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TMI Blog1996 (8) TMI 512X X X X Extracts X X X X X X X X Extracts X X X X ..... tionate share of income under section 161 of the Act ? Whether it is held that the provisions of section 161 do not apply to the incomeof the applicant from the contributory trust because of the power vestedin the trustees to add to the list of the beneficiaries on the terms laiddown in the indenture of trust and the contribution agreement, then ifsuch power is deleted, would the assessment of the applicant in respectof its proportionate share of income of the trust be made in accordancewith section 161 ? Whether if it is held that the shares of the additional beneficiaries are indeter-minate whether the capital gains arising to the applicant will be chargedto tax at the rate of 20 per cent. as prescribed in section 112 of the Act ? Whether will there be any tax withholding by the investee companies at the time of distribution of income to the CT ? Whether, on the facts and circumstances of the case,the character of the applicant’s proportionate share in the income of thecontributory trust will be same as in the hands of the contributory trust? Whether the applicant’s share in the dividend earned by the contributorytrust will be chargeable to tax and if so at what rate? Whether the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntial resources and understanding of the region". The transactions now proposed (which give rise to the present applications) are restricted in its operations to the "Indian sector". The American company in collaboration with an Indian financial service company now proposes to set up another fund. This fund will consist of two tranches (sections or branches), one a rupee tranche called a "contributory trust" holding funds in Indian currency and a Mauritian company (referred to as "the foreign tranche") holding funds in dollars. The rupee tranche is to be set up as a contributory trust (hereinafter referred to briefly as "the CT") constituted under an indenture of trust drawn up between the Indian financial service company and another Indian trust company. The trust company will be trustees of the CT and the trust funds will vest in it under the Indian law. The expression "CT" and "trustees" are, therefore, interchangeably used in the ensuing discussions. Parallel to the CT, the foreign tranche plans to hold funds to the tune of $100 million. The American company has committed to itself to contribute $15 million to this company for investment. Other contributors from several count ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... documents to give effect to the above arrangements have been drawn up and placed before the Authority. These are: (i) Draft indenture of trust (T. D.) between the Indian financial service company and the trust company constituting the CT of which the said company is appointed trustees. [A draft trust deed originally filed with the application was allowed to be replaced by a revised draft trust deed at the time of arguments and it is this revised T. D. that is referred to below]. (ii) Draft contribution agreement (C. A.) between the contributors on the one hand and the trustees and the IM on the other. (iii) Draft investment management agreement between the trustees and the IM. (iv) Draft advisory agreement between the Indian financial service company and the management company. Arguments before the Authority were addressed on the basis of these draft agreements. However, since the transactions are still in the stage of proposed ones, counsel for the applicant was willing to consider suitable modifications in the agreement in respect of clauses which, as they stand, may create some difficulties for the applicants from the tax angle. These aspects are touched upon in due course ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he date of winding up of the I. M. Clause 3(a) of the T. D. obliges the trustees to appoint the I. M. to carry out its investment policies. The mode of distribution of the trust fund and income is set out in clause 5 of the trust deed which reads thus: "Distribution of trust fund and income: 5. The trustee shall stand possessed of the trust fund and the income thereof shall accrue upon the trust for the benefit of the beneficiaries and the trustee shall make distributions to the beneficiaries/contributors as follows: (a) as regards the initial settlement as specified in the second schedule to distribute the same and any income accumulated thereon in equal proportions on termination of the trust amongst the beneficiaries as listed in the third schedule, (b) as regards all additional amounts to be distributed to the beneficiaries in proportion to the contributions made by them and in accordance with the fourth schedule-the contribution agreement.'' Clause 7 of the trust deed contains a provision to the following effect: "Power of addition: 7. (a) The trustee shall have the power at any time or times during the trust period to add as beneficiaries such one or more persons o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the trust are, as stated in the TD, to invest the trust funds and distributing the proceeds to the beneficiaries. This is, in a sense, nothing more than an arrangement by which certain parties agreed to contribute funds for a common purpose and divide the profits amongst themselves. No doubt, the same objective could be achieved by the constitution of a firm or a company but, equally, there seems to be no valid objection if the parties wish to do it in the form of a trust which, under the trust act, merely represents certain obligations annexed to the ownership of property in the form of the contributed funds. The purposes of the trust cannot be said to be forbidden by law or likely to defeat the provisions of any law or fraudulent or involving injury to any person or property or opposed to public policy: vide section 4 of the India Trusts Act (2 of 1882). It will appear later that, in entering into the present transactions, the parties took into account certain difficulties if the same transactions had been put through the format of a company and also took into account certain financial and tax implications. But these cannot render the purposes of the trust unlawful within the me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its, losses and distributions and so that any decisions of the trustee under this regulation whether made in writing or implied from their acts shall so far as the law may permit be conclusive and binding on the beneficiaries and all persons actually or prospectively interested under this settlement. 17. Decisions, etc., of the trustee.. . . . (d) The following powers of the trustee shall only be exercised by a majority of the directors of the trustee present and voting at a meeting of its board of directors: (i) application of the net profit of the trust otherwise than by way of distribution to the beneficiaries; and (ii) delegation of any powers and authorities of the trustee." The First Schedule to the T. D. sets out the Regulations that govern the trustee. Attention has been drawn to paragraph 2 and paragraph 8 which read thus: "2. The trust fund shall be managed by the investment manager in accordance with the investment objectives, policies and restrictions set forth in the private placement memorandum dated November, 1995, which is hereby incorporated by reference herein. 