TaxTMI 
TaxTMI 
1996 (8) TMI 512
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....With its considerable operational and investment experience, it has made a strong commitment to develop third party investment of funds in Asian countries. Towards this end, it constituted an infrastructure fund focussing on infrastructure and infrastructure related investments to which one of its subsidiaries agreed to contribute up to $100 million. Two other subsidiaries were made advisers. It believes that it is "well-positioned to establish emerging market direct investments bringing together the complex organisational elements, attracting experienced individuals and institutions as partners and fully utilising its own substantial resources and understanding of the region". The transactions now proposed (which give rise to the present applications) are restricted in its operations to the "Indian sector". The American company in collaboration with an Indian financial service company now proposes to set up another fund. This fund will consist of two tranches (sections or branches), one a rupee tranche called a "contributory trust" holding funds in Indian currency and a Mauritian company (referred to as "the foreign tranche") holding funds in dollars. The rupee tranche is to be....
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....and the American company can also constitute "service units" from their respective staff to assist them. (iv) The management agreement also envisages an advisory board consisting of representatives of industries, institutions, investors and the Asian Development Bank (ADB) which, as its name indicates, will be purely advisory in character. But though the investment committee, the investment advisers, service units and the advisory board may offer their suggestions and recommendations, the final word and responsibility will rest with the board of the IM which can be convened anywhere in the world except in India and the U. S. A. Necessary documents to give effect to the above arrangements have been drawn up and placed before the Authority. These are: (i) Draft indenture of trust (T. D.) between the Indian financial service company and the trust company constituting the CT of which the said company is appointed trustees. [A draft trust deed originally filed with the application was allowed to be replaced by a revised draft trust deed at the time of arguments and it is this revised T. D. that is referred to below]. (ii) Draft contribution agreement (C. A.) between the c....
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....ossessed of the trust fund, invest the same, hold the income for the benefit of the beneficiaries and distribute the income among the beneficiaries in terms of the C. A. The trust is expected to operate for a period defined as "the trust period" [clause 1(x)]. This is the period up to the first of the following dates: (i) the day on which shall expire 14 and half years from the date of the settlement; (ii) such dates as the trustee may appoint by deed at their discretion; (iii) such dates as shall be agreed upon by all the contributors; (iv) such dates as shall be determined by the I. M. after six months' prior notice to the contributors; and (v) the date of winding up of the I. M. Clause 3(a) of the T. D. obliges the trustees to appoint the I. M. to carry out its investment policies. The mode of distribution of the trust fund and income is set out in clause 5 of the trust deed which reads thus: "Distribution of trust fund and income: 5. The trustee shall stand possessed of the trust fund and the income thereof shall accrue upon the trust for the benefit of the beneficiaries and the trustee shall make distributions to the beneficiaries/contributors as fol....
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....tical subdivision or local authority, that trustees may consider a reputable investor." After a little discussion he was willing also to drop the last seven words which were considered to be somewhat vague. One may pause here to consider whether there could be any valid objections to the constitution of a trust in this manner. The authors of the trust are the IC, the Indian financial service company and others contributing to the trust by the date of the trust deed. Indeed even institutional investors contributing to the trust, in helping the CT achieve its target of 50 million dollars can be considered as supplemental authors of the trust, the C. A. constituting read with the trust deed, the instruments constituting the trust in their cases. The purposes of the trust are, as stated in the TD, to invest the trust funds and distributing the proceeds to the beneficiaries. This is, in a sense, nothing more than an arrangement by which certain parties agreed to contribute funds for a common purpose and divide the profits amongst themselves. No doubt, the same objective could be achieved by the constitution of a firm or a company but, equally, there seems to be no valid objection if ....
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....nd." It is necessary to mention clause 14 and paragraph (d) of clause 17 to which the Departmental Representative raised some objection to which reference will be made later. The provisions read as under: "14. Power to apportion between income and capital. The trustee shall have power to make such reserves out of the income or capital as the trustee deem proper for expenses, taxes and other liabilities of this settlement to pay from income or from capital or to apportion between income and capital any expenses of making or changing investment or selling, exchanging or leasing including broker's commissions and charges and generally to determine what part of the expenses of this settlement can be charged to capital and what part to income and to determine as between separate funds and separate parts or shares the allocation of income, gains, profits, losses and distributions and so that any decisions of the trustee under this regulation whether made in writing or implied from their acts shall so far as the law may permit be conclusive and binding on the beneficiaries and a....
