2019 (9) TMI 302 - AT - Income Tax

Benefit of India - Cyprus Double Taxation Avoidance Agreement (DTAA) - income on compulsorily convertible debentures ( CCD ) issued by ABPL to the Appellan - back-to-back transaction lacking economic substance - AO taxing the entire amount of interest income received by the Appellant at 40% (plus surcharge and cess) and denying the Appellant relief of beneficial rate or interest at 10% under Article 11 of the India - Cyprus DTAA HELD THAT - Mere fact that the CCDs were funded using monies received by the appellant from its immediate shareholder does not make the arrangement a back-to-back transaction. The appellant had the absolute control over the funds received from its immediate shareholder. Further, in the instant case the appellant wholly assumed and maintained the foreign exchange risk on the CCDs (as they were INR denominated), and the counter party risk on interest payments arising on the CCDs. In the instant case, the AO/DRP have failed to prove that (i) the appellant did not have exclusive possession and control over the interest income received, (ii) the appellant was required to seek approval or obtain consent from any entity to invest in ABPL, or to utilize the interest income received at its own discretion and (iii) the appellant was not free to utilize the interest income received at its sole and absolute discretion, unconstrained by any contractual, legal, or economic arrangements with any other third party. The transaction between the appellant and ABPL cannot be considered a mere back-to-back transaction lacking economic substance. Therefore, we direct the AO to accept the return of income filed by the appellant for the impugned assessment year disclosing a total income from interest on CCDs in ABPL, wherein it has offered such interest to tax @ 10%. - Decided in favour of assessee

Summary

Issues Involved:
1. Taxation of interest income at 40% versus 10% under the India-Cyprus DTAA.
2. Determination of beneficial ownership of interest income.
3. Allegation of the appellant being a conduit company.
4. Application of Circular No. 789 issued by the CBDT.
5. Imposition of interest under Section 234A, 234B, and 234C of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Taxation of Interest Income at 40% versus 10% under the India-Cyprus DTAA:
The appellant, a company incorporated in Cyprus, filed its return of income for AY 2013-14, showing total income from interest on Compulsorily Convertible Debentures (CCDs) in Adams Builders Private Limited (ABPL) and offered such interest to tax at 10% under Article 11 of the India-Cyprus DTAA. The AO denied this benefit, taxing the interest income at the domestic rate of approximately 42%, arguing that the appellant was not the beneficial owner of the interest income.

2. Determination of Beneficial Ownership of Interest Income:
The AO concluded that the appellant was not the beneficial owner of the interest income from ABPL, alleging that the appellant did not have dominion and control over the income and was merely a conduit for funds between Green World Developments Ltd (GWDL) and ABPL. The AO noted that the appellant invested in CCDs using funds received from GWDL, indicating a back-to-back loan transaction. The DRP upheld this view, stating that the appellant served as a mere conduit and not as a beneficial owner.

3. Allegation of the Appellant Being a Conduit Company:
The AO and DRP argued that the appellant was set up as a shell or conduit company, acting as a fiduciary on behalf of another party, and did not have independent control over the interest income. The appellant countered this by providing evidence of its incorporation, business activities, and control over the investment decisions, asserting that it acted independently and for its own benefit.

4. Application of Circular No. 789 Issued by the CBDT:
The appellant argued that as a tax resident of Cyprus, it should be entitled to the benefits under the DTAA, supported by Circular No. 789, which states that a Tax Residency Certificate (TRC) is sufficient evidence of residence and beneficial ownership. The DRP, however, held that the circular did not apply to the Cyprus treaty and that TRC alone was not conclusive evidence of beneficial ownership.

5. Imposition of Interest under Section 234A, 234B, and 234C of the Income Tax Act:
The appellant contended that the imposition of interest under Sections 234A, 234B, and 234C was done mechanically without due application of mind, and should be set aside.

Judgment:
The Tribunal found that the appellant was indeed the beneficial owner of the interest income, having invested in CCDs and received interest for its own benefit. The appellant had control over the funds and the interest income, and there was no evidence to prove otherwise. The Tribunal referred to the OECD Commentary on Article 11, stating that the beneficial owner is the one who has the right to use and enjoy the interest unconstrained by any obligation to pass it on to another person. The Tribunal directed the AO to accept the return of income filed by the appellant, offering the interest to tax at 10% under the DTAA, and allowed the appeal in favor of the appellant.

Conclusion:
The appeal was allowed, with the Tribunal directing the AO to apply the 10% tax rate on the interest income as per the India-Cyprus DTAA, recognizing the appellant as the beneficial owner of the interest income.