Substance over form in India-France DTAA gains: AAR treats foreign share sale as transfer of underlying Indian investment and control.

AAR examined whether an advance ruling application was barred under the proviso to section 245R(2) where the arrangement was prima facie designed to avoid Indian income-tax, and held that it could examine the substance of the connected steps and reject the jurisdictional objection. It then treated the sale of shares in a French subsidiary as, in substance, a transfer of the underlying Indian investment and control, and held that the resulting capital gains were taxable in India under Article 14(5) of the India-France DTAA. The alternative under Article 14(6) was not reached.

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Issues: (i) whether the advance ruling application was barred by the proviso to section 245R(2) of the Income-tax Act, 1961 on the ground that the transaction was prima facie designed for avoidance of income-tax in India; (ii) whether the capital gains arising from the sale of shares in the French subsidiary to another French company were taxable in India under Article 14 of the India-France DTAA.

Issue (i): whether the advance ruling application was barred by the proviso to section 245R(2) of the Income-tax Act, 1961 on the ground that the transaction was prima facie designed for avoidance of income-tax in India.

Analysis: The transaction was examined as a series of connected steps beginning with the creation of a wholly owned French subsidiary to hold the Indian investment, followed by transfers of that subsidiary's shares while the subsidiary had no independent business or assets apart from the Indian shareholding. On that view, the arrangement was treated as a pre-ordained structure intended to transfer the underlying Indian assets and control without transferring the Indian shares directly. The Authority held that it was entitled to examine whether the ruling sought related to a transaction designed, prima facie, for avoidance of income-tax and overruled the objection to its jurisdiction.

Conclusion: The application was not barred from consideration under the proviso to section 245R(2); the objection was rejected.

Issue (ii): whether the capital gains arising from the sale of shares in the French subsidiary to another French company were taxable in India under Article 14 of the India-France DTAA.

Analysis: Although the transfer was structured as a sale of shares in a French company, the Authority held that the substance of the arrangement was the alienation of the underlying Indian investment and controlling interest. It further held that Article 14 had to be construed purposively in the context of a scheme designed to avoid Indian tax. On that basis, the gain was treated as arising in relation to the Indian company's assets and control, and not as a transaction insulated from Indian taxation merely because the immediate share transfer occurred in France.

Conclusion: The capital gains from the sale of shares in the French subsidiary were taxable in India under Article 14(5) of the DTAA; the alternative question under Article 14(6) did not arise.

Final Conclusion: The Authority held that the transaction could not be accepted at face value for tax purposes and that the gain was chargeable in India; the ruling was therefore against the applicants and in favour of the Revenue.

Ratio Decidendi: A transaction structured as a share transfer in a foreign intermediary may be disregarded for Indian tax purposes where, on a holistic view, it is a pre-ordained device to transfer the underlying Indian assets and controlling interest and to avoid capital gains tax in India.

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