8. Trustee shall not engage in any business or trade: Provided however, they may make investmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tributor a takedown notice (draw down) in accordance with this agreement (notice clause) within 21 calendar days in advance of the date on which the capital contribution shall be required to be made. (b) On the draw down date, for any draw down of the contribution amount, if all conditions specified in article IV (conditions of contributions) are met, each of the contributors will pay their draw down in rupees, payable at par, to the trust's bank account as specified in the investment manager's notice of contribution. (c) Notwithstanding the above, the investment manager may choose to establish the contribution fund with minimum commitments of ₹ 750 million for the initial closing (the closing) with staged closings for subsequent commitments. Such staged closings will occur not later than 12 months after the closing. 2.05 Upon receipt of draw down amount from any of the contributors, the trustee, shall: (a) issue, to the respective contributor, units with a total nominal value equal to the instalment amount, credited as fully paid on the date of actual payment; (b) enter the respective contributor's name in a register of unitholders as the holder of those units; and (c) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such defaulting contributor defaulted, which corresponds to such defaulting contributor's contributed capital percentage as of such date; and (f) appropriate adjustments shall be made to the contributed capital percentages of the non-defaulting contributors. Each of the contributors hereby consents to the application to it of the remedies provided in this paragraph 2.06 in recognition of the risk and speculative damages its default would cause to the other contributors, and further agrees that the available such remedies shall not preclude any other remedies which may be available in law, in equity, by statute or otherwise." The "initial closing" is to be on the date of the trust deed [clause 1(k) of the deed] and will be followed by subsequent closings within 12 months from this date [paragraph 4.04]. Investments made subsequent to this date but before any subsequent closing are governed by paragraph 2.09 which reads: "2.09 Investments prior to second closing: In the event a portfolio investment by the trust is completed subsequent to the closing but prior to the subsequent closing, there will be a draw down from the commitments of investors participating in such subsequent c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the contributor until 100 per cent. of capital contribution has been deemed to have been returned plus a 9 per cent. annual rate of return compounded semi-annually on all such capital contributions from the time of draw down ('the priority return'). (b) Thereafter, 80 per cent. to the contributor and 20 per cent. to the investment manager, provided that distributions will be made in accordance with sub-paragraphs (a) above until the earlier of: (i) the first anniversary of the first closing, (ii) the date on which the fund is deemed to be fully invested by the investment manager, or (iii) the date on which the investment manager gives written notice of the dissolution of the contribution fund to the contributor. . . . 6.04 Income and expenses from other sources: All items of income gain, loss or expenses not directly attributable to a particular portfolio investment (e.g., interest or temporary investments, and the contribution fund's share of any advisory fees net of general operating expenses) shall be allocated among the investors in proportion to their capital contributions. . . . 6.06 Special allocation among late entering contributors of organisation and operating expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nto with it. The IM is a limited life company incorporated in Mauritius. It is a 100 per cent. subsidiary of an American asset management company but it is proposed to restrict its shareholding to 73 per cent. by transferring 22 per cent. to the Indian financial service company and five per cent. to the Asian Development Bank Ltd. (ADB). Its board of directors will also have representatives of the two companies and ADB. The IM is to be responsible for the day-today management of the trust fund "in accordance with the provisions of this Agreement and any directions and instructions of the trustees" [2.01]. Paragraph 3.03 states that "the investment manager shall be responsible for the day-to-day management of the trust fund, which shall be subject to any directions, instructions and guidelines provided by the trustees". Paragraphs 5.01, 6.04 and 7.01 refer to the areas in which the trust funds should be invested and their respective priorities. Paragraph 5.01 provides: "In addition, trust fund investments may include holdings of listed companies that could be of particular benefit of the fund". Under paragraph 6.02, the IM should make best endeavours to maximise capital gains incom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndian financial service company and the American company (paragraph 13.03) but makes it clear (paragraph 13.04) that, regardless of all delegation, the manager shall remain responsible for all decisions and be liable for any delegate's act or omission that it would otherwise have been liable for. Paragraph 14.01 stipulates for the payment to the IM of a fee of 2.5 per cent. of the aggregate capital commitments of the contributors reduced by returns of capital directly attributable to specific investments upon which distributed gains (or losses) of the trust have been realised. At the end of the commitment period, the investment management fee shall be based on the aggregate unreturned capital. To the extent that the balance of capital commitments or unreturned capital of the trust fund plus the capital commitment or unreturned capital of the "the fund" in the aggregate exceeds US $ 150,000,000 or the equivalent in rupees, the investment management fee with respect to such balance shall be reduced to two per cent. Paragraph 14.04 on distribution reproduces paragraph 6.02 of the C.A. entitling the IM, after a particular stage, to a part of the proceeds attributable to portfolio inves ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... umstances of the case, if it is held that the provisions of section 161 do not apply to the income of the applicant from the contributory trust because of the power vested in the trustees to add to the list of the beneficiaries on the terms laid down in the indenture of trust and the contribution agreement, then if such power is deleted, would the assessment of the applicant in respect of its proportionate share of income of the trust be made in accordance with section 161 ? 4. Based on the facts and circumstances of the case, even if it is held that the shares of the additional beneficiaries are indeterminate whether the capital gains arising to the applicant will be charged to tax at the rate of 20 per cent. as prescribed in section 112 of the Act ? 5. Based on the facts and circumstances of the case, will there be any tax withholding by the investee companies at the time of distribution of income to the CT ? 6. Whether, on the facts and circumstances of the case, the character of the applicant's proportionate share in the income of the contributory trust will be the same as in the hands of the contributory trust ? 