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....p; "(c) Indian trust company is a subsidiary of the Indian financial service company and is in an independent business of acting as trustee of trusts." Every additional investor will have to execute in favour of the trust company and the management company an agreement on the same lines [paragraphs 2.01 and 2.02]. Every contributor, by these agreements, agrees to contribute a stated amount (called his "commitment" amount) to the fund in exchange for a corresponding number of units [paragraphs 1.01(5), (7) and (16)]. Such commitment is valid for five years [paragraph 7.01]. Paragraphs 2.04 to 2.06 of the agreement are important and have to be extracted here in full: "2.04 Contribution procedure: (a) Capital contributions shall be made by the contributor to the trust for all or a portion of a contributor's unpaid capital commitment on an as needed basis as specified by the investment manager. Each contributor's capital contribution shall be in an amount pro rata to the contributor's capital commitments to the trust. The investment manager shall give the contributor a take....
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....and such defaulting contributor's contributed capital percentage shall be disregarded for purposes of any super majority vote or consent requirement; (c) such defaulting contributor's capital account shall be reduced to the lesser of (i) the defaulting contributor's unreturned capital contributions determined as on the date of the default and (ii) the defaulting contributor's contributed capital percentage multiplied by the excess of the fair market value of the trust's investments over the liabilities of the trust determined as on the date of the takedown notice with respect to which the defaulting contributor defaulted; (d) following the date of default, no items of income or loss shall be allocated to such contributor; (e) notwithstanding any provisions to the contrary in this agreement, following the date of default, such defaulting contributor shall be entitled to distributions from the trust in liquidation or otherwise, amounting in the aggregate to no more than its capital account adjusted under paragraph 2.06(c) and payable only out of, and to the extent of, that portion of the proceeds of investments made prior to the date of the takedown notice, with respect to w....
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....ls with the distribution of profits, allocation of income, etc. It may be sufficient to set out here paragraphs 6.01, 6.02, 6.04 and 6.06: "ARTICLE VI Distribution of profits, allocation of income and loss, cancellation of units and investors rights and obligations: 6.01 Distribution: Income received by the trust in respect of the contribution fund will be a charge on the income of the contribution fund, and will be distributed annually or at such direct intervals as the trustees may in their absolute discretion think fit. The contribution fund may also declare special distributions. The method by which the distribution will be made and the allocation of income between the contributor and the investment manager are as set out in paragraphs 6.02 to 6.07 and will depend upon the source of the income. 6.02 Income from portfolio investments: Contribution proceeds attributable to the fund's portfolio investments (which shall include all proceeds attributable to the disposition of such investments, together with interest, dividends and distributions from such investments, net of operating expenses including distribution of fees and share of profit to the investment manager an....
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....all expire 10 years and an additional three year period from the date of this settlement; and (ii) upon the winding-up of management company, this agreement shall terminate immediately; (iii) such day as determined by the board of directors of the investment manager upon at least six months prior written notice to the investors." Article X deals with miscellaneous matters of which it is necessary to refer to paragraph 10.02: "ARTICLE X Miscellaneous: 10.2 Liability of contributor: Except as specifically set forth herein, no contributor shall have any personal liability whatever in its capacity as a contributor whether to the trust, to any other contributor or to the creditors of the trust for the debts, liabilities, contracts or any other obligations of the trust or for any losses of the trust. A contributor shall only be liable to pay its capital commitments to the trust. After its capital commitment shall have been paid in full, a contributor shall not be obligated to make any further capital contribution to the trust or to repay to the trust, any contributor or any creditor of the trust all or any fraction of any negative amount of such contributor's capital ac....
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....unities, business restructuring and reorganisation strategies, among other areas. Investments may be spread across the focus sectors in new projects, expansions and diversifications, opportunities arising from restructurings and reorganisations, product development efforts, privatisations and the like. The fund will only invest in projects that at the time of the investment comply with all relevant Indian State and Central Government legislation regarding environmental protection, and such guidelines on environmental protection and social and rehabilitation issues which may be adopted by the Asian Development Bank, a core investor (as defined below). In addition, fund investments may include holdings of listed companies that could be of particular benefit to the fund." Clause (iii) of paragraph 10.01(a) also needs to be referred to. It says that the functions of the investment manager shall include, inter alia: "To engage professionally skilled and/or experienced personnel to provide the necessary advisory and investment managerial support and/ or guidance to the portf....
