TaxTMI 
TaxTMI 
2010 (3) TMI 106
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....orporation, USA. 1.2 The Applicant held equity shares in IL&FS Investsmart Limited ('Indian Company') which are listed on Stock Exchange in India. The Applicant had acquired these shares in the years 2005, 2006 and 2007. The shares were acquired by way of direct purchases as well as upon conversion of the Global Depository Receipts ("GDRs") as per the details set out in Exhibit 'A'. The Applicant has transferred 30,625,692 shares in the Indian Company to HSBC Violet Investment (Mauritius) Limited, a company organized under the laws of Mauritius, at Rs.200/- per share on 29th September 2008 and realized long term capital gains there-on in India. A Share Purchase Agreement was entered into on 16th May, 2008. 1.3 Being a tax resident of Mauritius, the Applicant is governed by the provisions of the India-Mauritius DTAA in respect of its tax liability in India. As the provisions of the India-Mauritius DTAA are more beneficial, the provisions of that DTAA would be applicable, as specifically provided for in Section 90(2) of the IT Act. Further, during the period the Applicant held shares in the Indian Company, it did not have any Permanent Establishment ('PE') in India as defined i....
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....hether the profit arising from the transfer of shares of Indian company is chargeable to Capital Gains tax under the I.T.Act. The answer is plain. If we go by the I.T.Act, the profits arising from the transfer of share are liable to be taxed under the head Capital Gains at the appropriate rate. However, the position of taxability of Capital Gains is otherwise under the provisions of DTAA (Tax Treaty between India & Mauritius). To be more specific, Article 13, Paragraph 4 of the DTAA confers the power of taxation of the gains derived by a resident of a contracting State from the alienation of specified property only in the State of residence i.e. in Mauritius. The fact that the capital asset is located in India is immaterial. In most of the Treaties, we find that the situs or location of the capital asset determines the competence of the State to tax the capital gain. Yet, there is no doubt that the tax payer is entitled in law to seek the benefit under the DTAA if the provision therein is more advantageous than the corresponding provision in the domestic law. This well settled principle has been re-stated by the Supreme Court in the case of Union of India vs. Azadi Bachao Andolan [....
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....iness property of a permanent establishment which an enterprise 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 enterprise) 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 property pertaining to the operation of such ships and aircraft, shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated. 4. Gains derived by a resident of a Contract State from the alienation of any property other than those mentioned in paragraphs (1),(2) and (3) of this article shall be taxable only in that State." 4.1 Obviously and undisputedly, Paragraph 4 of Article 13 governs because the property alienated - being shares in the company, does not fall under any of....
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.... provisions of its domestic law." 4.3 In reply to the stand taken by the department the learned Senior counsel for the applicant contended that beneficial ownership is really irrelevant in the context of Article 13. In contrast, such expression is used in Articles 10 & 11. In any case, it is submitted that the applicant has already furnished the information required by the Revenue at the stage of Section 264 Proceedings and filed before the AAR all the relevant material and clarifications to dispel the doubts entertained by Revenue. In fact, the enquiry is a futile and wholly unnecessary exercise in view of the clear Circular of CBDT which is binding on the Department and the law clarified by the Supreme Court in Azadi Bachao Andolan case. 4.4 Thus, strong reliance has been placed on behalf of the applicant on the two Circulars issued by the Central Board of Direct Taxes (CBDT) and the decision of the Supreme Court in Azadi Bachao Andolan case Supra. First we shall refer to those Circulars. "Circular No.682, dated 30th March, 1994: Subject: Agreement for avoidance of double taxation with Mauritius - Clarification regarding. A Convention for the avoidance of double ta....
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....ncorporated in that country. These entities are "liable to tax" under the Mauritius Tax Law and are, therefore, to be considered as residents of Mauritius in accordance with the DTAC. 2. Prior to 1st June, 1997, dividends distributed by domestic companies were taxable in the hands of the shareholder and tax was deductible at source under the Income-tax Act, 1961. Under the DTAC, tax was deductible at source on the gross dividend paid out at the rate of 5% or 15% depending upon the extent of shareholding of the Mauritius resident. Under the Income-tax Act, 1961, tax was deductible at source at the rates specified under section 115A, etc. Doubts have been raised regarding the taxation of dividends in the hands of investors from Mauritius. It is hereby clarified that wherever a certificate of residence is issued by the Mauritian authorities, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAC accordingly. 3. The test of residence mentioned above would also apply in respect of income from capital gains on sale of shares. Accordingly, FIIs, etc. which are resident in Mauritius should not b....