7. Based on the facts and circumstances of the case, whet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the other three questions that will be considered by the Authority. Though numerous and seemingly involved in their language, the points raised by the applicants lie within a narrow compass. In the case of the IC, the basic question to be decided is whether the assessments of the CT and the IC will be governed by section 161 or section 164 of the Act and what rates of tax would be applicable to the IC's receipts from the CT. In the case of the IM, the very short question that has to be answered is whether it can be said to have a permanent establishment in India within the meaning of the Agreement for the Avoidance of Double Taxation between India and Mauritius (DTAA) and, if not, whether any part of its income can be assessed in India. To understand the points raised by the applicant company, it is necessary to consider the provisions of sections 160, 161, 164 and 166 of the Act. The relevant portions of these sections are extracted below: "160. Representative assessee. - (1) For the purposes of this Act, 'representative assessee' means-. . . (iv) in respect of income which a trustee appointed under a trust declared by a duly executed instrument in writing whether testa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h part of the income and such persons being hereafter in this section referred to as "relevant income','part of relevant income' and 'beneficiaries', respectively), tax shall becharged on the relevant income or part of relevant income at the maxi-mum marginal rate: Provided that in a case where - (i) none of the beneficiaries has any other income chargeable under this Act exceeding the maximum amount not chargeable to tax in the case of an association of persons or is a beneficiary under any other trust; or (ii) the relevant income or part of relevant income is receivable under a trust declared by any person by will and such trust is the only trust so declared by him; or (iii) the relevant income or part of relevant income is receivable under a trust created before the 1st day of March, 1970, by a non-testamentary instrument and the Assessing Officer is satisfied, having regard to all the circumstances existing at the relevant time, that the trust was created bona fide exclusively for the benefit of the relatives of the settlor, or where the settlor is a Hindu undivided family, exclusively for the benefit of the members of such family, in circumstances where such relatives or m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch part thereof is receivable, are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed. 166. Direct assessment or recovery not barred. Nothing in the foregoing sections in this Chapter shall prevent either the direct assessment of the person on whose behalf or for whose benefit income therein referred to is receivable, or the recovery from such person of the tax payable in respect of such income." Before proceeding to discuss these provisions, it is necessary to deal with two preliminary objections to the maintainability of the application by the IC. It is contended for the Department that what the application seeks virtually is a ruling on the mode of assessment of the CT (i.e., the trustee company) which is an Indian domestic company-whether it should be assessed on its total income at the maximum rate under section 164or whether it should be assessed separately in respect of the portions of income earned by it on behalf of the various beneficiaries under section161. The effect of sections 161 and 164, which is sought to be got clarified by the IC, ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons to be asked, the Authority is of opinion that the question raised should be one which directly involves or affects the income-tax liability of the non-resident. That requirement is fulfilled in the present case. In the case cited, the question pertained to the assessment of an Indian company. The applicant, a totally different entity, was affected only in a remote and indirect manner in that any disallowances of expenses in the hands of the subsidiary might result in larger profit distributions to it. But here the applicant company and the CT are connected as beneficiary and trustee and the provisions of Chapter XV containing sections 161, 164 and 166really incorporate a method of assessing the beneficiary through the trustee. In other words, they are conferred a common identity for the purposes of the Act. Any assessment on the trustee is only in a representative character and will directly and vitally affect the beneficiary. Further, ifthe CT is assessed to income-tax at the maximum marginal rate under section 164, there will be no assessment at all on the IC. Moreover, not only will the income of the trust distributable to the beneficiaries, including the IC, be correspondin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ps should be taken in the matter in that eventuality, is a matter for the IC to decide at the appropriate time, and, if the IC is prepared to "risk a ruling" even now, it is not for the Authority to say "nay" to it. It is difficult to see how any ruling given by the Authority could be infructuous. The objection is overruled. The second objection raised to the maintainability of the application is on the basis of clause (c) of the proviso to section 245R(2). It is pointed out that the scheme for making investments in India in infrastructural and other core sectors has been initiated by the American company and the Indian financial service company. The American company could have, therefore, directly contributed to the CT and secured other investors also to participate directly. But, since the interest and dividend income realised, in that event, from India by the American company would not be entitled, under the DTAA between India and USA, to any tax concession, this arrangement has been devised to secure the concessional tax advantages that are available under the DTAA between India and Mauritius by put-ting up, as a front, a Mauritian subsidiary (the IC) for making the investment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... han 75 per cent. stake, they may be required to invest up to US $ 50 million, although the management company as such, does not require much capital. In one of the cases, we have received a letter from Ministry of Finance stating that the application has been rejected on the ground that the applicant does not satisfy the capitalisation norms for non-banking finance companies (attachment). Generally, FIPB takes approximately 90 days to approve a proposal. In the case of offshore funds, many a time, core investors insist to hold a stake in the management company. It would be a very cumber-some process for making application and obtaining FIPB approval separately for each investor who may be investing at different points in time. In view of the high capitalisation requirement and hardship involved, it is much convenient for the management company also to be located in the same jurisdiction where the fund is situated, i.e., Mauritius.'' It was found convenient for this purpose also to locate the IC in Mauritius. The IM was located at Mauritius as it functions as the manager of both the trusts. Mauritius was chosen for locating many of these companies because it has emerged recently ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th a share capital of only $4. This might seem to indicate that the company was a mere front, an insignificant entity incapable of substantial investment handling. Such an inference, however, would not be correct, for it is seen that the company advanced a loan of more than 1 million US dollars to a Canadian group through shareholders' capital contributions. Muchimportance need not, therefore, be attached to this circumstance. Secondly,one would certainly be too naive if one were to believe that self interestand tax considerations did not enter the picture. No doubt the American company and several subsidiaries thereof hope to make substantial profits. No doubt also, tax considerations did enter