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....reements') and all decisions relating to the fund, including, without limitation, the acquisition, management and disposition of portfolio investments, shall be made solely by the board of directors of the manager acting pursuant to and in accordance with the agreements." The Authority has been informed that the "initial closing" of the offshore tranche held by "fund" has already been completed with commitments of 70 million US dollars (66 per cent. of which is from international investors) and that a second closing had been targeted for the month of April for an additional corpus of 80 million US dollars. In the background of this configuration, two applications have been filed before the Authority. (a) The application filed by the IC raised as many as seven questions set out in annexure "I" to the application. After some discussions in the course of the hearing this has been revised in the form of eleven questions (to which one more was orally added). The revised questions are: "1. Based on the facts and circumstances of the case, whether the applicant would be assessed in respect of its proportionate share ....
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....ll the applicant's share in the capital gains earned by the contributory trust be chargeable to tax ? 10. Based on the facts and circumstances of the case, whether there would be any withholding tax liability on the CT in respect of the distributions made to the applicant ? 11. Whether, on the facts and in the circumstances of the case, the applicant's proportionate share in the surplus arising on the realisation of the investments made by the contributory trust would constitute capital gains ? 12. Whether, in case the answer to question No. 11 is in the negative, the proportionate share of the applicant in such surplus will be chargeable to income-tax in India in the applicant's hands ?'' (b) The application filed by the investment manager raises the four questions set out below: "1. Based on the facts and circumstances of the case, and in view of the provisions of the India-Mauritius double tax avoidance agreement, can it be construed that the applicant does not have a permanent establishment ('PE') in India ? ....
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....erwise (including any wakf deed which is valid under the Mussalman Wakf Validating Act, 1913 (6 of 1913)), receives or is entitled to receive on behalf, or for the benefit, of any person, such trustee or trustees; 161. Liability of representative assessee.-(1) Every representative assessee, as regards the income in respect of which he is a representative assessee, shall be subject to the same duties, responsibilities and liabilities as if the income were income received by or accruing to or in favour of him beneficially, and shall be liable to assessment in his own name in respect of that income; but any such assessment shall be deemed to be made upon him in his representative capacity only, and the tax shall, subject to the other provisions contained in this Chapter, be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him. (1A) Notwithstanding anything contained in sub-section (1), where any income in respect of which the person mentioned in clause (iv) of sub-section (1) of section 160 is liable as representative assessee consists of, or includes, profits and gains of busines....
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....or members were mainly dependent on the settlor for their support and maintenance; or (iv) the relevant income is receivable by the trustees on behalf of a provident fund, superannuation fund, gratuity fund, pension fund or any other fund created bona fide by a person carrying on a business or profession exclusively for the benefit of persons employed in such business or profession, tax shall be charged on the relevant income or part of relevant income as if it were the total income of an association of persons: Provided further that where any income in respect of which the person mentioned in clause (iv) of sub-section (1) of section 160 is liable as representative assessee consists of, or includes, profits and gains of business, the preceding proviso shall apply only if such profits and gains are receivable under a trust declared by any person by will exclusively for the benefit of any relative dependent on him for support and maintenance and such trust is the only trust so declared by him. (2) In the case of relevant income which is derived from property held under trust wholly for charitable or religious purposes, or which is of the nature referred to in sub-clause (ii....
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....rified by the IC, may be explained by a simple example. If a trustee earns an income, say, of Rs. 10,00,000 holding it on behalf of certain beneficiaries, section 161 calls for an examination whether the beneficiaries and their shares are indeterminate or unknown. Suppose it is clear that the beneficiaries would be A, B, C and D entitled to shares in the ratio 2: 2: 3: 3,then, four assessments would be made on the trustee, one on behalf of each of the beneficiaries, bringing to tax the respective share incomes of Rs. 2 lakhs, Rs. 2 lakhs, Rs. 3 lakhs and Rs. 3 lakhs at the tax rates appro-priate thereto. Alternatively, but not additionally, A, B, C and D could also be assessed on such income. On the other hand, if the shares of the beneficiaries should be unknown or indeterminate, the officer would assess the trustee on the entire income of Rs. 10,00,000 at the maximum rate as defined in section 2(29C) of the Act as the Department would not beable to make assessments on the individual beneficiaries whose identityor shares are not known. Here, the IC wants to know which of these methods of assessing the trust should be adopted by the Assessing Officerand such a question cannot be en....
