Over decades, foreign investors have poured $180 billion into India via the tax haven of Mauritius. Now, an Indian court ruling is spooking investors as it could potentially reshape the M&A and investment landscape by strengthening New Delhi’s hand against tax evasion.

On Thursday, the Supreme Court ruled against Tiger Global in a landmark case, saying its $1.6 billion stake sale in India’s Flipkart to Walmart in 2018 should be taxed. The judges said India had proved that Tiger Global’s deal used its Mauritius units, which were “conduit” firms, in a bid to make use of an “impermissible tax-avoidance arrangement”.

Tiger Global had denied the allegations as well as India’s depiction of its structures, saying it had correctly used available tax benefits under the India-Mauritius bilateral treaty. It has not commented on the ruling.

The court directive, however, upends years of aggressive tax planning and investment routes created by foreign investors to make use of an effective no-tax regime, in which share sales in India by Mauritius-based investors were only subject to taxes in the tiny island nation, where the rate was nil.

The ruling will give sweeping powers to India to lift the lid on corporate deals, however, as it means that domestic law will now allow tax officials to override any treaty benefit being incorrectly claimed via the use of sham business structures, according to interviews with 15 lawyers and consultants.

Additional Solicitor General of India N. Venkataraman told Reuters on Friday that the fact that the ruling will impact investments is “nothing but a distraction”, adding that such deals are made based on several factors and not just capital-gains tax.

Investors jittery on ruling

First signed in 1982, the India-Mauritius treaty played a key role in boosting investments into India as, thanks to the tax benefits it entailed, investors set up units in Mauritius to route money to India, according to research by Indian law firm Nishith Desai Associates.

Even though it was a controversial treaty often litigated in courts, the investments kept flowing. Indian government data shows that in the 23 years to 2023, foreign investment inflows from Mauritius were the largest at $171 billion - a quarter of all the investment inflows in that period.

Some lawyers said they are already fielding nervous investor calls from Europe and the U.S. as they decode the landmark 152-page ruling, which also risks increased scrutiny of past deals where treaty benefits were used.

In the Tiger Global ruling, the Supreme Court said merely having so-called Tax Residency Certificates from Mauritius was not enough proof of having a legitimate business there and inspectors could challenge the deal by proving funds were routed via Mauritius only to avoid tax - as they were in Tiger Global’s case.

An updated India-Mauritius treaty in 2017 ended the tax-free system but said all pre-2017 investments would continue to enjoy the previous benefits under a so-called grandfathering clause.

The judges ruled on Thursday, however, that India’s strict anti tax-evasion law GAAR can “pierce the structure and deny treaty benefits where the transaction lacks genuine commercial substance.”

As one lawyer put it: “Grandfathering protection has gone for a toss.”

“On past investments made, investors would hold their breath on how their exits pan out,” said Bijal Ajinkya, tax partner at Indian law firm Khaitan & Co.

Tax environment worries

India, one of the world’s fastest-growing economies and its most populous nation, has been a darling of foreign investors. But tax uncertainty has often been a sore point for investors, be it about the interpretation of treaties, the scrutiny of imports or prolonged litigation.

Volkswagen is challenging in court India’s demand for back taxes running into a record $1.4 billion, which came after 12 years of scrutiny over alleged improper import declarations.

In another high-profile tax saga, Vodafone won its case against a $2 billion retrospective Indian tax demand in 2020 after more than a decade of legal battles with New Delhi, including international arbitration at the Hague.

The court ruling “has given more teeth to an already aggressive tax administration... What investors are looking for is certainty, and that confidence is likely to be shaken,” said Mumbai-based tax lawyer Dhruv Janssen-Sanghavi.

It may not be the kind of certainty investors were hoping for, but the Supreme Court was crystal clear: “Treaty provisions cannot be interpreted so as to facilitate abuse.”