2014 (8) TMI 606 - HC - Income Tax

Indian Court: Capital gains on shares by Mauritian firms not taxable, no withholding tax.

Director of Income Tax (International Tax) Versus Copal Research Limited, Moody’s Group Limited, Moody’s Analytics, USA

The court upheld the ruling that the capital gains from the sale of shares by Mauritian companies were not taxable in India under the India-Mauritius ... Capital gain on sale of shares of Indian company by one Non resident to another Non resident outside India – Liability to deduct TDS u/s 195 - Whether the two transactions i.e. for sale and purchase of CRIL shares and Exevo- USA shares are designed prima facie for avoidance of income tax under the Act and whether the applications in respect of the said transactions were liable to be disallowed by the AAR in terms of Clause (iii) of Proviso to Section 245R(2) of the Act – introduction of the Explanations 4 and 5 to Section 9(1)(i) of the Act as being clarificatory by virtue of Finance Act, 2012 - Held that:- The object of Explanation 5 was not to extend the scope of Section 9(1)(i) of the Act to income, which had no territorial nexus with India, but to tax income that had a nexus with India, irrespective of whether the same was reflected in a sale of an asset situated outside India. Viewed from this standpoint there would be no justification to read Explanation 5 to provide recourse to section 9(1)(i) for taxing income which arises from transfer of assets overseas and which do not derive bulk of their value from assets in India. In this view, the expression “substantially” occurring in Explanation 5 would necessarily have to be read as synonymous to “ principally”, “mainly” or at least “majority”. Explanation 5 having been stated to be clarificatory must be read restrictively and at best to cover situations where in substance the assets in India are transacted by transacting in shares of overseas holding companies and not to transactions where assets situated overseas are transacted which also derive some value on account of assets situated in India - there can be no recourse to Explanation 5 to enlarge the scope of Section 9(1) of the Act so as to cast the net of tax on gains or income that may arise from transfer of an asset situated outside India, which derives bulk of its value from assets outside India. Even if the transaction had been structured in the manner as suggested on behalf of the Revenue, the gains arising to the shareholders of Copal-Jersey from sale of their shares in Copal-Jersey to Moody UK would not be taxable under Section 9(1)(i) of the Act, as their value could not be stated to be derived substantially from assets in India - the CRL and CMRL cannot be stated to be shell companies so as to ignore their corporate identities - Even according to the revenue, the companies are generating revenue from intra-group services - The fact that a company may render services to its related enterprise would not render the company to be non-existent or give reasons for lifting its corporate veil - The financial statements placed on record indicate that CRL and CMRL have been generating revenues and we also have no reason to doubt the statement that CRL and CMRL have been providing services in relation to business of financial research and market research respectively. Residential status - Whether CRL and CMRL should be considered as residents of UK on account of the alleged role of Rishi Khosla in its affairs – Held that:- AAR was rightly of the view that the role of Rishi Khosla highlighted by the Revenue is in respect of the sale transactions undertaken and in pushing them through - It does not appear to be a role in connection with the running of the businesses of the companies concerned - It is not shown that the management of the companies in Mauritius in general, is not with a Board of Directors of those companies sitting in Mauritius and that the management and control is from United Kingdom of which Rishi Khosla is a resident - Even if one were to take the Business Advisory Agreement relied on by the applicants with a pinch of salt, it cannot be said that the role played by Rishi Khosla in these transactions establish that the management and control of the Mauritian companies is with Rishi Khosla - The material on record is insufficient to conclude that the corporate structure of CRL and CMRL should be ignored and the residence of Rishi Khosla be considered as the situs of the said companies – Decided against Revenue. Issues Involved:1. Taxability of capital gains arising from the sale of shares by Mauritian companies to companies in Cyprus and the USA.2. Obligation to withhold tax under Section 195 of the Income Tax Act, 1961.3. Commercial rationale and structuring of transactions.4. Effective management and control of the Mauritian companies.5. Interpretation of Explanation 5 to Section 9(1)(i) of the Income Tax Act.Issue-wise Detailed Analysis:1. Taxability of Capital Gains:The primary issue was whether the capital gains arising from the sale of shares of Copal Research India Private Limited (CRIL) and Exevo Inc. by Mauritian companies to Moody's Group Cyprus Ltd. and Moody's Analytics, Inc. respectively, were taxable in India. The AAR ruled that these gains were not taxable in India due to the India-Mauritius Double Taxation Avoidance Agreement (DTAA). The Revenue challenged this ruling, arguing that the transactions should be viewed collectively with the sale of shares of Copal-Jersey to Moody-UK, suggesting that the entire structure was designed to avoid tax.2. Obligation to Withhold Tax:The AAR held that Moody's Group Cyprus Ltd. and Moody's Analytics, Inc. had no obligation to withhold tax under Section 195 of the Income Tax Act, 1961, from the consideration payable to the Mauritian companies. The Revenue contended that the transactions were structured to avoid withholding tax obligations.3. Commercial Rationale and Structuring of Transactions:The Revenue argued that the transactions were part of a single commercial understanding to transfer the entire Copal Group to the Moody Group. They claimed that the structuring of transactions was designed to avoid tax on gains that would have been taxable if the shares of Copal-Jersey were sold directly. The court examined the commercial rationale and concluded that the transactions had a legitimate commercial purpose and were not solely designed to avoid tax.4. Effective Management and Control:The Revenue contended that the effective management and control of the Mauritian companies (CRL and CMRL) were in the United Kingdom, given the significant role played by Rishi Khosla. The court, however, found insufficient evidence to disregard the corporate structure of the Mauritian companies and concluded that the management and control were with the respective Boards of Directors in Mauritius.5. Interpretation of Explanation 5 to Section 9(1)(i):The court examined whether the gains from the sale of shares of an overseas company, which derives its value substantially from assets situated in India, could be deemed to accrue in India. The court referred to Explanation 5 to Section 9(1)(i) and concluded that the expression 'substantially' should be interpreted to mean 'principally' or 'mainly.' The court held that gains arising from the sale of shares of Copal-Jersey, which derived less than 50% of their value from assets in India, would not be taxable under Section 9(1)(i) of the Act.Conclusion:The court dismissed the writ petitions filed by the Revenue, upholding the AAR's ruling that the capital gains arising from the sale of shares by the Mauritian companies were not taxable in India and that there was no obligation on the purchasing companies to withhold tax under Section 195 of the Income Tax Act. The court found that the transactions had a legitimate commercial purpose and were not structured solely to avoid tax. The court also upheld the AAR's finding that the effective management and control of the Mauritian companies were with their respective Boards of Directors in Mauritius.