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....duced but if the income-tax is, for some reason, not paid by, or recoverable from, the trust, the Department can take recourse against the beneficiaries (including the IC) in respect of the higher tax charged on the trustee from the distributions received by them. On the other hand, if the assessment is made on the trust under section161, the tax leviable in respect of the IC's share thereof will be a much smaller amount. Thus, the investor company is directly and immediately affected by the nature and mode of assessment of the trust. The right of the applicant, therefore, to seek a ruling on the questions raised can not be denied. The ruling in A.A.R. 207 of 1994 will not be applicable on thefacts and circumstances of the present case. It is argued for the Department that a ruling given by the Authority on its application can bind only the IC and the Department in relation to the IC and that the trustee or the Department, in relation to an assessment on the trustee, will not be bound. They will be at liberty to proceed independently and take, if so advised, a different stand. It is, therefore, suggested that any ruling by the Authority in the matter would be infructuous or inef....
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....It is contended that the transaction in question is thus a transaction by the American company designed, prima facie, for the avoidance of Indian income-tax and that the application should be dismissed on this ground. Strong reliance is placed, in support of this argument, on the ruling given by this Authority in another case. In reply to this objection, learned counsel for the applicants con-tended that there was no substance in this contention and that the location of the IC and the IM in Mauritius was decided upon after taking into account several circumstances. This is not the first experiment of the kind made by the American company and reference has been made to the constitution of other companies by it earlier to focus on infrastructure and infrastructure-related investments in China and Asia. This trust has been patterned on like basis. The present set-up is not confined to India in that, though investments are proposed to be made in India, at some stage a co-investment by both tranches is envisaged and contributions may be invited eventually from international investors belonging to several countries. A central location for the foreign tranche was, therefore, desirable.....
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..... Mauritius was chosen for locating many of these companies because it has emerged recently as a low cost off-shore financial centre and is preferred by off-shore investors in view of its well-developed low cost financial services sector. It was explained: "Since investors come from a wide range of countries, it is absolutely essential to domicile the fund in a tax neutral jurisdiction. Also, costs for legal, accounting and other professional services are comparatively lower there." The applicant's counsel also furnished comparative figures of thefinancial cost incurred in operating from various centres, as follows: Country Cost in INR United States of America (USA) 8,840,000 - 17,680,000 United Kingdom (UK) 1,558,170 Hong Kong 1,768,000 - 2,121,600 Guernsey 537,300 -Mauritius 805,950702,200 - 1,060,800 Counsel has pointed out that it was not essential to the scheme of the American company to incorporate the IC at Mauritius to gain a tax advantage. The scheme of the American company could have operated ....
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....rom favourable treatment under the India-Mauritius Double Taxation Treaty (the 'treaty'), the company will file with the investee companies in which it owns stock, a no objection certificate from the Indian Tax Department granting benefits under the treaty for the company. Thereafter, dividends received from any Indian company in which the company owns stock will be subject to a withholding tax of (i) 5 per cent. For companies in which the company has a percentage ownership of 10 per cent or more and (ii) 15 per cent. for companies in which the company's percentage ownership is less than 10 per cent. Interest income generated from or received in India will be subject to a withholding tax of 20 per cent. Capital gains of the company generated from or received in India will be exempt from otherwise applicable Indian withholding taxes, including all Indian capital gains taxes. Under current law, such tax treatment will be available so long as the company does not maintain a permanent establishment in India. The manager intends to operate the fund to ensure to the extent possible that neither the fund nor the company in Mauritius will be treated as having a permanent establishment in I....
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....ave weighed with the parties to evolve a particular arrangement, it cannot be described as one "designed, prima facie", for the avoidance of Indian Income-tax. The existence of tax concessions under the DTAA was one of the factors taken into account but was not the only, or dominant,object of the transaction. There is, in particular, one important circumstance to show that the transaction was not designed for the avoidance of Indian income-tax. The applicants have pointed out that, on account of restrictions under Indian law, it was found more expedient to channel is all foreign investments into India through one entity rather than to attempt persuading such investors to come to India individually. That being so, the applicant, it may be said, could have channelised its funds through the offshore trust company instead of setting up the IC. It has been explained that the setting up of the IC was intended as an indication of the bona fides of the IC which would encourage other entrants. If the offshore tranche alone had been launched and it had made direct contributions to the CT it would have been beyond the pale of criticism and been welcome in India. Unlike the other ruling of the....
