motive or treaty-shopping element did not automatically establish a sham.
Present qualification: Later statutory anti-abuse rules, treaty amendments and the Supreme Court’s 2026 Tiger Global judgment permit closer scrutiny of treaty structures in appropriate cases. Azadi should therefore not be understood today as granting absolute immunity to every holder of a tax-residency certificate.