largely into their calculations. It indeed finds place in the private placement memorandum. At page 40, reference is made to the advantages of the DTAA: "Limited life company interests = Indian tax considerations: In order to benefit from favourable treatment under the India-Mauritius Double Taxation Treaty (the 'treaty'), the company will file with the investee companies in which it owns stock, a no objection certificate from the Indian Tax Department granting benefits under the treaty f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tax at specified rates not exceeding35 per cent. It is the intention of the company in Mauritius that it may elect to pay tax on income distributions received from its investments in India at a rate, which, when offset by the credits available in respect of tax withheld in India on payments of income to the company in Mauritius, will result in a net payment in Mauritius in respect of such distributions at a maximum rate of one per cent. No tax on capital gains will be payable in Mauritius on disposals by the company of its investments in India." And U.S. tax considerations are then dealt with. But it cannot be said that the disabling requirement of section 245R (2) is attracted here. On behalf of the applicant several circumstances have been indicated which induced the setting up of the IC and the IM in Mauritius and these are certainly relevant considerations. When there are several relevant considerations which have weighed with the parties to evolve a particular arrangement, it cannot be described as one "designed, prima facie", for the avoidance of Indian Income-tax. The existence of tax concessions under the DTAA was one of the factors taken into account but was not the only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (1) applies, the trustee cannot be assessed on the aggregate income received by it. The assessment in the name of the trustee in terms of the sub-section can be made in two ways. The Assessing Officer may make as many assessments, in the name of the trustee, as there are beneficiaries and levy the tax appropriate to such income at the rate of tax applicable to the total income of each beneficiary. Or, he may make a single assessment on the trustee but indicate therein the share income of each beneficiary and the tax attributable to it. In other words, in the present case, if section 161 were to apply, the CT cannot be assessed on the total income derived by it from its investments and the assessment qua the IC, should indicate, inter alia, the income distribution made to it and levy the tax appropriate thereto after taking into account such reliefs and concessions as may be available to it. To the above rule, however, three exceptions have been in corporatedin the Act: (a) Under section 161(1A), this rule of apportionment and determination of proportionate tax attributable to the beneficiary will not apply to any income earned by the trustee as profits and gains of a business. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the Asian Development Bank, a core investor. In addition, trust fund investments may include holdings of listed companies that could be of particular benefit to the fund." Under this paragraph, the IC can also invest directly in projects in the infrastructure sectors and this can be on terms and conditions which may amount to the carrying on of a business. Under paragraph 6.05 of the I.M.A., it can, though temporarily, invest in "high quality short term debt instruments in accordance with the quality guidelines set forth in the private placement memorandum", a relevant extract from which has been set out earlier. The DR would describe, at least a part of the income of the CT, as profits and gains from a business of "providing financial assistance and money market operations". He says that its activities are analogous to those of organisations like the Industrial Credit and Investment Corporation of India (ICICI) or the Industrial Development Bank of India (IDBI) which return, and are assessed on, income from business and of the Unit Trust of India (UTI) which is deemed to be a company and whose income would be assessable as business income but for the exemption it enjoys under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dic intervals could amount to a business. It cannot be postulated in the abstract that none of the surpluses of the activities carried on by the CT could amount to profits and gains of business at all. All that the Authority can say now is that if any income of the CT is found to be assessable as profits and gains of business, the Assessing Officer will be entitled to assess such income under the provisions of section 161(1A) or the proviso to section164(1), as the case may be, at the maximum marginal rate. Turning then to objection (b) referred to in paragraph 33 (at page503) above, is the income of the CT liable to assessment under section161 (1) or are the provisions of section 164(1) attracted? Section 164(1) will not be attracted unless it can be postulated that the shares of the beneficiaries of the income are indeterminate or unknown, having regard to the terms of the Explanation. For this purpose, one has to examine the provisions of the T.D. Paragraph 5 says that the income accruing under the trust shall be distributed among the beneficiaries in equal proportions so far as the initial settlement to be returned on the termination of the trust is concerned and, as regards o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ties would be willing to recast the wording of paragraph 6.01 placing this beyond all doubt. The proposed modification was as follows: "6.01. Distributions. Income received by the trust in respect of the contribution fund will be a charge on the income of the contribution fund, and will be distributed annually or at such direct intervals as the trustees may in their absolute discretion think fit, in proportion to the contributions made by the contributors. The contribution fund may also declare special distributions. The method by which the distribution will be made and the allocation of income between the contributor and the investment manager are as set out in sections 6.02 to 6.07 and will depend upon the source of the income." However, this alternation also did not answer the second criticism of the DR and the AR agreed that this will also be set right by inserting, after the words "special distributions" in the proposed paragraph, the words "Such special distributions shall also be made to the contributors in proportion to the respective contributions made by them". This has been reiterated by counsel in a letter dated June 27, 1996, addressed to the Authority but the revise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l be proportionate to their contribution and the DR's objection would no more be valid. The second objection based on paragraph 6.02 is this. Paragraph 6.02provides that the distributable income will be determined after adding back the "fees and share of profit to the investment manager" which the DR says, is absurd as it will not be possible to distribute the income without making payment of the fee and share of profit to the IM. He also sub-mitted that the provision in this paragraph enabling the trustees to deduct, in computing the net profits, "capital expenditures as the investment manager shall reasonably determine" also renders the share income indeterminate. The AR contended that this clause does not place any obstacle in the way of determination of the share income of the contributortors but would only involve the use of a simple algebraic formula for making the computation. He, however, agreed that, with a