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....er, three exceptions have been in corporatedin the Act: (a) Under section 161(1A), this rule of apportionment and determination of proportionate tax attributable to the beneficiary will not apply to any income earned by the trustee as profits and gains of a business. The whole of such income shall be taxed at the "maximum marginal rate". A similar proviso occurs also in section 164(1) restricting benefits where business income is involved. (b) Under section 164(1), if the individual shares of the persons on whose behalf and for whose benefit the income is receivable are indeterminate or unknown, such income, again, will be taxed at the "maximum marginal rate". (c) In certain other circumstances, set out in the proviso to section164 (1), the relevant income will be assessable not at the maximum rate but at the rate applicable to it as if it were the total income of an association of persons. The Department's case is that the circumstances of the present case attract both (a) and (b) above and this has to be examined. The representative of the Income-tax Department (DR) urged that the income derived by the CT will be in the nature of "profits and gains of a business". ....
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.... of India (ICICI) or the Industrial Development Bank of India (IDBI) which return, and are assessed on, income from business and of the Unit Trust of India (UTI) which is deemed to be a company and whose income would be assessable as business income but for the exemption it enjoys under section 32 of the UTI Act, 1963. He also points out that organisations which are entirely engaged in investment can seek approval and claim exemption under section 10(23F) of the Act. This has not chosen to do so, he says, as its income is not restricted to long-term capital gains as envisaged in that clause. On the other hand, the AR draws attention to paragraph 8 of the Regulations contained in the First Schedule to the trust deed barring the trustees from carrying on business. Both paragraphs 5.01 and 6.02 of the I.M.A. outline the trust's objective to seek to achieve long-term capitalappreciation. He draws attention to paragraphs 18 and 19 of a letter to the Indian Foreign Investment Promotion Board pointing out how the objectives of the CT could be achieved only by investing in unlisted securities and the clarification given in a subsequent letter of February23, 1996, that the fund would not....
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....this purpose, one has to examine the provisions of the T.D. Paragraph 5 says that the income accruing under the trust shall be distributed among the beneficiaries in equal proportions so far as the initial settlement to be returned on the termination of the trust is concerned and, as regards other distributions, in proportion to their respective contributions and in accordance with the CA. Paragraph7(c) of the TD is also to like effect. One has, therefore, to turn to the CA. The principal clause in the CA that deals with this topic is paragraph 6.01which has already been set out. The representative of the Income-tax Department (DR) says that this paragraph is defective in two respects rendering the shares of the contributors vague and indeterminate: (a) It does not set out in definite terms that the allocation of income among the contributors will be in the respective proportions of their contributions to the trust. On the contrary, paragraph 6.04, which says so, concerns income other than that earned on portfolio investments. (b) It says that the trustees will be at liberty to make special distributions and there is nothing to limit the manner or extent of such distributions....
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.... words "special distributions" in the proposed paragraph, the words "Such special distributions shall also be made to the contributors in proportion to the respective contributions made by them". This has been reiterated by counsel in a letter dated June 27, 1996, addressed to the Authority but the revised paragraph has been couched in the following words: "6.01. Distributions. Income received by the trust in respect of the contribution fund will be a charge on the income of the contribution fund, and will be distributed annually or at such direct (sic) intervals as the trustees in their absolute discretion think fit. The contribution fund may also declare special distributions. Both the distributions shall be in proportion to contributions made by the contributors. The method by which the distribution will be made and the allocation of income between the contributor and the investment manager are as set out in sections 6.02to 6.07 and will depend on the source of the income." These modifications, it is clear, overcome the objections based on the CA and establish beyond doubt that the distribution of income will be proportionate to the contributions. The DR next objected t....
