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TMI Blog2010 (3) TMI 106X X X X Extracts X X X X X X X X Extracts X X X X ..... nravel some incriminating facts. Though it looks odd that the Indian tax authorities are not in a position to levy the capital gains tax on the transfer of shares in an Indian company, this is an inevitable effect of the peculiar provision in India-Mauritius DTAA, the Circular issued by CBDT and the law laid down by Supreme Court in Azadi Bachao case. Whether the policy considerations underlying the crucial Treaty provisions and the spirit of the Circular issued by the CBDT would still be relevant and expedient in the present day fiscal scenario is a debatable point and it is not for us to express any view in this behalf. - 826 of 2009 - - - Dated:- 22-3-2010 - Mr. P.V.Reddi and J. Khosla, JJ. Present for the applicant: Mr. S.E. Dastur, Sr. Advocate, Mr. Madhur Agarwal, Advocate, Mr. Sanjay Sanghvi, Mr. Ronak Ajmera Mrs. Daksha Baxi, Advocate of M/s. Khaitan Co. Present for the Department: Mr. G.C. Srivastava, Advocate RULING (By Hon'ble Chairman) 1. This application for advance ruling has been filed by a non-resident company under section 245Q(1) of the Income-tax Act (hereinafter referred as IT Act). The following facts are stated in the applicati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d HSBC Violet Investment (Mauritius) Ltd. to deposit an amount of Rupees Twenty Four crores fifty lakhs with the Court until the disposal of the revision petition by the DIT. On 1st January 2009, the DIT disposed of the revision petition. He concurred with the view of the ADIT that the transaction prima facie gave rise to a chargeable capital gains and upheld the denial of nil rate withholding Certificate. He computed the capital gains tax liability of Rs.24,31,05,710/-. The summary proceedings regarding issuance of tax deduction Certificate thus ended with the issuance of the order of DIT. 1.5 The Applicant has now approached this Authority to determine whether by virtue of being a Mauritius resident, it is eligible to the benefits of the India-Mauritius DTAA and hence not subject to tax in India on the capital gains realized. 2. The applicant has formulated the following questions for seeking advance ruling: (i) Whether on the stated facts and in law, the Applicant, a tax resident of Mauritius, is exempt from payment of capital gains tax in India under the Double Taxation Avoidance Agreement (or "DTAA") between India and Mauritius ("India-Mauritius DTAA") in respect of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ake a departure from the general principle of chargeability to tax under section 4 and the general principle of ascertainment of total income under section 5 of the Act, then there was no purpose in making those sections "subject to the provisions" of the Act. The very object of grafting the said two sections with the said clause is to enable the Central Government to issue a notification under section 90 towards implementation of the terms of the DTAs which would automatically override the provisions of the Income-tax Act in the matter of ascertainment of chargeability to income-tax and ascertainment of total income, to the extent of inconsistency with the terms of the DTAC. 3.1 The contention of the respondents which weighed with the High Court, viz., that the impugned Circular No.789 (see [2000] 243 ITR (St.)57) is inconsistent with the provisions of the Act, is a total non sequitur. As we have pointed out, Circular No.789 is a circular within the meaning of section 90; therefore, it must have the legal consequences contemplated by sub-section(2) of section 90. In other words, the circular shall prevail even if inconsistent with the provisions of the Income-tax Act, 1961, in s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e US Company which controls the applicant and the applicant company is merely a fa ade made use of by the US holding Company to avoid capital gains tax in India. It is pointed out that in the order passed under section 264 of the IT Act, the DIT has taken a prima facie view that the capital gains is taxable in the hands of the US entity. Certain aspects were pointed out to conclude that there was sufficient justification to make further enquiries to arrive at the finding as who is really the beneficial owner of the gains. Though certain details have been ascertained from the applicant, still some more enquiries are necessary to unravel the correct facts as regards the source of funds, treatment of share holdings, the manner of accounting and the role played by the US Company in the deal. It is, therefore, inappropriate at this stage to give a ruling on the questions raised by the applicant, according to the Revenue's counsel. It has been clarified in the course of arguments that the Department has not come to a definite conclusion, but such a conclusion could only be reached after fuller investigation. It is pointed out that if the Department comes to the conclusion that the benefi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing from the alienation of any property other than those mentioned in the preceding paragraphs and gives the right of taxation of capital gains only to that State of which the person deriving the capital gains is a resident. In terms of paragraph 4, capital gains derived by a resident of Mauritius by alienation of shares of companies shall be taxable only in Mauritius according to Mauritius tax law. Therefore, any resident of Mauritius deriving income from alienation of shares of Indian companies will be liable to capital gains tax only in Mauritius as per Mauritius tax law and will not have any capital gains tax liability in India. 