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....ound in which the Circulars were issued has been indicated in Azadi Bachao Andolan case at page 716 of ITR thus: "By Circular No.682, dated March 30, 1994 (see[1994] 207 ITR (St.)7) issued by the Central Board of Direct Taxes in exercise of its powers under section 90 of the Act, the Government of India clarified that capital gains of any resident of Mauritius by alienation of shares of an Indian company shall be taxable only in Mauritius according to Mauritius taxation laws and will not be liable totax in India. Relying on this, a large number of foreign Institutional Investors (hereinafter referred to as "the FIIs"), which were resident in Mauritius, invested large amounts of capital in shares of Indian companies with expectations of making profits by sale of such shares without being subjected to tax in India. Some time in the year 2000, some of the income-tax authorities issued show cause notices to some FIIs functioning in India calling upon them to show cause as to why they should not be taxed for profits and dividends accrued to them in India. The basis on which the show cause notice was issued was that the recipients of the show cause notice were mostly "shell companies"....
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....Certificate of residence issued by Mauritius income-tax authorities is not contemplated either under the DTAA or under the IT Act, (iv) 'Treaty shopping' by which the resident of a third country takes advantage of the provision of the DTAC is illegal, (v) the Circular confers power to lay down a law which is not contemplated under the Act for reasons of political expediency and, therefore, it cannot but be ultra vires , (vi) having regard to the law laid down by the Supreme Court in Mc Dowell case [154 ITR 148], it is open to the ITO in a given case to lift the corporate veil for finding out whether the purpose of the corporate veil is avoidance of tax or not, (vii) the impugned Circular takes away the power of the assessing authority to hold that the assessee is a resident of a third country having only paper existence in Mauritius without any economic impact with the sole object of taking advantage of DTAC and is therefore illegal. 6.3 The Supreme Court expressed its disagreement with all these findings of the High Court and reversed the decision of the High Court and upheld the Circular No. 789. The Circular was strongly supported by the Union of India which challenged the de....
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....e inextricable nexus between the two? These doubts, though linger in our minds, should however not impel us to question the wisdom or rationale behind the clarification given in the Circular especially when it has received the seal of approval of the Supreme Court in Azadi Bachao on all aspects. 7. Apart from considering the validity of the circular, the Supreme Court examined various aspects revolving round the avoidance of tax by Mauritian business entities set up by the holding companies in other countries for the purpose of taking advantage of India-Mauritius DTAC. In the context of the arguments advanced by the Revenue, the views expressed by the Supreme Court on these various aspects such as the motive and device adopted to avoid the tax, Treaty shopping, lifting the corporate veil, the import of the expressions 'sham' and 'device', the implications of McDowell case deserve serious attention. We would like to refer to the pertinent observations made by the learned Judges rather extensively. 7.1 At page 753, the Supreme Court referred to the argument of the respondent based on the dicta of Chinnappa Reddy J, in McDowell [154 ITR p.148] case, repelled the same and reitera....
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.... War sentiments expressed by the British courts. It is urged that McDowell's case has taken a new look at fiscal jurisprudence and "the ghost of Fisher's case (1926) AC 395 at 412 (HL) and Westminister's case (1936) AC 1(HL) have been exorcised in the country of its origin". It is also urged that McDowell's case (1985) 154 ITR 148 (SC) radical departure was in tune with the changed thinking on fiscal jurisprudence by the English courts. As we shall show presently, far from being exorcised in its country of origin, Duke of Westminister's case (1936) AC 1 (HL) ; 19 TC 490 continues to be alive and kicking in England. Interestingly, even in McDowell's case (1985) 154 ITR 148 (SC), though Chinnappa Reddy J. dismissed the observation of J.C.Shah J. in CIT vs. A Raman and Company (1968) 67 ITR 11(SC) based on Westminister's case and Fisher's Executors case (1926) AC 395 at 412 (HL), by saying (page 160 of 154 ITR) "we think that the time has come for us to depart from the Westminister principle as emphatically as the British courts have done and to dissociate ourselves from the observations of Shah J., and similar observations made elsewhere", it does not appear that the rest of the l....
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....ect that "tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods". Immediately thereafter, the learned Judges commented that this opinion of the majority is a "far cry from the view of Chinnappa Reddy J" who spoke in the following words: "In our view the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether a provision should be construed literally or liberally nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it." Then, the learned Judges in Azadi Bachao commented: "We are afraid that we are unable to read or comprehend the majority judgment in Mc Dowell's case as having endorsed this extreme view of Chinnappa Reddy J which in our considered opinion, actually militates against the observations of the majority of the Judges which we have just extracted". ....
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.... "If the court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not be permissible for the court to treat the intervening legal steps as non est based upon some hypothetical assessment of the "real motive" of the assessee. In our view, the court must deal with what is tangible in an objective manner and cannot afford to chase a will-o'-the-wisp." 8.2 Earlier, the learned Judges quoted several judgments to reinforce their view that the motive of tax avoidance is irrelevant in considering the legal efficacy of a transaction. 9. Now, we shall refer to the relevant passages in Azadi Bachao Andolan case dealing with 'Treaty shopping'. 'Treaty shopping' broadly means "the use of a Tax Treaty by a person who is not resident in either of the treaty countries, usually using a conduit entity residing in one of the countries". (see Glossary of International Tax Terms, - Appendix to Vol.I of Basic International Taxation by Mr. Roy Rohtagi). 9.1 The following passages at pages 746, 749 and 752 may be noted: "The respondents vehe....