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....omputation. He, however, agreed that, with a view to avoiding any unnecessary controversy in the matter, the parties are willing to delete the words "including distribution of fees and share of profit to the investment manager" occurring in this clause. He contended that the second criticism of this paragraph by the DR is unwarranted as the discretion to the trustees in this regard also may affect the distributable income but not its mode of distribution. The Authority is of the view, as mentioned earlier, that this modification removes the first ambiguity pointed out by the DR. It also agrees with the AR that the second criticism is unjustified. It is for the trust deed (and the CA is part of it) to decide how distributable income should be determined for distribution among the beneficiaries and also indicate, if it results in the retention of any part of the income in the hands of trustees, in what way the trustees should hold such undistributed part of the income remaining in their hands. Under the present clause, the capital expenditure referred to goes out of the coffers of the trust and does not remaining the trustees' hands for distribution at all. The direction of the tr....
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....ticular portfolio investment (e.g., interest on temporaryinvestments and the contribution fund's share of any advisory fees netof general operating expenses) shall be distributed to the contributor inproportion to their capital contributions." There is a slight mistake here as the reference in this amendmentshould really be to both paragraphs 2.06(d) and (e) and the opening wordsof the revised paragraph 6.04 should read Subject to paragraph 2.06''.paragraph 6.04 is, therefore, read with the correction. In fact, by theirletter dated April 27, 1996, the applicant's counsel have modified the CAby substituting the words: "Subject to paragraph 2" in the opening wordsof paragraph 6.04. It is clear that, with this amendment, the DR's objec-tion is overcome. The DR also drew attention to clause 17(d)(i) of the trust deed andsubmitted that the shares of the beneficiaries in the net profits wouldbecome indeterminate if such portion of it, as the trustees may determine,could be applied "otherwise than by way of distribution to the beneficia-ries". The answer to this criticism is also the same as discussed above.Any amount applied by the trustees for other purposes would just ceaseto....
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....the persons who have agreed to contribute to the trustmuch later. But this creates no difficulty as the contributors are known.A difficulty may arise here since a contributor will not be called upon topay up the entire amount of his commitment at one time. It is left to theIM to call for such amounts from the contributors as may be necessaryto meet the amounts needed for the investments necessary at any particularpoint of time. There could be difficulty if different contributors are askedto contribute different amounts but this is obviated by making clear thatthe contributions called up from the contributors cannot be haphazardbut should be in proportion to the amount of commitment undertakenby him so that the inter se proportions are maintained. Two furtherdifficulties that can arise would be by reason of the facts: (a) that thecontributors come in at different points of time, and (b) that some of thecontributors may default in the payments they are called upon to make.These situations are covered by paragraphs 2.01 and 2.06 of the CA. Theseclauses have been set out earlier and need not be discussed in detail exceptto say that these difficulties are overcome by procedures respecti....
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....rminate or unknown, is chargeable to tax as a single unit treatingit as the total income of an association of persons. This provision affordsscope for reduction of tax liability by transferring property to trustees andvesting discretion in them to accumulate the income or apply it for thebenefit of any one or more of the beneficiaries, at their choice. By creatinga multiplicity of such trusts, each one of which derives a comparativelylow income, the incidence of tax on the income from property transferredto the several trusts is maintained at a low level. In such arrangements,it is often found that one or more of the beneficiaries of the trust arepersons having high personal incomes, but no part of the trust incomebeing specifically allocable to such beneficiaries under the terms of thetrust, such income cannot be subjected to tax at the high personal ratewhich would have been applicable if their shares had been determinate. In order to put an effective curb on the proliferation of such trusts,and to reduce the scope for tax avoidance through such means, the FinanceAct, 1970, has replaced section 164 of the Income-tax Act by a new section.Under section 164 as so replaced, a 'rep....
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....urt. Interpreting the scopeof section 2(15) of the Act, the Supreme Court in CIT (Addl.) v. Surat ArtSilk Cloth Manufacturers Association [1980] 121 ITR 1, observed that "ifthe language of a statutory provision is ambiguous and capable of twoconstructions, that construction must be adopted which will give meaningand effect to the other provisions of the enactment rather than that whichwill give none". This principle has been further extended in later cases.In K. P. Varghese v. ITO [1981] 131 ITR 597 (SC), the court was concernedwith the interpretation of section 52(2) of the Income-tax Act, 1961. Thissub-section provided that where the consideration for a transfer of propertystated in the instrument of transfer falls short of its market value by morethan a particular percentage, the property should be deemed to have beentransferred at the market value (and not the stated consideration) and thecapital gains computed accordingly. Literally, this provision would applyeven to cases where the transferor received no more than the actuallystated consideration although the market value was higher. But the courtconstrued the provision in a restricted manner and held that it could beinvoked ....
