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TMI Blog2020 (1) TMI 1470X X X X Extracts X X X X X X X X Extracts X X X X ..... er the said income is passed on to the participants in its entirety is a separate issue and stage 2 of transaction and has nothing to do with accrual of income in India. On the one hand we have participants who have not directly invested in India and on the other hand there are funds who are not legal and taxable entities of Netherlands. The treaty benefits are admissible if the stipulations contained in the convention are fulfilled by the entities. For claiming treaty benefits, the entity has to satisfy the definition of person and resident under the treaty articles. In the cases before us, articles 1, 3 and 4 read together clearly point that treaty benefit is not available to fiscally transparent entity as it is not a taxable entity in Netherlands. In order to qualify as resident of a contracting State one needs to qualify as person as per the definition given in the tax treaty. Here the funds are neither persons nor residents of Netherlands. Secondly India has not concurred with the view in OECD commentary and has elucidated by stating that there is need for enabling provision in treaty to allow the treaty benefit to beneficiaries of transparent entities. It is also ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd 3 have raised the following questions before this authority : 3. Questions raised in application Nos. AAR/1358/2012), AAR/ 1359/2012 and AAR/1361/2012 1. Whether the income arising to PQR and STU from investment made in securities in India out of the contributions made by ABC, DEF or GHI will be assessed in the hands of ABC, DEF or GHI, as the contributions made by it to PQR and STU will be considered as, revocable transfer under section 61 of the Act ? 2. If the answer to question 1 is in the positive, given that the applicant is a resident of Netherlands, whether such income is taxable in India in view of article 13 of the India-Netherlands Double Taxation Avoidance Agreements (DTAA) ? 3. If for any reason the contribution made by the participants is not treated as revocable transfer, then would the income arising to PQR and STU be assessed in accordance with the provisions of section 161 of the Act ? 4. If the answer to the above question 3 is in the positive, given that the applicant is a resident of the Netherlands then by virtue of article 13 of the India-Netherlands Double Taxation Avoidance Agreement whether any part of the capital gains chargea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cants 4 and 5 are responsible entities of PQR and STU. The applicants 1 to 3 have invested in PQR and STU (the funds). PQR and STU are registered with Securities and Exchange Board of India (SEBI) as a sub-account of The Funds Asset Management BV (TFAM BV) and TFAM BV is registered with Securities and Exchange Board of India as a Foreign Institutional Investor (FII). 5. PQR and STU are a funds for joint account (FJA) (fonds voorgemene rekening (FGR)). As per the Dutch laws, a FGR does not have a separate legal status of its own. An FGR arises pursuant to a contractual arrangement between a fund manager, fund custodian and its investor (known as participants). A management and custody agreement are formed between the fund manager and custodian. Under the Dutch laws, an FGR does not have a separate legal status of its own. Thus, it is not regarded as a taxable entity for Dutch tax purposes. Further, the Dutch tax laws specifically include the entities which are considered as taxable entities in Netherlands. However, an FGR has been excluded from the said list of taxable entities. 6. Consequently, all income and gains derived by the FGR is attributed to the investors in p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd is offered to tax by them at the rate of 25 per cent. in the Netherlands. 13. The applications were admitted by the Principal Bench of this authority vide order dated February 13, 2017. Applicant's contentions 14. The learned authorised representative has contended that as per sections 60, 61 and 62 of the Income-tax Act, 1961, a transfer shall be deemed to be revocable transfer if it contains any provision for the retransfer directly or indirectly of the whole or any part of the income or assets to the transferor, or it, in any way, gives the transferor a right to reassume power directly or indirectly over the whole or any part of the income or assets. 15. It is reiterated that as per article 8(1) of the Master Funds Management and Custody Conditions, 2012, a participant shall be entitled to terminate or reduce its interests in one or more of the respective investment funds by exchanging its participations in whole or in part for the selling prices (repayment). Thus, the Master Funds Management and Custody Conditions, 2012 contains a provision for the retransfer directly or indirectly of the whole or any part of the income to the transferor at any point ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only in the Netherlands as per the provisions of article 13 of the India-Netherlands treaty. Thus, the income earned by PQR and STU on transfer of Indian securities is taxable in the hands of its participants in the Netherlands. The income earned from PQR and STU by a participant is reported in its return of income filed with the Netherlands Revenue Authorities. Such income earned is offered to tax as capital gains in the Netherlands. In view of the fact that a participant is a tax resident of the Netherlands in terms of article 4 of the India-Netherlands tax treaty and the income earned by the PQR and STU is assessable in its hands, the allocable portion of income earned by it from the said funds should not be taxable in its hands pursuant to article 13 of the India-Netherlands treaty. 18. Without prejudice it is contended that as per the provisions of the Indian Trusts Act, 1882, (Trusts Act) a trust is defined as being an obligation annexed to the ownership of property and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him for the benefit of another, or of another and the owner . 