2012 (1) TMI 52 - SC - Income Tax

Scope of total income - Revenue seeks to tax the capital gains arising from the sale of the share capital of CGP on the basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets. - Held that - Applying the look at test in order to ascertain the true nature and character of the transaction, we hold, that the Offshore Transaction herein is a bonafide structured FDI investment into India which fell outside India s territorial tax jurisdiction, hence not taxable. The said Offshore Transaction evidences participative investment and not a sham or tax avoidant preordained transaction. The said Offshore Transaction was between HTIL (a Cayman Islands company) and VIH (a company incorporated in Netherlands). The subject matter of the Transaction was the transfer of the CGP (a company incorporated in Cayman Islands). Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax the said Offshor Transaction. FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner. Legal doctrines like Limitation of Benefits and look through are matters of policy. It is for the Government of the day to have them incorporated in the Treaties and in the laws so as to avoid conflicting views. Investors should know where they stand. It also helps the tax administration in enforcing the provisions of the taxing laws. As stated above, the Hutchison structure has existed since 1994. According to the details submitted on behalf of the appellant, we find that from 2002-03 to 2010-11 the Group has contributed an amount of ₹ 20,242 crores towards direct and indirect taxes on its business operations in India. Transfer outside India - held that - On transfer of shares of a foreign company to a nonresident off-shore, there is no transfer of shares of the Indian Company, though held by the foreign company, in such a case it cannot be contended that the transfer of shares of the foreign holding company, results in an extinguishment of the foreign company control of the Indian company and it also does not constitute an extinguishment and transfer of an asset situate in India. Transfer of the foreign holding company s share off-shore, cannot result in an extinguishment of the holding company right of control of the Indian company nor can it be stated that the same constitutes extinguishment and transfer of an asset/ management and control of property situated in India. Section 9 has no look through provision and such a provision cannot be brought through construction or interpretation of a word through in Section 9. In any view, look through provision will not shift the situs of an asset from one country to another. Shifting of situs can be done only by express legislation. Capital gains are chargeable under Section 45 and their computation is to be in accordance with the provisions that follow Section 45 and there is no notion of indirect transfer in Section 45. - Section 9(1)(i), therefore, in our considered opinion, will not apply to the transaction in question or on the rights and entitlements, stated to have transferred, as a fall out of the sale of CGP share, since the Revenue has failed to establish both the tests, Resident Test as well the Source Test. Deduction of TDS u/s 195 - Territorial jurisdiction - Article 246 of the Constitution gives Parliament the authority to make laws which are extra-territorial in application. Article 245(2) says that no law made by the Parliament shall be deemed to be invalid on the ground that it would have extra territorial operation. Now the question is whether Section 195 has got extra territorial operations. It is trite that laws made by a country are intended to be applicable to its own territory, but that presumption is not universal unless it is shown that the intention was to make the law applicable extra territorially. Section 195, in our view, would apply only if payments made from a resident to another non-resident and not between two nonresidents situated outside India. In the present case, the transaction was between two non-resident entities through a contract executed outside India. Consideration was also passed outside India. That transaction has no nexus with the underlying assets in India. Order of Bombay High Court set aside - decided in favor of assessee.

Summary

Issues Involved:
1. Taxability of the transfer of shares of a foreign company indirectly holding assets in India.
2. Applicability of Section 9 of the Income Tax Act, 1961.
3. Interpretation of tax avoidance and tax evasion principles.
4. Applicability of Section 195 of the Income Tax Act regarding tax deduction at source.
5. Status and implications of the India-Mauritius Double Taxation Avoidance Agreement (DTAA).
6. The concept of "controlling interest" and its tax implications.
7. The role of corporate structures and the lifting of the corporate veil in tax matters.

Issue-wise Analysis:

1. Taxability of the Transfer of Shares of a Foreign Company Indirectly Holding Assets in India:
The Supreme Court examined whether the transfer of shares of CGP Investments (Holdings) Ltd. (CGP), a Cayman Islands company, by Hutchison Telecommunications International Ltd. (HTIL) to Vodafone International Holdings BV (VIH) could be taxed in India. The Court concluded that the transaction was an offshore transfer between two non-residents, and the subject matter was the transfer of a single share of CGP, which held indirect control over Indian assets. The Court held that this offshore transaction did not attract Indian tax jurisdiction.

2. Applicability of Section 9 of the Income Tax Act, 1961:
Section 9(1)(i) of the Income Tax Act deems certain incomes to accrue or arise in India. The Court emphasized that for Section 9 to apply, the income must arise from a capital asset situated in India. The Court held that the transfer of CGP shares did not involve the transfer of any capital asset situated in India, as the situs of the CGP share was in the Cayman Islands. Therefore, Section 9(1)(i) was not applicable.

3. Interpretation of Tax Avoidance and Tax Evasion Principles:
The judgment discussed the principles laid down in McDowell & Co. Ltd. v. CTO and Union of India v. Azadi Bachao Andolan. The Court reiterated that legitimate tax planning within the framework of the law is permissible, but colorable devices and dubious methods to avoid tax are not. The Court clarified that the transaction between HTIL and VIH was a bona fide structured FDI investment and not a preordained tax avoidance scheme.

4. Applicability of Section 195 of the Income Tax Act Regarding Tax Deduction at Source:
Section 195 requires tax to be deducted at source on payments made to non-residents if the income is chargeable to tax in India. The Court held that Section 195 applies only to payments made from a resident to a non-resident and not between two non-residents. Since the transaction between HTIL and VIH was an offshore transaction between two non-residents, Section 195 was not applicable.

5. Status and Implications of the India-Mauritius Double Taxation Avoidance Agreement (DTAA):
The Court discussed the India-Mauritius DTAA and the Circular No. 789 issued by the CBDT, which clarified that the Tax Residency Certificate (TRC) issued by Mauritius authorities is sufficient evidence of residency and beneficial ownership. The Court held that in the absence of a Limitation of Benefits (LOB) clause in the DTAA, the benefits of the treaty could not be denied to Mauritius-based companies. However, the TRC does not prevent the Revenue from investigating tax fraud or round-tripping.

6. The Concept of "Controlling Interest" and Its Tax Implications:
The Court examined whether controlling interest constitutes a separate capital asset. It held that controlling interest is an incident of holding shares and not an identifiable or distinct capital asset independent of the holding of shares. Therefore, the transfer of CGP shares did not result in the transfer of controlling interest as a separate taxable event.

7. The Role of Corporate Structures and the Lifting of the Corporate Veil in Tax Matters:
The judgment emphasized that corporate structures created for genuine business purposes should be respected. The Court held that the Revenue must establish that a structure was created or used as a sham or tax avoidant to invoke the principles of lifting the corporate veil or substance over form. In this case, the Court found that the Hutchison structure was a legitimate business arrangement and not a device to avoid tax.

Conclusion:
The Supreme Court set aside the Bombay High Court's judgment and held that the transfer of CGP shares by HTIL to VIH was not taxable in India. The Court directed the Revenue to return the sum of Rs. 2,500 crores deposited by Vodafone with interest and to return the Bank Guarantee within four weeks.