4. Paragraph 5, defines "alienation" to mean the sale, exchange transfer or relinquishment of the property or the extinguishment of any right in it or its compulsory acquisition under any law in force in India or in Mauritius. ( Sd. ) Secretary, Central Board of Direct Taxes" 4.5 Circular No.789, dated 13th April, 2000 "Subject: Clarification regarding taxation of income from dividends and capital gains under the Indo-Mauritius Double Tax Avoidance Convention (DTAC) - Regarding The provisions of the Indo-Mauritius DTAC of 1983 ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned, the circular cannot be relied on by the applicant. The learned counsel for the Revenue then clarified that Revenue is not seeking to argue that the treaty benefit should be denied merely because the applicant is controlled and managed by the US entities or that the financial assistance was extended by the holding company for acquisition of shares. It is pointed out that the Revenue's case is that despite setting up a subsidiary in Mauritius, if US holding company factually does the business in India and exercises rights of ownership in shares, the US entity cannot get out of tax net. What the US entity is doing in India can be the subject matter of inquiry and the Income-tax authority is not inhibited to undertake such inquiry. Among other things, it is submitted that the inquiry can be made into the question whether the US company directly appropriated the income from the transfer of shares or it went into to the profits of the applicant company. If it is latter, there can possibly be no objection. In short, it is submitted that ownership is a question of fact and it is only after inquiry, it will be known whether the apparent is real. From the mere fact that the receipts ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rcular No. 789 dated April 13, 2000. Since this is the crucial circular, it would be worthwhile reproducing its full text." 6.1 On the scope and validity of the Circular, the learned Judges said: "As early as on March 30, 1994, the Central Board of Direct Taxes had issued Circular No. 682 (see [1994] 207 ITR (St.7)) in which it had been emphasized that any resident of Mauritius deriving income from alienation of shares of an Indian company would be liable to capital gains tax only in Mauritius as per Mauritius tax law and would not have any capital gains tax liability in India. This Circular was a clear enunciation of the provisions contained in the DTAC, which would have overriding effect over the provisions of sections 4 and 5 of the Income-tax Act, 1961 by virtue of section 90(1) of the Act ." 6.2 It may be noted that the Circular No. 789 of the year 2000 was quashed by the Delhi High Court in a public interest litigation initiated under Article 226 of the Constitution of India. The High Court, inter alia, held (i) in asmuchas the impugned Circular directs the Income-tax authorities to accept a certificate of residence issued by the authorities of Mauritius as sufficient e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... " 6.5 The learned counsel for the Revenue attempted to draw some subtle distinctions to make out the point that the Circular is to be confined only to dividends and secondly the aspect of beneficial ownership is not to be found in the third para of the circular dealing with the capital gains. We do not think that there is any substance in this contention. There is nothing in the language of the Circular to support the contention. As seen from the 'Subject', the Circular purports to give clarification both in respect of dividends and capital gains. May be, as pointed out by the counsel for Revenue, the reason for issuing the circular was to give quietus to certain doubts raised regarding the taxation of dividends turning on the residential status, but, it is crystal clear that the Circular also applies in respect of income from capital gains arising from sale of shares of Indian companies. Both paras 2 3 of the circular shall be read together. It seems to be an untenable proposition to say that as far as capital gains is concerned, a certificate of residence will not be relevant to determine the beneficial ownership of the gains, but it would only be relevant for the purpose of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the legality of treaty shopping merely because one section of thought considers it improper. The respondents strenuously criticized the act of incorporation by FIIs under the Mauritian Act as a "sham" and "a device" actuated by improper motives. They contend that this court should interdict such arrangements and, as if by waving a magic wand, bring about a situation where the incorporation becomes non est. For this they heavily rely on the judgment of the Constitution Bench of