view to avoiding any unnecessary controversy in the matter, the parties are willing to delete the words "including distribution of fees and share of profit to the investment manager" occurring in this clause. He contended that the second criticism of this paragraph by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lying a rule of three. Moreover, these factors may have some impact on the determination or computation of the distributable income but have no impact on the identity of the beneficiaries or in the share of income that is to be distributed to them. His third point was that while under paragraph 2.06, a defaulting contributor will not be entitled to any distribution after the date of his default, this clause provides for a distribution even to such contributors. This, he says, will disturb the inter se proportion vis-a-vis contributions that is sought to be maintained otherwise. The AR stated that as a point of possible conflict has been raised, the parties are prepared to amend paragraph 6.04 to read thus: "6.04. Income and expenses from other sources. Subject to paragraph 2.06(3), all distributions of income, gain, loss or expenses not directly attributable to a particular portfolio investment (e.g., interest on temporaryinvestments and the contribution fund's share of any advisory fees netof general operating expenses) shall be distributed to the contributor inproportion to their capital contributions." There is a slight mistake here as the reference in this amendmentshould rea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provision in the CA regarding the rights ofmembers who default in payment of the contributions demanded fromthem in compliance with their commitment (paragraph 2.06). This objec-tion calls for detailed consideration. The scheme under which the income distributions are to take placeunder the TD is somewhat complicated but the basic principle is quiteclear. The fund is initially set up with minimum commitment of ₹ 750million as on the date of the trust deed but the IM can stage closings forsubsequent commitments up to a period of 12 months thereafter (para-graphs 2.04 and 4.04 of CA). Naturally later commitments will be receivedonly after the date of the trust deed. The trust deed will contain only thenames of those who have agreed to contribute up to the date of the TD.However, on the terms of the trust deed, income distributions will haveto be made to the persons who have agreed to contribute to the trustmuch later. But this creates no difficulty as the contributors are known.A difficulty may arise here since a contributor will not be called upon topay up the entire amount of his commitment at one time. It is left to theIM to call for such amounts from the contributors as m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e sharesshould be expressly stated in the TD, proceeds to say that they should alsobe ascertainable from it. It may, therefore, be useful to study the historyof this provision and examine the object of the introduction of the Explana-tion. Section 164(1) was in the Act when it was enacted in 1961 but itswording underwent a change, introducing a concept of taxation at marginalrate in 1970 by the Finance Act of 1970 with effect from 1st April, 1971.The object and scope of this amendment were elaborated in a circular ofthe Central Board of Direct Taxes (CBDT) (Circular No. 45 dated 2ndSeptember, 1970 (see [1971] 79 ITR (St.) 33)) as under (at page 46): "Private discretionary trusts. Under the provisions of section164 of the Income-tax Act before the amendment made by the FinanceAct, 1970, income of a trust in which the shares of the beneficiaries areindeterminate or unknown, is chargeable to tax as a single unit treatingit as the total income of an association of persons. This provision affordsscope for reduction of tax liability by transferring property to trustees andvesting discretion in them to accumulate the income or apply it for thebenefit of any one or more of the beneficiari ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om these extracts it would seem that the object of the amendmentsto the provision was only that the distribution of the income should notbe entirely at the discretion of the trustees and that the trust deed shouldregulate the shares. The DR contends that the beneficiaries under the TD here are neitherknown nor are their shares determinable as on the date of the trust deed.The AR, on the other hand, contends that the section does not require thenames of the beneficiaries or the extent of their shares to be mentionedin the TD. It is sufficient if it provides a formula for their ascertainment.To construe the section as requiring more would defeat the object of theprovision and render it impracticable and unworkable. Such an interpre-tation, he urges, should be avoided. In support of this contention, herelied on certain decisions of the Supreme Court. Interpreting the scopeof section 2(15) of the Act, the Supreme Court in CIT (Addl.) v. Surat ArtSilk Cloth Manufacturers Association [1980] 121 ITR 1, observed that "ifthe language of a statutory provision is ambiguous and capable of twoconstructions, that construction must be adopted which will give meaningand effect to the other provis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... If a strict and literal construction of the statute leads to an absurd result, i.e., a result not intended to be sub served by the object of the legislation ascertained from the scheme of the legislation, then, if another construction is possible apart from the strict literal construction, then, that construction should be preferred to the strict literal construction and, again, where the plain literal interpretation of a statutory provision produces a manifestly unjust result which could never have been intended by the Legislature, the court might modify the language used by the Legislature so as to achieve the intention of the Legislature and produce a rational result." The AR contends that a similar situation prevails here and should be dealt with in like manner. There is force in his contention. The whole object and intent of the section, as amended, is to prevent the shares of beneficiaries being manipulated at the discretion of the trustees. If it is read as requiring the specification of the beneficiaries and their shares in the deed itself, it may lead to absurdities. A trust is very often created to benefit a class of beneficiaries who may exist on the date of the trust ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndividual shares. For e.g., if a deed were to say that four beneficiaries should share the income equally or in the ratio of 1: 2: 3: 4, it must be considered to have expressly stated the individual shares through a process of arithmetical computation is necessary to arrive at the individual shares. This rule can be said to be satisfied even in a more complicated example. For instance, if the deed were to say that the settlor's five grandchildren will get the income each male adult being entitled to four times the share of minor and twice the share of a female included in the class, there is no difficulty in saying even in such a case that the individual shares are expressly stated in the trust deed. The words "and are ascertainable at the date of the instrument" will in any event apply in such cases, though they are actually intended to cover a slightly different type of case where the number of beneficiaries are not known at the date of the deed but the shares are ascertainable by reference to the specifications and directions given in the deed itself. Thus, to take the examples given above, a trusteed providing that the sons of the