19. The following elements are essential t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s Chapter, be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him. Thus, the income earned by PQR and STU from investing in securities in India would be assessable in the hands of JKL but in the same manner and in the like extent as the participants of these funds would have been assessable in respect of such income. 23. The learned authorised representative argues that the participants of PQR and STU are tax residents of the Netherlands and are eligible to claim relief under the India-Netherlands Double Taxation Avoidance Agreement. Therefore, income of these funds which is distributed to its participants will be taxable only in the Netherlands as per article 13 of the India-Netherlands DTAA. Thus, where the income is directly assessable in the hands of the participants, it will not be taxed in India by virtue of article 13 of the India-Netherlands Double Taxation Avoidance Agreement. Where the income is assessable in representative capacity in the hands of JKL such income should not again be chargeable to tax in India as the assessment would have to be made in the like ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions of the Income-tax Act, the contributions made by participants to PQR and STU as revocable transfer under section 61 of the Act cannot be considered. 27. Further, the Revenue refers to clause 4 of article 8 of Master Funds Management and Custody Conditions dated June 30, 1997 and Basic Fund Conditions of Management and Custody January, 2012- Article 8 . . . (4) Where, in the opinion of the manager, the sale of the underlying investments necessary to raise the funds required for the exchange of the participations would, owing to exceptional circumstances, encounter practical problems in the market, the exchange of participations by the custodian shall be deferred or effected in stages. Every party offering participations affected by this shall be notified hereof in writing and shall be entitled with due speed after receipt of such notification to withdraw in writing its selling instructions. Should there be practical problems in selling investments to raise the funds required for the exchange of participations other than for the reasons stated above, the manager may make other arrangements . . . 28. From the above it is inferred by the Revenue that in v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of company as per section 2(17)(ii) of the Income-tax Act, 1961. 31. The Revenue contends that, section 161 of the Income-tax Act, 1961 deals with the liabilities of representative assessee. However, as stated earlier, the funds fall under the definition of company as per section 2(17)(ii) with an independent status. Therefore, the question of treating the funds as representative assessee of the applicant does not arise. Further, the Department has submitted that in a typical trust arrangement, there are three separate and distinct entities, i. e., settlor, trustee and beneficiary. However, in the instant arrangement, the entity which has parted away its asset, i.e., settlor and the entity which is beneficiary, i.e., applicant are not different, separate and distinct entities but are one and the same. Hence, it can be stated that the current arrangement under consideration in no way resembles trust, trustee and beneficiary arrangement. Hence, the provisions of section 161 of the Income-tax Act will not be applicable to the applicant. 32. Further, fund PQR and STU to be eligible as representative assessee of the applicant, they must receive or be entitled to receive inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the participants as if the participants are investing directly in the investment assets. Therefore, a close-ended FGR is treated as tax transparent entity in their jurisdiction and does not have a separate tax legal status of its own. (b) Under an open-ended FGR, participation is freely transferable and therefore, it becomes administratively difficult to tax the participants. Hence, an open-ended FGR is treated as tax resident of Netherlands and income of the open-ended FGR is treated as tax resident of Netherlands and income of the open-ended FGR is taxed at the fund level in Nether lands. 37. The funds, namely, PQR and STU are registered with Securities and Exchange Board of India as sub-account of TFAM BV. TFAM BV is registered with Securities and Exchange Board of India as Foreign Institutional Investor. There is no dispute that these funds are not legal or taxable entities in Netherlands and JKL is the custodian of all assets and legal title holder of funds. JKL is a private company incorporated in Netherlands and is tax resident of Netherlands. TFAM BV is a fund manager responsible for management and administration of fund and it is also a private company incorpo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... may be taxed in that other State. 3. Gains from the alienation of ships or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft, shall be taxable only in the State in which the place of effective management of the enterprise is situated. For the purposes of this paragraph, the provisions of paragraph 3 of article 8A shall apply. 4. Gains derived by a resident of one of the States from the alienation of shares (other than shares quoted on an approved stock exchange) forming part of a substantial interest in the capital stock of a company which is a resident of the other State, the value of which shares is derived principally from immovable property situated in that other State other than property in which the business of the company was carried on, may be taxed in that other State. A substantial interest exists when the resident owns 25 per cent. or more of the shares of the capital stock of a company. 5. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3 and 4 shall be taxable only in the State of which the alienator is a resident. However, gains from the alienati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... investors or participants in their respective ratios of invested funds and taxes are borne by these participants in Netherlands and they are also residents of Netherlands, the participants satisfy the treaty requirements and thus the capital gain accruing to them is exempt in terms of article 13(5). 