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....e section, as amended, is to prevent the shares of beneficiaries being manipulated at the discretion of the trustees. If it is read as requiring the specification of the beneficiaries and their shares in the deed itself, it may lead to absurdities. A trust is very often created to benefit a class of beneficiaries who may exist on the date of the trust or who may come into being later and the shares of the individual beneficiaries may also vary depending upon the numerical strength of the class to which they belong or the conditions attached to the receipt of the benefit. Several instances of trusts, particularly family trusts, can be thought of in which reversionary interests in favour of the author's descendants are created. They would all be caught by the mischief of section 164 if this interpretation were adopted even though the class of beneficiaries is clearly ascertainable from the deed as also the share which every beneficiary is entitled to receive. It could hardly have been the intention of the Legislature to bring the income of such trusts to charge at the maximum marginal rate though it is very clear that the income of a particular previous year is held by the trustees s....
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....ed to cover a slightly different type of case where the number of beneficiaries are not known at the date of the deed but the shares are ascertainable by reference to the specifications and directions given in the deed itself. Thus, to take the examples given above, a trusteed providing that the sons of the settlor should receive the income would fulfil the requirements of the Explanation as, on the date of the deed, it is possible to say who will share the income and in what proportion although the number of shares may not be known on such date. So also, in the second example, if the deed were to say that all descendants of the author will get the income in the proportion 1: 2: 3: 4 calculated as stated earlier, the specification would be sufficient to satisfy the terms of the Explanation. This would be so even where the ascertainment of the class and the actual share may depend on certain conditions precedent or subsequent which may or may not be fulfilled in the previous year the distributable income of which is under consideration at any point of time. It would be a fair construction of the provision to say that section 164(4) will not come into operation if the trust deed sets....
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....inty and definiteness as to who would be the beneficiaries and whether their shares would be determinate and specific, if the event on the happening of which the distribution is to take place occurred on that date, the case will be governed by sub-section (4) of section 21." The Authority is of opinion that the question: "Has the Explanation superseded this interpretation ?" has to be answered in the affirmative only in respect of cases where the instrument of trust leaves the determination of the shares of the beneficiaries in a particular previous year dependent on a person other than the author of the trust or events and conditions not specified in the instrument of trust. If there be any ambiguity in the matter it should be resolved by resort to the principles stated by the Supreme Court in the cases referred to earlier. Judged by these considerations, the TD and the CA (which is a partthereof) in the present case leave no doubt as to who would be the beneficiaries and what their individual shares would be. The beneficiaries are the persons whose names are set out in the Third Schedule to the trusteed as well as other persons who are permitted to make contributions to the....
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....he effect of the application of section 161. This section treats the trustee as having a representative character. The assessment on the trustee is to be in like manner and to the same extent as if it were made on the beneficiary himself directly. The practical effect of this provision is to render the assessment of the trustee and beneficiary identical in every respect. Thus if the trustee receives income by way of dividend or interest or capital gains it cannot but be treated as dividend, interest or capital gains respectively in the representative assessment which is to be made on the trustee. Any plausibility of an argument to the contrary is ruled out by the decisions of the Supreme Court in the cases of CIT v. H. E. H. Mir Osman Ali Bahadur [1966] 59 ITR 666 (SC) and in CITv. P. Krishna Warrier's case [1970] 75 ITR 154. In CIT v. H. E. H. MirOsman Ali Bahadur [1966] 59 ITR 666 (SC), the Nizam had delivered certain tax-free State securities on trust with directions that the interest income therefrom be paid to certain beneficiaries, including himself, for life. As such a beneficiary, the Nizam claimed that he was exempt from tax on the distribution made to him. The Revenue too....
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....on the trustee or the beneficiary. We cannot, therefore, accept the construction put upon section 41 of the Act by the High Court." In P. Krishna Warrier's case [1970] 75 ITR 154 (SC), the assesse hadsettled his business in Ayurvedic drugs on trust. He directed the trustees to maintain a school and hospital that had been set up by him out of 60per cent. of the income from the business and apply the balance of 40per cent. on two tavazhies. The Income-tax Officer sought to levy a special surcharge on the latter treating it as "unearned" income under the Finance Act (No. 2) of 1957 and the Finance Acts of 1958 to 1961. "Earned income "was defined in the Finance Acts as meaning, "in the case of income chargeable under the head 'Profits and gains of business', 'profession or vocation', where the business, etc., is carried on by the assesse". The Income-tax Officer held that since the business was carried on by the trustees and not the tavazhies it could not be treated as earned income. By a short order, the Supreme Court upset that conclusion. It observed (at page 157): "Under the will of P. S. Warrier the trustees were directed to carry on the business of 'Arya Vaidya Shala'. In ....
