2012 (4) TMI 154 - AAR - Income Tax

DTAC between India & Mauritius Taxability of gains arising from transfer of shares and CCDs held by Mauritius company in Indian company Z ltd (Mauritius company) along with Vltd (Indian Company) invested in shares and CCDs of S Ltd (Indian company) engaged in development of real estate project in India prior to the mandatory conversion date of CCDs, V was given the call option to purchase particular shares and CCDs from Z, which was exercised by it applicant contending CCDs not to be loan or advances and gains to be capital gains exempt from tax withholding of taxes - Held that - CCD creates or recognizes the existence of a debt, which remains to be so, till it is repaid or discharged. Further, it is observed that S Ltd being subsidiary of V ltd is though independent juridical person, S exercises no powers in managing its own affairs. It is de facto under the control and management of its parent company, V. It is V who is developing and running the real estate business of S, standing as a guarantor of the investment made by Z. V rather than S, acknowledges the CCDs as debts. The relationship between them as a parent and subsidiary is on paper they are one and the same entity. Acknowledgment of debt with commitment to pay is factually upon V. Since, V and S are one and the same, hence the amount paid by V is clearly towards the debt that was taken by S from the Applicant. Gains arising on the sale of equity shares and CCDs are not exempt from capital gain tax in India under DTAC with Mauritius. The gains arising on the sale of CCDs being interest within the meaning of Section 2(28A) of the Act and Article 11 of the DTAC and are taxable as such. Tax is to be withhold on such payments Decided against the applicant.

Summary

Issues Involved:
1. Taxability of gains arising from the sale of equity shares and Compulsory Convertible Debentures (CCDs) under the Indo-Mauritius Double Taxation Avoidance Agreement (DTAA).
2. Characterization of CCDs as debt instruments or equity.
3. Determination of whether the transaction is a sham designed for tax avoidance.
4. Applicability of interest income provisions under the Income Tax Act and DTAA.

Detailed Analysis:

1. Taxability of Gains under DTAA:
The applicant, a Mauritius-based company, contends that gains from the sale of equity shares and CCDs in an Indian company are exempt from capital gains tax in India under Article 13.4 of the Indo-Mauritius DTAA. The Revenue, however, argues that the gains should be characterized as interest income and thus taxable in India.

2. Characterization of CCDs:
The applicant asserts that CCDs are not loans or advances but investments, citing the Sahara India Savings and Investment Corporation case. The Revenue counters that CCDs represent debt until converted into equity and should be treated as such. The legal definition of debentures and convertible debentures, as discussed in various legal texts and case laws, supports the view that CCDs acknowledge a debt that remains until repaid or converted.

3. Transaction as a Sham:
The Revenue argues that the transaction is a sham, designed to avoid tax by camouflaging loan and interest as capital gains. The agreements (SHA and SSA) and the interrelations among the parties indicate that the transaction lacks commercial substance and is intended to benefit from the DTAA's provisions. The applicant refutes this, stating that the transaction is genuine and compliant with FDI regulations.

4. Applicability of Interest Income Provisions:
The Revenue submits that the sale proceeds of CCDs include a component of interest income, as defined under Section 2(28A) of the Income Tax Act and Article 11 of the DTAA. The calculation of the purchase price, which includes accrued return and applicable rates, indicates that the gains are essentially interest income. The applicant's computation of the call option purchase price further supports this view.

Conclusion:
The ruling concludes that the entire gains from the sale of equity shares and CCDs are not exempt from capital gains tax in India under the DTAA. The gains from the sale of CCDs are characterized as interest income and are taxable under Section 2(28A) of the Income Tax Act and Article 11 of the DTAA. The transaction, when viewed in its entirety, supports the Revenue's contention that the CCDs represent debt, and the gains include interest income. The ruling was pronounced on March 21, 2012.