settlor should receive the income would fulfil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e relevant valuation date that the beneficiaries are known and their shares are determinate, the possibility that the beneficiaries may change by reason of subsequent events such as birth or death would not take the case out of the ambit of sub-section (1) of section 21. The position has to be seen on the relevant valuation date as if the preceding life interest had come to an end on that date and if, on that hypothesis, it is possible to determine who precisely would be the beneficiaries and on what determinate shares, sub-section (1) of section 21 must apply and it would be a matter of no consequence that the number of beneficiaries may vary in the future either by reason of some beneficiaries ceasing to exist or some new beneficiaries coming into being. If, on the relevant valuation date, it is not possible to say with certainty and definiteness as to who would be the beneficiaries and whether their shares would be determinate and specific, if the event on the happening of which the distribution is to take place occurred on that date, the case will be governed by sub-section (4) of section 21." The Authority is of opinion that the question: "Has the Explanation superseded this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the provisions contained in the Agreement for Avoidance of Double Taxation between India and Mauritius (DTAA). The point arises this way. The income earned by the CT from the investments made in India may be in the nature of dividends, interest, capital gains, and perhaps also, business income. Will the aliquot part of this income, when distributed to the IC partake of the same character ? The answer prima facie may appear to be that it cannot. For example, the CT may receive dividends in respect of the investments made by it in various companies. But so far the IC is concerned they cannot be dividends since this company has made no investments in shares of companies but is just receiving a share of the income of the trust in which receipts of various kinds are mingled. This answer, however, does not take into account the effect of the application of section 161. This section treats the trustee as having a representative character. The assessment on the trustee is to be in like manner and to the same extent as if it were made on the beneficiary himself directly. The practical effect of this provision is to render the assessment of the trustee and beneficiary identical in every r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... security of the State Government issued income-tax free shall be payable by the State Government. No tax on interest on such securities is payable by the assessee. After ascertaining the income and after giving the exemptions, the income-tax authority has the option to assess the beneficiary directly or, in respect of the same income, the trustee on behalf of the beneficiary. This construction finds support in the decision of the Bombay High Court in CIT v. Balwantrai Jethalal Vaidya [1958] 34ITR 187. If that be the scope of the assessment under section 41 of the Act, we find it difficult to appreciate the contention that the interest on securities in the hands of the trustee becomes an income other than such interest in the hands of the beneficiary. The interest retains its character whether the assessment is made on the trustee or the beneficiary. We cannot, therefore, accept the construction put upon section 41 of the Act by the High Court." In P. Krishna Warrier's case [1970] 75 ITR 154 (SC), the assesse hadsettled his business in Ayurvedic drugs on trust. He directed the trustees to maintain a school and hospital that had been set up by him out of 60per cent. of the income f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at, in making an assessment on an assessed in respect of a beneficiary, the assessment should be made as if the income in question had been directly earned by the beneficiary and not the trustee. The Supreme Court has thus read the effect of section 41 of the 1922 Act (section 161 here) as obliterating, except for the facility of making an assessment on it, the personality of the trust and of assessing the trust (for the beneficiary) as he would have been assessed had he been earning the income himself directly, instead of through the trust. The argument of learned counsel for the applicants that the character of the income for purposes of the assessments in so far as they relate to the investor company cannot be different from its character in the hands of the trust has, therefore, to be accepted. Dividends, interest and capital gains included in the distributable income would be dividends, interest and capital gains in the hands of the investor company to an a liquot extent. The consequence of the above conclusion results in benefits to the IC under the DTAA. This agreement confers certain benefits on a resident in Mauritius within the meaning of the DTAA in respect of various c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this article . . . Article 13 CAPITAL GAINS (1) Gains from the alienation of immovable property, as defined in paragraph 2 of article 6, may be taxed in the Contracting State in which such property is situated. (2) Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enter-prise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enter-prise) or of such a fixed base may be taxed in that other State. (3) Notwithstanding the provisions of paragraph 2 of this article, gains from the alienation of ships and aircraft operated in international traffic and movable propert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t articles 10 and11 and would fall within the purview of article 22 with the consequence that they can be charged to tax only in Mauritius and not in India. The advantage to the IC is that at Mauritius it is not liable to tax unless it elects to pay tax at specified rates not less than 15 per cent. and not exceeding 35 per cent. (vide page 41 of the placement memorandum). (Inparanthesis, it may be observed that when it was pointed out at the hearing that this seemed to be a rather unusual type of provision that gives the assessee an option of choosing his tax rate, it was stated by counsel that a provision of such nature can be found even under the Indian law: for, e.g., see section 44AD of the Act. But that is really a different kind of provision giving an option to the Revenue to estimate the income at a prescribed rate or a higher income declared by the assessee). Ingenious as this argument is, the Authority is of the view that it cannot be accepted as it cuts across the principle behind section 161 on which he has built up his argument, relying on the Supreme Court decisions, that the assessment on the IC should be made as if it were in direct receipt of the income and not thro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The other point raised by the AR also raises certain difficulties. Hebases his claim for having the CG assessed at 20 per cent. on the language of section 112 of the Act. This provision may now be extracted, to the extent relevant, for facility of easy reference: "112. Tax on long-term capital gains. (1) Where the total income of an assesse includes any income, arising from the transfer of a long-term capital asset, which is chargeable under the head 'Capital gains' the tax payable by the assesse on the total income shall be the aggregate of, - (a) in the case of an individual or a Hindu undivided family, being a resident,- (i) the amount of income-tax payable on the total income asreduced by the amount of such long-term capital gains, had