41. The other argument by the applicant is that JKL is custodian and legal owner of these funds held to the account and risk of the participants. JKL is the tax resident of Netherlands and that there is no restriction on the legal owner of the assets to claim the benefit of capital gains exemption under article 13(5) of the treaty. Without prejudice it is contended that under section 161 of the Income-tax Act, JKL being the custodian of funds would be assessable as representative assessee of funds on behalf of the participants and the same shall be taxable in same manner and to like extent as the participants of the funds. Since all the participants are tax residents of Netherlands and are entitled to exemption under article 13(5) of the treaty, the income earned by JKL as custodian is not taxable in India. 42. We have examined the pleas of the learned authorised representati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t State in respect only of income from sources in that State ; and (b) in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries. 45. The provision, quoted above, defines the term resident of a contracting State for the purpose of the Treaty to mean any person who under the laws of that State is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature. In the context of article 4 resident of a contracting State would mean a resident of the contracting State. But this is subject to provisos (a) and (b) to para 1. Proviso (a) says that resident of a contracting State does not include any person who is liable to tax in that State in respect only of income from sources in that State. Proviso (b), states that in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to receive on behalf or for the benefit of any person, such trustee or trustees ; (v) in respect of income which a trustee appointed under an oral trust receives or is entitled to receive on behalf or for the benefit of any person, such trustee or trustees. . . . 48. A plain reading of the above section suggests that at best custodian can be representative assessee under section 160(1)(i) or 160(1)(iv) but the custodian is a resident of Netherlands and certainly not an agent of the participants or the funds. The custodian is not a trust under Indian Trust Act, 1882 and therefore does not fall under section 160(1)(iv). Even otherwise the plea is not convincing for the reason that no income has accrued to the custodian and thus there is no issue of taxing it in the like manner and to the like extent as participants. In any case JKL is not a trust as per Dutch laws or under Indian Trust Act. It is a private limited company incorporated under Dutch laws. It may resemble a trust but it is not a trust. 49. A trust is a legal entity that holds property for the benefit of others and managed by a trustee. Trusts have 4 components : settlor, trustee, beneficiaries, and pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9 ITR (Trib)) : . . . in terms of article 1(1), India-UK tax treaty 'shall apply to per sons who are residents of one or both of the Contracting States'. As to what are the connotations of expression 'resident of a Contracting State', article 4(1) of the treaty provides that, for the purposes of the said tax treaty, term 'resident of a Contracting State' means 'any per son who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature'. It is thus, necessary that the resident can only be 'person' and that person should be 'liable to taxation by rea sons of his domicile, place of management or any other criterion of similar nature'. It is also important to bear in mind the fact that in terms of the provisions of article 3(2), 'a partnership which is treated as a taxable unit under the Income-tax Act, 1961, of India shall be treated as a person' for the purposes of this treaty. To the extent that a partnership is required to be treated as a person, thus, the position is free from any doubt or ambiguity. [para 35] . . ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 71] . . . As it has been observed that the partnership firm is eligible for treaty benefits in the source country even as it is not taxable in its own right in the residence country, the Bench is alive to the fact that the OECD report on partnership does not approve that proposition. As evident from paragraph 40 of the said report reproduced earlier in the order, even when partnership firm is not taxable in the residence in its own right, the treaty entitlements to the firm are to be denied. However, in the same report, at paragraph 56, the OECD report recommends that, in such a situation, the treaty benefits should accrue to the partners in the partnership firm. However, that is a solution rejected by India. [para 77] In this situation, i. e., when the Government of India has rejected the stand taken in the OECD partnership report and the changes made in the OECD Model Convention Commentary as a result of the same, it cannot be open to hold that in the light of the OECD report, the partnership firm must be declined treaty entitlement benefits. The remedy to unintended consequence of a treaty provision in the said report has been rejected, and, therefore, the treatment ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... '. In other words, if the body of individuals or any other entity is not a taxable entity in the concerned State, it will not be a person. The partnership is one formed in Switzerland. Under Swiss law, it is not taxable entity. There is no definition of a person in Swiss law corresponding to section 2(31) of the Income-tax Act, which confers the status of a 'person' on a partnership. If so, going by the inclusive definition in clause (d) of article 3 of the DTAC, it cannot be held that the partnership is a taxable entity in Switzerland. Therefore, the partnership which receives the income cannot claim the benefit of the DTAC between India and Switzerland. In that case, there would be no occasion to apply article 14 of the DTAC on the basis that it is a professional income. [para 12] - In respect of applicant's reliance on the OECD commentary on article 3, it can be said that admittedly, India, not a member of the OECD countries, has not agreed to this and has adopted the position that it