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TMI Blog2012 (4) TMI 154X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. - A.A.R. No.1048 of 2011 - - - Dated:- 21-3-2012 - Mr. Justice P.K.Balasubramanyan, Mr. V.K. Shridhar, JJ. Present for the applicant Mr. Vinay Mangla, CA(S.R.Batliboi Co.), Mr. Gaurav Kanwin, (S.R.Batliboi Co.), Mr. Percy Pardiwala, Senior Advocate, Ms. Preeti Goel, Advocate Present for the Department Ms. Poonam Khera Sidhu, DIT(Intl.Taxn.)-II, New Delhi., Mr. R.K.Kakar, RULING (By V K Shridhar) Applicant (Z) is a company incorporated under the laws of Mauritius and is a tax resident of Mauritius. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... all portion of the investment comprises of equity shares and the rest is in the form of CCDs. To characterize the gains to have arisen on account of transfer of a capital asset is improper. The CCDs recognize the existence of a debt till repaid or discharged LMN India Ltd. 307 ITR 40. The two agreements are entered into to camouflage the true character of income from that of loan and interest, to capital gains. Relying on a number of authorities, it is submitted that the essence of the agreements as a whole needs to be taken into account while interpreting the said agreements and not merely their form. Without prejudice to the above, the Revenue has also submitted in the alternative that the nature of the income arising from the present transaction is a business income. For this, revenue relies on the submission of the Applicant that it is engaged in the real estate business but its only transaction in India is an investment of Rs.‟y‟ crores in S. Further, the agreements were signed in India and one of the directors in S is its representative. 5. Learned counsel submits that the applicant has made an investment in equity and CCD of S. It has not lent the money. CCDs w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7 for an option to be exercised 6 years later. The Revenue then submits that there is no commercial purpose in support of the view that equity valuation could be based on rate of conversion of ECBs into equity after a particular period or guaranteeing a minimum rate of return irrespective of whether the company makes profit or not. The transaction clothed as a purchase of equity and CCDs in a joint venture, is sham, designed for avoidance of tax. It is to take advantage of the Article 13.4 of the DTAA with Mauritius to claim exemption from capital gains. 7. In a rejoinder, the applicant reiterated that in law it cannot be disputed that a CCD is in the nature of a debt till the time it is converted into equity. When the Revenue took a stand in Ashima Syntex 100 ITD 247 10 344 ITR 1(SC) that a CCD is in the nature of share capital, it is not open to the Revenue to contend that the debenture is in the nature of debt instrument. There is no borrowing by V for incurring of debt by V from the applicant. The commercial intent of the transaction was never to provide a loan to V. There is no dispute of the fact that interest on CCDs paid by S will qualify as interest. The applicant is tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was held that when an assessee buys Bonds and Debentures of approved nature of non-banking company, they constitute investment and cannot be treated as loans and advances and hence interest on such investment cannot be taxed under the Interest Tax Act, 1974. It is pointed out that the decision is in the context of Interest Tax Act, 1974, where the Debentures of approved nature were not to be treated as loans and advances and hence the reliance placed has no application, other than under the said Act. 10. The facts noted by us are as follows. S and V are two Indian companies. S was incorporated on 4.7.2007 and is a subsidiary of V, whereby, V got 9999 shares and its nominee 1 share. The shares are of the face value of Rs.10/- each. Z is a Mauritius based company in which Z Holding Mauritius, and XE LLC Mauritius, has equal participation. Z, V and S have entered into a Share Holders Agreement (SHA) on 11.8.2007, within 35 days of the formulation of S. It is stated in the SHA that on the basis of representation, warranties and indemnities provided by V and S, Z agreed to invest in S. The manner of investment is set out under SSA. Z, V and S entered into both the agreements on th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing on three transactions, two of which were already undertaken in FY 2010-11. As the application is filed on 16.02.2011, we assume that the proposed transaction has taken place at a time when no return of income for the accounting year ended March 31, 2011 was filed, and, would not be hit by the bar under the first proviso to section 245R(2) of the Income-tax Act, 1961 (Act). 12. Let us examine the law on the issues before us. First, let us see, what is meant by the term Debenture‟ and Convertible Debenture‟. Debenture is not a term of art and has no precise meaning. In Black‟s Law Dictionary, the following meanings are given: (in re AAR No.769 of 2007) Debenture : 1. A debt secured only by the debtor‟s earning power, not by a lien on any specific asset. 2. An instrument acknowledging such a debt. 3. A Bond that is backed only by the general credit and financial reputation of the corporate issuer, not by a lien on corporate assets. - Also termed debenture bond; Convertible debenture: a debenture that the holder may change or convert into some other security, such as stock In Halsbury‟s Laws of England, 4thedition, 7thvolume, at paragraph 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... High Court pointed out that notwithstanding the fact that the bonds are not styled as debentures, the substance of the instrument has to be looked into. The test of creation or acknowledgment of debt was applied. In Narendra Kumar Maheswari vs. UOI AIR, 1989 SC, 2138 AT 2178, the Supreme Court observed that debenture‟ is essentially an acknowledgement of a debt with commitment to repay the principal with interest. The Supreme Court further observed that a compulsorily convertible debenture does not postulate any repayment of the principal. Therefore, it does not constitute a debenture‟ in its classic sense . The expression repayment of principal‟ has been used obviously in the sense of repayment in cash. In Stroud‟s Judicial Dictionary of Words Phrases (5thEdition, Volume 2), while stating that the term debenture‟ has no definite meaning, it refers to the observations of Charles J. in Brown v. Inland Revenue Commissioners (64 L.J.M.C. 211), which are quite apposite. The learned Judge said: A debenture, though never, I believe, legally defined, is included under one or other of the three descriptions laid down by Bowen L.J., in English Scot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be so, till it is repaid or discharged. 