the total incomeas so reduced been his total income; and (ii) the amount of income-tax calculated on such long-term capital gains at the rate of twenty per cent.: Provided that where the total income as reduced by such long-term capital gains is below the maximum amount which is not chargeable to income-tax, then, such long-term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maxi-mum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be assessed to tax. Should it be treated as an "individual", "domestic company" or "association of persons"? The second's: what are the rates at which the CG part of its total income should be assessed; at the maximum rates as directed by section 164 or at the appropriate rate applicable under section 112(1)(a), (b) or (d), as the case may be ? The AR contends that the assessment should be made in the status of "individual" and that the rate of 20 per cent. Prescribed by section112 (1) (a) will apply. The first question thus is whether the AR is right in claiming that whereas, if an assessment is made on the CT as trustee qua Investor Company, the status should be taken as that of the beneficiary, viz., as a "company", assessment under section 164 on it will have to be in the status of an "individual". He prefers this status because of the rate of 20per cent. Prescribed under section 112(1) (a), in contradistinction to the rate of 30 per cent. under section 112(1)(b) or (d). In support of his contention, Sri Dastur relies on the decisions of the Supreme Court in trustees of Gordhandas Govindram Family Charity Trust's case [1973] 88 ITR 47and in Nizam's case [1977] 108 ITR 555. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A) of section 161 or section 164 or section164A or section 167B of the Income-tax Act, 1961 (43 of 1961) (hereinafter referred to as Income-tax Act), apply, the tax chargeable shall be deter-mined as provided in that Chapter or that section, and with reference to the rates imposed by sub-section (1) or the rates as specified in that Chapter or section, as the case may be: Provided that the amount of income-tax computed in accordancewith the provisions of section 112 shall be increased in the case of adomestic company by a surcharge as provided in Paragraph E of Part Iof the First Schedule: Provided further that in respect of any income chargeable to taxunder section 115B, or in the case of a domestic company having a total income exceeding seventy-five thousand rupees, under section 115BB ofthe Income-tax Act, the income-tax computed shall be increased by asurcharge calculated at the rate of fifteen per cent. of such income-tax.'' This not only makes section 112 applicable in such a case and pro-vides for a surcharge in addition, where the assessee is a domestic com-pany, to the rate of 30 per cent. Where, however, the assessment is onemade under section 164, the choice has to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lable to him in either Contracting State, he shall be deemed to be aresident of the Contracting State in which he has an habitual abode; (c) if he has an habitual abode in both Contracting States orin neither of them, he shall be deemed to be a resident of the ContractingState of which he is a national; (d) if he is a national of both Contracting States or of neitherof them, the competent authorities of the Contracting States shall settlethe question by mutual agreement. (3) Where by reason of the provisions of paragraph 1, a personother than an individual is a resident of both the Contracting States, thenit shall be deemed to be a resident of the Contracting State in which itsplace of effective management is situated." Clause (2) of this definition is not relevant for the present purposes.The residential criterion has to be decided only with reference to clauses(1) and (3). Taking up clause (1), it is argued by the AR that the companiesare liable to tax in Mauritius. They are incorporated there-the certificatesof incorporation as well as tax residency certificates to the effect that thecompanies are resident in Mauritius under the Income-tax Act, 1995, ofthat country have been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idual in that case wasa 'resident' of India within the meaning of article 4(1) (in that case,identified with the one here) as he was liable to tax on his Indian income.There was a liability on him to Indian income-tax based on the criterionof residence, etc., and this was sufficient for purposes of the article. TheAR contests the correctness of this part of that ruling as, according to him,if that principle is applied, all persons (individuals, companies or otherassociations, wherever living) would be resident of India for purposes ofthe DTAA. This authority has pointed out in Mohsinally AlimohammedRafik's case [1995] 213 ITR 317 (AAR), that there is no substance in thisobjection because: (i) a person seeks relief under the DTAA in India onlywhen he is subjected to tax here and so there would be no error in sayingthat he is liable to tax in India within the meaning of article 4(1); and(ii) the article itself provides for the eventuality of a person being residentin both countries and prescribes tie-breaker tests to meet the situation.Hence, his contention that the IC and the IM are not resident in Indiacannot be accepted. Nor can the interpretation by the DR of article 4(3)be accep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CT assessable under the head "Profitand gains of business, profession and vocation" in the hands of the investorcompany when an assessment is made on the CT under section 161. Thissituation is dealt with in article 7 of the DTAA which makes such incometaxable only if the investor company has a permanent establishment inIndia and the income is attributable to such permanent establishment(PE). There are no facts to suggest that, apart from barely investing thefunds, the investor company has any office, place of business or otherapparatus that would come within the definition of permanent establish-ment in article 5 of the DTAA. It is true that section 161(1A) provides fora tax at the maximum rate on the income from business in the hands ofa trust but the beneficiary here being eligible for the benefit of the DTAA,that benefit can be availed of under section 90(2) of the Act. The Authority,therefore, accepts the plea of counsel for the investor company that incase there are any business profits earned by the CT and an aliquot sharethereof is distributed to the investor company, such distribution will notbe liable to income-tax in India. The discussion thus far disposes of the issues ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... investment manager unless otherwise agreed to bythe trustee. Thirdly, the investment manager also enters into separatecontracts with the Indian financial services company and the Americancompany as investment advisors. The terms and conditions of the draftinvestment advisory agreement with the Indian financial service companyhave already been set out. The Indian financial service company and theAmerican company team of advisors provide the investment manager withthe advisory services, consulting services and assistance in the identifi-cation, analysis and review of the investments of the CT. From the termsof the advisory agreement, it is also seen that the investment advisorsmay function with the help of service units. But these only appear to beadvisory bodies in no way controlling the decision of the board. The provisions of the investment management agreement, however,contain certain provisions which require consideration. Reference may befirst made to paragraph 2.01 under which the investment manager agreesto