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....ly not equated to a colourable device. That means, if a resident of a third country, in order to take advantage of the tax reliefs and economic benefits arising from the operation of a Treaty between other countries through a conduit entity set up by it, the legal transactions entered into by that conduit entity cannot be declared invalid. The motive behind setting up such conduit companies and doing business through them in a country having beneficial tax treaty provisions was held to be not material to judge the legality or validity of the transactions. The approach adopted in Mc Dowell's case by one of the Judges that judicial approval should not be accorded to a transaction meant to be a device to avoid the tax irrespective of whether it is prohibited by Statute was not endorsed. The principle pithily stated in Duke of West Minister that "every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be" was emphatically approved. However, a colourable device adopted through dishonest methods is one of the areas which could be looked into in judging a legal transaction from the tax angle [vide the dicta ....
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....cute the Share Purchase Agreement and Escrow agreement for and on behalf of the applicant's company. The legal formalities for transfer of shares have been gone through by the applicant. The consideration for the sale of shares was credited to the applicant's accounts, as borne out from the entries in the audited accounts. On receipt of the sale price, the applicant passed a resolution on 9th October, 2008 reducing its capital and paying dividends to its parent. It is thus clear that the applicant - undoubtedly the legal owner of the shares entered into a transaction of sale of shares backed up by Board's resolution and received the sale price. In this fact situation, ex-facie, it is difficult to assume that the capital gain has not arisen in the hands of the applicant, more so when according to the binding pronouncement of the Supreme Court, the motive of tax avoidance is not relevant so long as the act is done within the framework of law, the 'treaty shopping' through conduit companies is not against law and the lifting of corporate veil is not permissible to deny the benefits of a tax treaty. None of the grounds on which the Delhi High Court struck down the circular no. 789 woul....
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....n inquiry/verification would be necessary which according to him will have bearing on the question as to who is the beneficial owner of the capital gains. Some of these points also find place in the order of the DIT passed under section 264. In reply thereto, certain clarifications have been furnished by the learned counsel for the applicant in the course of arguments, followed by a written note. Before we may briefly refer to them, we would like to point out that the counsel for the Revenue stated more than once that the question whether the US company was actually exercising acts of ownership over the shares is one relevant point which needs to be looked into. However, it has not been elaborated as to what exactly is meant by exercising acts of ownership and what would be the possible line of inquiry especially in view of the fact that the record discloses the applicant as the owner, the recipient of dividend and the party which entered into the Share Purchase Agreement. Be that as it may, we shall refer to some of these points. 11.1. The first doubt raised is about the execution of the contract - that no employee or director of the applicant signed the SP Agreement dated 16th....
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....eference to this, it is clarified that it only shows the purpose for which the funds have been sent and the nature of the receipt i.e. whether it is a capital contribution or loan can be clearly seen from the final accounts and the balance sheet. It is asserted that there is no basis for the allegation that the accounts have been falsified. Regarding the submission of Revenue that on earlier occasions, funds were sent as "return of excess funds and inquiry is therefore needed to find out how the funds have been remitted back to the parent", the applicant has reiterated that there are board's resolutions for declaring the dividends and reduction of share capital by utilizing from the proceeds of the sale of shares (those copies of resolutions have been filed). It is pointed out that the applicant could not have declared the dividends to reduce the shares capital, if funds on sale of shares were not received. Upon receiving dividends from IL&FS, there is nothing unusual in a company reducing its liabilities and or reducing its capital and paying dividends to its parent on receipt of the sale price of shares. The short interval within which the dividends were paid and capital reductio....
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....in such recital. Further, the applicant is not a party to the said agreement dated 28th May, 2008. It was an agreement between ETFC & IL&FS for the purpose of providing certain services by ETFC to IL&FS on completion of sale of shares. 12. We have adverted to the clarifications furnished by the applicant supported by its accounts and other documents to see whether there is anything to rebut the presumptive evidence of beneficial ownership arising from the tax residency certificate and to see whether there is any compelling reason for not giving effect to the Circular of CBDT issued in the context of Treaty provisions. We have looked into the facts presented before us in the light of Revenue's submissions to satisfy ourselves whether there is anything demonstrably clear to show that the capital gain has not arisen in the hands of the applicant or whether any colourable device is apparent. In doing so, the legal position expounded by the Supreme Court in Azadi Bachao case have been kept in view. The said decision, it may be recalled, has explained what are not objectionable devices in the context of the India-Mauritius Treaty and the treaty shopping. On such consideration, this Au....