13. The next question to be answered is: Whether the sale proceeds realized on the sale of CCDs in terms of the two agreements, SHA and SSA, include a component of income by way of interest under the Act or the DTAC? Section 2 (28A) of the Income tax Act, 1961 defines interest as follows:- Interest means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized; Article 11 of the DTAC with Mauritius defines interest as follows:- (4) The term interest as used in this Article means income from debt-claims of every kind whether or not secured by mortgage and whether or not carrying a right to participate in the debtor‟s profits, and, in particular, income from government securities, and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures .. Both the definitions are substantially similar. However, Article 11.5 spec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e investor pursuant to the assessee and shall include any equity share issued to the investor upon conversion of the CCD It means that for the purpose of calculation of purchase price, the amount of CCDs will be considered, as the investor securities include CCDs. Accrued Return shall mean an amount that would provide to the investor a cumulative annual rate of return equal to the applicable rate compounded quarterly on the investment amount. It means that the amount of rate of return is to be compounded quarterly as per the applicable rate. Applicable Rate shall mean: (a) 20%, if the call option is exercised or a Buy Back Offer is made on or prior to the expiry of 42 (forty two) months from the First Closing Date; (b) 22%, if the call option is exercised or a Buy Back Offer is made on or after the expiry of 42 (forty two) months but prior to the expiry of 48 (forty eight) months from the First Closing Date; (c) 24%, if the call option is exercised or a Buy Back Offer is made after the expiry of 48 (forty eight) months from the First Closing Date; (d) 24%, if the put option is exercised by the investor or if a Drag Along Notice is delivered by the investor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price has two components: equity share and CCD. The income derived from sale of equity shares would fall under capital gains and on CCDs as interest, CCD being a debt instrument. In the present case, these CCDs do not carry any interest, but instead, give option for the conversion into share at a different price. While calculating the purchase price, the conversion rates vary depending upon the period of holding these CCDs. This is nothing else but interest falling within the meaning of section 2(28A) of the Act as well under Article 11 of the DTAC with Mauritius. The Revenue and the Applicant have also given a computation of the purchase cost of A No. shares (which were received by way of investment) and A-7 shares receivable on conversion of CCDs, by considering the average value of each share at Rs. AV-1 and Rs. AV-2, respectively. In re AAR 769, the bonds are convertible into equity shares at the end of five years. The interest on bonds at a specified rate is payable by the applicant on half yearly basis irrespective of the fact whether the applicant makes profit or not. While answering a question this Authority ruled that when the money is advanced and debentures are issue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the exercise of S‟s rights under any project documents, unless Z agrees. The acts of Z would be binding on S. It is further provided that any decision, consent, approval relating to project documents has to be with the written approval of Z or the directors nominated by Z (4.9.2). It shows that control and management of S is not in its own hands. ii) Though Z and V are shareholders and have their nominees as directors in S, it is Z and V who have decided to have their own independent representatives who would have access to all the facilities, properties, tax returns and records of S during normal business hours (6.2). iii) The auditors are appointed by the Board of directors of S who assume all responsibilities required to be discharged as Auditors, leaving no scope to appoint a parallel qualified accountant by a third party to keep watch on the statutory auditors Ernst Young and internal auditors. However, Z and V have the right to appoint a qualified accountant to inspect S‟s accounting records (6.4). Exercise of such power shows that the affairs of S are not managed by its Board of Directors. iv) Z and V are given the right to be consulted by the managemen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of an option on the completion date in respect of such option, then V undertakes to sell all its right title and interest in project land to S which would be purchased for a consideration of Re.1. The directors of V would also resign from the Board of Directors to make the directors of Z a majority in the Board. Thus V stands as a guarantor of the investment Z has made in S and also to own and run the affairs of S. 17. What we observe from the above is that S and V, though independent juridical persons, 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. It is V who is 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. The Hon‟ble Supreme Court in the case of Vodafone International Holdings BV 334 ITR 1 (SC) has held that: in a proper case of lifting of corporate veil it should be proper to say that the parent company and the subsidiary form one entity . Thus, even though a subs ..... X X X X Extracts X X X X X X X X Extracts X X X X
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