provide and be responsible for day to day management and adminis-trative services to the trust fund in accordance with the provisions of theagreement and any directions a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o asentence occurring at page 40 of the placement memorandum which hasbeen extracted earlier. Attention was also drawn to paragraph 10.01 of theIMA under which the functions of the investment manager will includethe engagement of "professionally skilled and/or experienced personnelto provide the necessary advisory and investment managerial support and/or guidance to the portfolio and investment and the entrepreneurs andif necessary to assist in the administration of the trust fund". It wascontended that the amplitude of this clause was so wide as to enable theinvestment manager to carry on its work and functions with the aid ofits own personnel rendering services in India. The AR replied to thisobjection by saying that this clause should be read with paragraph 13.04and that it only envisages the appointment of professionally skilled personsto assist the IM in the discharge of its functions. He also explained thatthe passage at page 40 of the placement memorandum pertains to theinvestor company and not the investment manager. He, however, saw the force of the arguments of the DR. Counsel, bytheir letter dated June 27, 1996, have proceeded to give the followingundertaking: "During ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for example, establish an office in India to facilitateits functions. It could have agents and other persons of that type to helpit in discharging its functions. Or again if the activities became toonumerous it can also make use of paragraph 10.01 to appoint its ownemployees or personnel to carry on its activities in India. The AR placedconsiderable reliance on clause 5 of article 5 of the DTAA. He pointed outthat the mere presence of professional agents or independent parties dealtwith at arm's length for carrying out its activities in India would notamount to the setting up of a permanent establishment in India. That isno doubt true. But one cannot anticipate in what manner the investmentmanager will organise its activities. The language of paragraph 10.01 issufficiently wide to enable it to carry on its activities, if not through anoffice in India, at least through its own employees and other personnelfunctioning in India and looking after some or all of its operations. It istrue that some changes in paragraph 10.01 have been made and counselhave given certain assurances in their letter of 27th June, 1996. These areno doubt of some help but the absence of a clause such as parag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rom such payments. Before parting with the case, reference must be made to two matters.The first is this. Reference has been made in the course of the discussionsto the consent of counsel to make certain changes in the draft instrumentsto meet the criticisms raised by the other side. This may seem to be asomewhat unusual procedure but there is nothing wrong in it. The appli-cants are seeking a ruling on certain proposed transactions which havenot yet materialised. There could be no objection to their revising theproposed drafts so as to be beyond the pale of criticism. The Authorityhas, however, ensured that there is no ambiguity about the changes madeby indicating both the changes and the reasons for them in bold lettersin this order. That apart, the changes in the draft have to be made by theIndian financial service company, the IC, the IM and the trust company,as the case may be. The Authority has been informed by counsel's letterdated June 27, 1996 (in each of the cases), of the precise terms of thechanges effected in the various documents and presumes that these modifi-cations have been by the persons respectively competent to effect thesechanges. The ruling given by this ord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rse of open business operations to benefit India and its placementmemorandum has been circulated to prospective investors. The Indianfinancial service company is actively interested in securing participationfrom Indian investors. It would, therefore, seem that publicity of the setupproposed is actually being solicited by the applicants. The Authority, there-fore, does not consider that there is any element of confidentiality involved.The Authority is, therefore, of the opinion, having regard to the importanceof the various questions raised by the applicants in the present cases, bothon the interpretation of sections 112, 161 and 164 of the Act as also ofseveral important treaty provisions of the DTAA with Mauritius, that itis desirable to publish the rulings. The Commissioner of Income-tax onthe Authority is, therefore, directed to have the rulings on these applica-tions also published in due course. However, in doing so, he may carefullyexamine the contents of the rulings and consider the possibility of expunc-tion therefrom of references to persons, figures and other like details ofa personal nature to the extent it can be done without detracting froma proper comprehension of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncome earned by the contributory trust as per the provision ofsection 161 of the Income-tax Act, 1961 (the Act) ? Question No. 2: Based on the facts and circumstances of the case,whether the contributory trust would be regarded as a 'see through' or'transparent entity' vis-a-vis the applicant; i.e., to say, the applicant willbe taxed in respect of its proportionate share of income under section 161of the Act ? Answer Nos. 1 and 2: The applicant company can be assessed andmade liable either directly or through the CT only in respect of its propor-tionate share of income derived from the CT. Question No. 3: Based on the facts and circumstances of the case,if it is held that the provisions of section 161 do not apply to the incomeof the applicant from the contributory trust because of the power vestedin the trustees to add to the list of the beneficiaries on the terms laiddown in the indenture of trust and the contribution agreement, then ifsuch power is deleted, would the assessment of the applicant in respectof its proportionate share of income of the trust be made in accordancewith section 161 ? Answer No. 3: Yes. As the trustees' power to add to the list ofbeneficiaries has be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... econtributory trust will be chargeable to tax at normal rates. Question No. 9: Whether, on the facts and in the circumstances ofthe case, the applicant's share in the capital gains earned by the contribu-tory trust will be chargeable to tax ? Answer No. 9: The capital gains embedded in the applicant's shareof distributions made by the CT will be exempt from tax under article13. Question No. 10: Based on the facts and circumstances of the case,whether there would be any withholding tax liability on the CT in respectof the distributions made to the applicant ? Answer No. 10: The CT would be liable to withhold tax from thedistributions made to the applicant in so far as such distributions areattributable to dividend and interest income earned by the trust. Question No. 11: Whether, on the facts and in the circumstances ofthe case, the applicant's proportionate share in the surplus arising on therealisation of the investments made by the contributory trust wouldconstitute capital gains ? Answer No. 11: It is difficult to give a ruling on this question at this stage. The surplus arising on investments pure and simple will be capital gains in the hands of the CT. But circumstances ..... 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