The Supreme Court on Tuesday reserved its judgment on the Centre’s plea against the Delhi High Court’s decision quashing a circular that allowed foreign investors avoid tax on capital gains and dividends.

India has a double taxation avoidance treaty with Mauritius. This treaty is based on Section 90 of the Income-Tax Act, which holds that capital gains and dividends are taxable only in the country where a person is resident.

A number of foreign companies, have been coming through Mauritius, seeking to avoid payment of tax invoking the treaty provisions.

These companies and therefore not liable to pay tax in India. In Mauritius itself, capital gains and dividends are not taxable. They hardly do any business there.

A number of foreign companies operating in India were misusing the treaty provisions. These companies were showing that they are registered in Mauritius and therefore not liable to pay tax in India.

Capital gains and dividends are not taxable in Mauritius also and these companies hardly do any business there.

When the joint commissioner found that these investment firms were not residents of Mauritius, but belonged to a third country, he denied them the treaty benefits.

Subsequently, the CBDT issued a circular which treated them as residents of Mauritius and exempted them from being assessed for tax in India.

However, the Delhi High Court quashed the circular after being petitioned by the Azadi Bachao Andolan.

Defending the circular, Attorney General Soli Sorabjee said that the tax avoidance was “perfectly legitimate”.

But, the petitioners pointed out the Supreme Court’s observations in the McDowell case: “The courts are now concerning themselves not merely with the genuineness of the transaction, but with the intended effect of it on fiscal purposes. None can get away with a tax avoidance project with the mere statement that there is nothing illegal about it.”

In his arguments, Sorabjee said that the judgment did not apply to the present situation. According to the Attorney General, motives did not matter while incorporating a company and was irrelevant to the issue of the applicability of the treaty.

Further, Sorabjee said it was beyond the power of the assessing officer to enquire into the motive of incorporation and deny the benefits of the treaty if they are otherwise available.