this court in McDowell and Co. Ltd. v. Commercial Tax Officer (1985) 154 ITR 148. Placing strong reliance on McDowell's case it is argued that McDowell's case has changed the concept of fiscal jurisprudence in this country and any tax planning which is intended to and results in avoidance of tax must be struck down by the court. Considering the seminal nature of the contention, it is necessary to consider in some detail as to why McDowell's case, what it says, and what it does not say." 7.3 At page 754, the dicta of Lord Tomlin in IRC vs. Duke of West Minister (1936 AC-1 (HL) was quoted with approval. We are quoting the same: "Every man is entitled if he can to order his affairs so that the tax attach ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it." "The principle does not involve, in my opinion, that it is part of the judicial function to treat as nugatory any step whatever which a taxpayer may take with a view to the avoidance or mitigation of tax. It remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one of which will result in liability to tax and the other of which will not, is at liberty to choose the latter and to do so effectively in the absence of any specific tax avoidance provision such as section 460 of the Income and Corporation Taxes Act, 1970." 7.6 After elaborate discussion on the above points, the Supreme Court observed at page 758: "With respect, therefore, we are unable to agree with the view that Duke of Westminister's case (1936) AC 1 (HL) ; 19 TC 490 is dead, or that its ghost has been exorcised in England. The House of Lords does not seem to think so, and we agree, with respect. In our view, the principle in Duke of Westminister's case ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was observed at page 761: "Though the words "sham", and "device" were loosely used in connection with the incorporation under the Mauritius law, we deem it fit to enter a caveat here. These words are not intended to be used as magic mantras or catch-all phrases to defeat or nullify the effect of a legal situation." In the previous para, the learned Judges also referred to the decision in Barber-Greene Americas Inc vs Commissioner of IR (35 TC 365) para wherein it was observed that: "A corporation will not be denied Western Hemisphere trade corporation tax benefits merely because it was purposely created and operated in such way as to obtain such benefits. Similarly, a corporation otherwise qualified should not be disregarded merely because it was purposely created and operated to obtain the benefits of the United States-Swiss Confederation Income Tax Convention." Then, the following observations of Lord Tomlin in Duke of West Minister's case were quoted with approval: "There may, of course, be cases where documents are not bona fide nor intended to be acted upon, but are only used as a cloak to conceal a different transaction". 8. At page 763, the proposition was em ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion provisions in the treaty itself or by domestic legislation. This per se does not render an attempt by a resident of a third country to take advantage of the existing provisions of the DTAC illegal." "Many developing countries tolerate or encourage treaty shopping, even if it is unintended, improper or unjustified, for other non-tax reasons, unless it leads to a significant loss of tax revenues. Moreover, several of them allow the use of their treaty network to attract foreign enterprises and offshore activities. Some of them favour treaty shopping for outbound investment to reduce the foreign taxes of their tax residents but dislike their own loss of tax revenues on inbound investment or trade of non-residents. In developing countries, treaty shopping is often regarded as a tax incentive to attract scarce foreign capital or technology. They are able to grant tax concessions exclusively to foreign investors over and above the domestic tax law provisions. In this respect, it does not differ much from other similar tax incentives given by them, such as tax holidays, grants, etc. (see Roy Rohtagi, Basic International Taxation, pages 373-374. Developing countries need foreign inve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... they give the appearance of creating. Thus, in regard to 'colourable devices' and 'sham' arrangements, the scope is still left to ignore such dubious methods subject to the clarifications and caveat entered on the import of the said expressions. It is in the light of the law laid down in Azadi Bachao Andolan and the principles succinctly stated therein, that we have to approach the whole issue in the instant case. 10. The indisputable facts are: the applicant received the funds for the purchase of shares from the parent company, namely, Converging Arrows, USA by way of capital contribution and loans. GDRs were also utilized for the acquisition of some shares. The FIPB Unit of Ministry of Finance by its communication dated 29.12.2004 approved the increase in foreign equity participation in the equity capital of IL FS investsmart Ltd. by the applicant (ETM Mauritius) The shares were registered in the name of the applicant. IL FS has recognized it as the share holder. The dividends from the shares were being received by