TaxTMI 
TaxTMI 
2014 (8) TMI 9
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....ains arising on the sale of CCDs are interest within the meaning of Section 2(28A) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') and Article 11 of the DTAC and are taxable as such. 2. Brief facts of the case are that Vatika Limited (hereinafter referred to as 'Vatika') is an Indian company and is inter alia engaged in the business of developing and dealing in real estate. Vatika is the owner of a contiguous tract of land admeasuring 6.881 acres or 10,00,000 sq. ft situated in village Badshahpur Tehsil, Gurgaon (hereinafter referred to as the 'Land'), which has been reserved for being developed as a cyber park, to be used for software development activities and IT enabled services as per the provisions of Notification No. CCP (NCR)/GDP-III/2001/1555 dated 30.07.2001 as amended from time to time. SH Tech Park Developers Private Limited (hereinafter referred to as the 'JV Company') is an Indian Company and was incorporated on 04.07.2007 as a 100% subsidiary of Vatika. 3. The petitioner is a company incorporated under the laws of Mauritius and is a tax resident of Mauritius and is inter alia engaged in the business of investment into Indian companies engaged ....
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....in on the transfer of equity shares and CCDs would be treated as interest and tax at the rate of 20% (plus surcharge and cess) should be withheld on the same. 7. Thereafter, on 16.02.2011, the Petitioner filed an application before the AAR for advance ruling on the question:- "Whether on the facts stated in the application and in law gains arising to the Applicant, being a tax resident of Mauritius on sale of equity shares and Compulsorily Convertible Debentures (CCDs) held by the Applicant in SH Tech Park Developers Private Limited, an Indian Company are exempt from capital gains tax in India under Article 13(4) of Double Taxation Avoidance Agreement between India and Mauritius ('DTAA')?" 8. By the impugned ruling dated 21.03.2012, the AAR held as follows: "We, accordingly, answer the question that the entire gains arising to the applicant on the sale of equity shares and CCDs are not exempt from capital gain tax in India under DTAC with Mauritius. The gains arising on the sale of CCDs being interest within the meaning of Section 2(28A) of the Act and Article 11 of the DTAC and are taxable as such." 9. The learned counsel appearing for the petitioner submitted that ....
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.... 11. The controversy in the present case revolves around the issue of whether the gains resulting to the petitioner from sale of CCDs held in the JV company are taxable as "interest" in its hands. 12. The AAR examined various decisions including the decision of the Supreme Court in the case of CWT v. Spencer & Co.: (1973) 88 ITR 429 and held that:- "In view of the facts before us, and the law laid down by the Hon'ble Supreme Court, we are of the view that the CCD creates or recognizes the existence of a debt, which remains to be so till it is repaid or discharged ". 13. There is no dispute as to the nature of Compulsorily Convertible Debentures. A debenture indisputably creates and recognizes the existence of a debt and till it is discharged, either by payment or by conversion, the debenture would essentially represent a debt. A Compulsorily Convertible Debenture is a debt which is compulsorily liable to be discharged by conversion into equity. Any amount payable by the issuer of debentures to its holder would usually be interest in the hands of the holder. Black's Law Dictionary (7th Edition) defines 'interest' inter alia as compensation fixed by agreement or allowed by....
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....rty, would be capital gains and not interest. In other words, if a debenture (which is a capital asset) is transferred by a holder to a third party, the gains that arise i.e. difference between the costs of purchase and the sale consideration would be capital gains in the hands of a transferor. The dispute in the present case arises only because it has been held that the transaction between the petitioner and the Vatika is a sham transaction and is essentially a transaction of loan to Vatika which has been camouflaged as an investment in shares and CCDs of the JV company. 16. The substratal controversy that needs to be addressed in the present petition is whether the AAR was correct in holding that the corporate veil ought to be lifted and that the JV Company and Vatika were essentially the same entity. And consequently, the amount paid/payable by Vatika in excess of the amount invested by the petitioner would be 'interest' within the meaning of Section 2(28A) of the Act and Article 11 of the DTAA between India and Mauritius. 17. Before proceeding further it is necessary to note certain facts. On 04.07.2007, the JV Company was incorporated as a wholly owned subsidiary of Vati....
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....tioner would also subscribe to the shares and Compulsorily Convertible Debentures in 3 additional tranches. In aggregate, the petitioner would invest Rs. 100 crores and be allotted 46,307 equity shares, and 88,25,85,590 zero percent CCDs having a face value of Rs. 1. 19. The terms and conditions of the issue of CCDs were specified in schedule III to the SHA. The CCDs were compulsorily convertible into equity shares after expiry of 72 months from the date of the first closing (i.e. the date when the first tranche of investment was made by the petitioner). In addition, the CCDs were also convertible prior to 72 months at the option of the petitioner. On the expiry of 42 months from the First Closing Date, the petitioner was entitled to require the JV Company to convert 33,485,494 CCDs into equity shares. The petitioner was entitled to conversion of 37,526,847 CCDs, 42,346,809 CCDs and 48,159,116 CCDs after expiry of 48 months, 54 months and 60 months respectively. The SHA also recorded the agreement between the petitioner, Vatika and the JV Company with regard to the management of the JV Company. 20. The AAR has concluded that the entire transaction which is embodied in the SSA....
