Colourable buy-back treated as dividend, with tax withholding required on remittance to the Mauritius shareholder.

AAR examined whether a proposed share buy-back involving a Mauritius shareholder was a colourable device to avoid Indian tax and, on the facts, found it lacked commercial substance and was structured to repatriate accumulated profits without tax on distributed profits. It treated the payment according to its true character as a distribution of profits, making it taxable in India as dividend under the domestic law and treaty framework. Because the remittance was held taxable, the applicant was also required to deduct tax at source on payment to the Mauritius shareholder.

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Issues: (i) whether the proposed buy-back of shares was a colourable device devised for avoidance of tax and therefore taxable as dividend under the Income-tax Act and the India-Mauritius DTAC; (ii) whether the applicant was required to withhold tax on the remittance of the buy-back proceeds to the Mauritius shareholder.

Issue (i): Whether the proposed buy-back of shares was a colourable device devised for avoidance of tax and therefore taxable as dividend under the Income-tax Act and the India-Mauritius DTAC.

Analysis: The arrangement was examined in the context of the prolonged non-payment of dividends after the introduction of dividend distribution tax, the accumulation of reserves, the selective acceptance of the buy-back offer by the Mauritius shareholder, and the treaty position under which capital gains would not be taxable in India. The Authority held that the earlier order permitting the application did not bar reconsideration of the avoidance objection. On the facts, the proposed buy-back was found to lack commercial substance and to be structured to repatriate accumulated profits without attracting the tax on distributed profits. Once treated as a colourable transaction, the arrangement could not be recognised as a genuine buy-back for tax purposes and the payment was to be characterised in substance as a distribution of profits.

Conclusion: The issue was decided against the applicant and in favour of the Revenue. The proposed payment was held taxable in India as dividend under the applicable treaty and domestic law framework.

Issue (ii): Whether the applicant was required to withhold tax on the remittance of the buy-back proceeds to the Mauritius shareholder.

Analysis: Having held the proposed remittance taxable in India as dividend, the Authority considered the withholding consequence under the Income-tax Act. The taxability finding necessarily attracted the obligation to deduct tax at source on the remittance of the amount abroad.

Conclusion: The issue was decided against the applicant and in favour of the Revenue. The applicant was held liable to withhold tax on the proposed remittance.

Final Conclusion: The ruling determined that the proposed buy-back could not be treated as a genuine tax-free capital transaction and that the remittance was taxable in India with corresponding withholding obligations.

Ratio Decidendi: A transaction lacking real commercial substance and devised to avoid taxation on distributed profits may be disregarded and taxed according to its true character, including as dividend where the statutory definition is attracted.

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