the applicant. The applicant represented by its Secretary, namely, Abacus Management Solutions Limited entered into a Share Purchase agreement on 16th May, 2008 wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ggesting or negotiating the sale or that the consideration received ultimately goes to the parent company in the form of dividends or the diminution of capital do not lead to a legal inference that the holding company in reality owned the shares and/ or the recipient of capital gains arising from transfer of shares is the holding company but not the subsidiary. To take such a view would be clearly contrary to the ground realities of the mutual business and economic relations between a holding and subsidiary company and the inter-se legal structure. The fact that the subsidiary has its own corporate personality and is a separate legal entity cannot be overlooked. The fact that the holding company exercises acts of control over its subsidiary does not in the absence of compelling reasons dilute the separate legal identity of the subsidiary. It is unrealistic to expect that a subsidiary should keep off the clutches of the holding company and conduct its business independent of any control and assistance by the parent company. It would have been a different matter if the Supreme Court had disapproved the treaty shopping and the tax avoidance measures. In the present state of law i.e. t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d with ETFC were on the board of IL FS in which the applicant was a share holder. ETFC was also deputing its senior executives to IL FS to work there. The applicant states that the parent company never exercised any rights as shareholder in IL FS. The applicant's name was entered in the register of shareholders and it was receiving dividends in its bank account and deputing its own representative to attend the shareholder meeting. As regards the appointment of directors and other executives, it was the prerogative of IL FS and such appointments were made pursuant to the Board's resolutions. Another point raised in the Revenue's comments of 24.2.2010 is about the movement of funds between ETFC and the applicant. It is pointed out that not only the funds for investments in shares were sourced from the parent company, even the dividend amount was being remitted to the ETFC as reimbursement of excess fund. As noted earlier, the applicant has admitted that the funds for purchase of shares were received from the parent company by way of capital contributions and loans. The learned counsel for the Revenue has fairly stated that there could be no objection for such sourcing of funds. There ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arified: the fact that the applicant is the owner of the shares is borne out by record; the source of funds for purchase of shares has been explained with reference to the accounts; and the factum of sale proceeds being received by the applicant is not a matter of dispute. The fact that the sale proceeds were not retained for long by the applicant but remitted to its parent company in USA after taking steps to declare the dividend and reducing the capital are not legally impermissible steps going by the ratio of the decision in Azadi Bachao case In regard to the exercise of ownership rights allegedly by ETFC, it is pointed out that the Directors on the Board of IL FS is appointed by the share holders and moreover the executive control are in the hands of two directors who are connected with IL FS Group and not ETFC. It is reiterated that the applicant has always been recognized as the share holder and it is submitted that its status as share holder of IL FS is not in any way affected by the overall control exercised by the holding company. 11.2. The learned counsel for the Revenue has also made some comments on the Transitional Services Agreement dated 28th May, 2008 entered into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hority. On the basis of the facts presented by the applicant, many of which are not in dispute and some of which find support from the records, we have recorded the answer to the question posed by the applicant. 14. Though it looks odd that the Indian tax authorities are not in a position to levy the capital gains tax on the transfer of shares in an Indian company, this is an inevitable effect of the peculiar provision in India-Mauritius DTAA, the Circular issued by CBDT and the law laid down by Supreme Court in Azadi Bachao case. Whether the policy considerations underlying the crucial Treaty provisions and the spirit of the Circular issued by the CBDT would still be relevant and expedient in the present day fiscal scenario is a debatable point and it is not for us to express any view in this behalf. 15. On the facts presented by the applicant and in the light of legal position discussed, the applicant is not liable to pay capital gains tax in India in respect of the transfer of shares held in IL FS Investsmart Ltd. (Indian Company) to HSBC Violet Investment (Mauritius) Ltd. having regard to the provisions of India-Mauritius DTAA. The question is thus answered in the affirmati ..... X X X X Extracts X X X X X X X X Extracts X X X X
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