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....n, Vatika hereby grants to the Investor an option (the "Put Option"), exercisable at any time on or subsequent to the fifth anniversary of the First Closing Date or in the event of a Material Default by the Company or Vatika which default has not been remedied or cured within thirty (30) days of notice of such default by the Investor, to sell to Vatika, all the Investor Securities ("Put Option Securities") and upon exercise of the Put Option, Vatika shall be obliged to purchase the Put Option Securities at the Put Option Purchase Price (as defined hereinafter). (b) The purchase price of the Put Option Securities (the "Put Option Purchase Price") shall be the sum of (I) the Investor Subscription Amount (less any Bought Back Subscription Amount); (II) the amount equal to the Accrued Return till the Completion Date; and (III) the Equity Payment, less the Vatika Return, if any." 22. In our opinion, the aforesaid clauses cannot be read to mean that the petitioner was only entitled to a fixed return on the investments made by it in the equity and CCDs issued by the JV company. Article 10(1) of the SHA entitles Vatika to call upon the petitioner to sell its investment at a price to ....
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....mon in any joint venture agreement for the co-venturers to include covenants for buying each-others' stakes. Although, the SHA enables the petitioner to exit the investment by receiving a reasonable return on it, and in that sense it is assured of a minimum return, the same cannot be read to mean that the CCDs were fixed return instruments, since the petitioner also had the option to continue with its investment as an equity shareholder of the JV Company. 23. Article 11 of the SHA also provides additional rights to the petitioner including the right to sell its entire equity in the JV Company to a third party and recover the value as calculated under clause 11.2(d)(i) of the SHA. It is also necessary to bear in mind that the rights with regard to options as well as additional rights under Article 11 of the SHA were the mutual rights and obligations between Vatika and the petitioner and not the JV company. The JV Company would in any event, whether the options were exercised inter se Vatika and the petitioner or not, convert the CCDs into equity shares on completion of 72 months from the First Closing Date. 24. The next issue to be examined is whether the covenants of the SHA ....
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....take any decisions or actions in relation to any of the matters set forth in the Schedule-II (the "Affirmative Vote Items"). xxxx xxxx xxxx xxxx xxxx 4.7 General Meeting 4.7.1 An AGM shall be held each calendar year within three (3) months following the end of the previous Financial Year. The Board shall provide the Company's previous Financial Year's Financial Statements to all Shareholders at least one (1) month before the AGM is held to approve and adopt the Financial Statements. All other General Meetings, other than the AGM, shall be EGMs. The quorum for General Meetings shall be in accordance with the Act, subject to at least one (1) authorized representative representing the Investor and one (1) authorized representative representing Vatika. 4.7.2 Subject to the Act, a minimum twenty one (21) Business Days prior written notice shall be given to all the Shareholders of any General Meeting, accompanied by the agenda for such General Meeting (unless the Investor and Vatika shall have given written approval for a meeting called at shorter notice, in accordance with the provisions of the Act). xxxx xxxx xxxx xxxx xxxx 4.9 Certain Matters concerning the P....
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....rvice providers, customers, vendors, contractors or the like, that are common between the Company and Vatika or its Affiliates, shall be on an arm's length basis. xxxx xxxx xxxx xxxx xxxx 9.7 Bank Accounts The Company shall, and Vatika shall cause the Company to open and maintain a bank account or bank accounts in its own name with such bank or banks as may be determined by the Board. Such account or accounts shall be operated as the Board shall resolve from time to time. All payments to or by the Company shall be paid into or withdrawn from such account or accounts. It is agreed that all payments made by the Company (including any payments under the Construction Contract) shall be made only after such payments have been authorized, in writing by the Asset Manager." 25. Article 4 of the SHA contains clauses with regard to the manner in which the JV Company would be managed. As per clause 4.1.1, Vatika was entitled to nominate three directors and the petitioner was entitled to nominate two directors on the board of the JV Company. Clause 4.5.2 of the SHA provided that at least one director nominated by the petitioner and one director nominated by Vatika be present fo....
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....he real estate sector, provided that certain mandatory conditions are met. According to Press Note 2 of 2005 issued by the Department of Industrial Policy & Promotion, 100% FDI under the automatic route was allowed for investments in townships, housing, built up infrastructure and construction-development projects subject to the guidelines specified therein. The guidelines specified under the Press Note are quoted below:- "a. Minimum area to be developed under each project would be as under: i. In case of development of serviced housing plots, a minimum land area of 10 hectares ii. In case of construction-development projects, a minimum built-up area of 50,000 sq.mts iii. In case of a combination project, anyone of the above two conditions would suffice. b. The investment would further be subject to the following conditions: i. Minimum capitalization of US$10 million for wholly owned subsidiaries and US$ 5 million for joint ventures with Indian partners. The funds would have to be brought in within six months of commencement of business of the Company. ii. Original investment cannot be repatriated before a period of three years from completion of minimum capita....
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.... further held that the court cannot start with the question of whether the transaction is a tax saving device, but should instead apply the "look at test" to ascertain its true legal nature. The relevant extract from the said judgment of the Supreme Court is quoted below:- "79. When it comes to taxation of a holding structure, at the threshold, the burden is on the Revenue to allege and establish abuse, in the sense of tax avoidance in the creation and/or use of such structure(s). In the application of a judicial antiavoidance rule, the Revenue may invoke the "substance over form" principle or "piercing the corporate veil" test only after it is able to establish on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant. To give an example, if a structure is used for circular trading or round tripping or to pay bribes then such transactions, though having a legal form, should be discarded by applying the test of fiscal nullity. Similarly, in a case where the Revenue finds that in a holding structure an entity which has no commercial/business substance has been interposed only to avoid tax then in such cases app....