can be so, only if provisions to that effect are included in the convention entered into with the State where the partnership is situated. Clearly, there is no such provision i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng in the tax net, the proviso is concerned with actual taxation. Thus it would follow that the term 'resident of USA' for the purpose of the treaty would mean a person who under the laws of USA is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature ; however, in the case a trust, the term 'resident of USA' would apply only to the extent that the income derived by such trust is subject to tax in the USA as the income of a resident either in its hands or in the hands of its beneficiaries. Applying this test of residence to the applicant, it becomes clear that though under the laws of the USA, the applicant is liable to tax by reason of its place of management and place of incorporation and as such 'the tax resident' yet having regard to the wording of proviso (b), the applicant being tax exempt in the USA can be treated as a tax resident of the USA for the purpose of the Treaty only to the extent that the income derived by the applicant is subject to tax in the USA as the income of a resident either in its hands or in the hands of beneficiaries to avai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Kulandagan Chettiar [2004] 267 ITR 654 (SC) ; [2004] 137 Taxman 460 (SC) the hon'ble Supreme Court observed (page 672 of 267 ITR) : Taxation policy is within the power of the Government and section 90 of the Income-tax Act enables the Government to formulate its policy through treaties entered into by it and even such treaty treats the fiscal domicile in one State or the other and thus prevails over the other provisions of the Income-tax Act, it would be unnecessary to refer to the terms addressed in the OECD or in any of the decisions of foreign jurisdiction or in any other agreements. 58. From the above it is apparent that if the tax treaty provides specific provisions which are unambiguous, no reference may be made to the international materials and commentaries. The approach of the Indian judiciary is to interpret the law as per the letter and spirit of the law. 59. On the other hand, Indian judicial forums at various instances have acknowledged the importance of international commentaries in interpreting the provisions of tax treaties. The apex court in Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 (SC), has observed that the commentaries of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs with respect to the same income. It is important to note that a Double Taxation Avoidance Agreement deals with only juridical double taxation., i. e., double taxation on one juridical entity. The decision relied upon by learned authorised representative focuses on economic double taxation aspect to which Double Taxation Avoidance Agreement does not apply. 63. If a specific benefit is to be extended to an entity or to a beneficial owner the treaty, makes special provision for it. In article 12 of Indo-Netherlands treaty at para 2 the recipient of the royalty and fee for technical services who is also the beneficial owner, the tax charged is restricted to 10 per cent. of the gross amount of the royalty or fee for technical services. There is no such similar benefit for beneficial owner in article 13 for taxability of capital gains. 64. Assuming arguendo the contention of learned authorised representative that is the beneficiaries have paid taxes then treaty benefit should arise in their hands, consider a situation where after peeling the layers of fund flow we find that some of investors are residents of Germany, US and UK to whom Dutch-German, Dutch-US, Dutch-UK Treatie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e convention and as a corollary in their absence the treaty benefit cannot be extended to partnership. This view also finds support from various subsequent mutual agreements between Netherlands and US, Norway, UK, Denmark, Sweden, Canada, Germany and Indonesia which provide for the treaty benefit to tax transparent closed FGR. The following link and corresponding article below affirm this view-https ://www.ifcreview.com/articles/2017/september/the-netherlands-a-hybrid-instrument-that-offersa-closed-fund-for-mutual-account/ The Netherlands : A Hybrid Instrument that Offers a Closed Fund for Mutual Account- Leo Neve LL.M FGR's Tax Position FGR has a hybrid tax position. It can organize itself as a closed fund (closed entry) or as an open fund (open entry). Only an 'open' FGR is an 'entity' subject to corporate Income-tax. A 'closed' FGR is not to be confused with a 'closed end' fund. The element 'closed' only relates to the entry and transfer of the participants. A FGR is 'closed' if entry and transfer of participation require the approval of all other participants or the participation can be transferred to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ia-Netherlands treaty. In the alternative India can enter into competent authority agreement with Netherlands to allow treaty benefit to transparent entity. This is in line with similar arrangements Netherlands have with some other countries. 69. In view of the above the questions raised in the applications are answered as under : (i) Application Nos. AAR/1358/2012), AAR/ 1359/2012 and AAR/ 1361/2012 (Questions 1 to 5) No, it will be assessed in the hands of PQR and STU and benefit under article 13 of the India-Netherlands Double Taxation Avoidance Agreement is not admissible to these funds. Other queries raised i. e. whether the contribution made by participants to the fund will be considered as revocable transfer under section 61 or whether the funds are assessable under section 161 are in the nature of alternate pleas have become infructuous in view of the specific finding that the income is assessable in the hands of the funds. (ii) Application Nos. AAR/1360/2012 and AAR/1362/2012 (Questions 1 to 6) No, JKL cannot be considered as a responsible entity of PQR and STU funds and benefit under article 13 of the India-Netherlands Double Taxation Avoidance Ag ..... X X X X Extracts X X X X X X X X Extracts X X X X
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