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....nterest and capital gains included in the distributable income would be dividends, interest and capital gains in the hands of the investor company to an a liquot extent. The consequence of the above conclusion results in benefits to the IC under the DTAA. This agreement confers certain benefits on a resident in Mauritius within the meaning of the DTAA in respect of various categories of income earned by him in India. Relevant portions of articles 10,11, 13 and 22 of the DTAA which deal with the benefits relevant for the purposes of the case need to be set out (see [1984] 146 ITR (St.) 214, 221): "Article 10 DIVIDENDS (1) Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State. (2) However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed: (a) 5 per cent. of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 per cent.of the ....
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....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 enter-prise) 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 Contracting 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 . . . Article 22 OTHER INCOME (1) Subject to the provisions of paragraph 2 of this article, items of income of a resident of a Contracting State, wherever arising, which are not expressly dealt with in the foregoing articles of this Convention, shall be taxable only in that Contracting State. (2) The provisions of paragraph 1 shall not apply to income, other than income from immovable property ....
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....on to the Revenue to estimate the income at a prescribed rate or a higher income declared by the assessee). Ingenious as this argument is, the Authority is of the view that it cannot be accepted as it cuts across the principle behind section 161 on which he has built up his argument, relying on the Supreme Court decisions, that the assessment on the IC should be made as if it were in direct receipt of the income and not through the CT. Though it is the CT that receives the dividend and interest and makes the capital gains, it is the hand of the IC that is deemed to have received the income directly. It is true that the fiction is one created by section 161 of the Act but the fiction of section 161should be extended to its legitimate consequences: in the present context, even to the interpretation of the DTAA. If the IC wishes to seek the benefit of the provision for the purpose of an assessment on it, it cannot turnaround and deny the logical follow up of the fiction for purposes of the DTAA. The Authority is, therefore, of opinion that interest will be assess-able to income-tax in India, that dividends will be liable to be charged to tax at five per cent. or 15 per cent. (as the c....
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....al incomeas so reduced been his total income; and (ii) the amount of income-tax calculated on such long-term capital gains at the rate of twenty per cent.: Provided that where the total income as reduced by such long-term capital gains is below the maximum amount which is not chargeable to income-tax, then, such long-term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maxi-mum amount which is not chargeable to income-tax and the tax on the balance of such long-term capital gains shall be computed at the rate of twenty per cent.; (b) in the case of a domestic company, - (i) the amount of income-tax payable on the total income asreduced by the amount of such long-term capital gains, had the total income as so reduced been its total income; and (ii) the amount of income-tax calculated on such long-term capital gains at the rate of thirty per cent.: Provided that in relation to long-term capital gains arising to a venture capital company from the transfer of equity shares of venture capital undertakings, the provisions of sub-clause (ii) shall have effect as if for the words 'thirty per cent.', the words 'twenty....
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.... assessment under section 164 on it will have to be in the status of an "individual". He prefers this status because of the rate of 20per cent. Prescribed under section 112(1) (a), in contradistinction to the rate of 30 per cent. under section 112(1)(b) or (d). In support of his contention, Sri Dastur relies on the decisions of the Supreme Court in trustees of Gordhandas Govindram Family Charity Trust's case [1973] 88 ITR 47and in Nizam's case [1977] 108 ITR 555. The decisions referred to by him were rendered under the Wealth-tax Act, 1957, on the question as to whether, where there is more than one trustee, the body of trustees could be treated as an "individual" and brought to tax even though "association of persons" was not a category of assesse under that Act as under the Income-tax Act. They are not helpful to decide that even where there is a sole trustee and it is a company and the assessment is made on it under section 164, the assessment should be made on it in the status of an "individual". Having considered the pros and cons carefully, the Authority is of the view that the assessment on the CT will have to be made in its status as a company. The Authority cannot see how ....
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....ng a total income exceeding seventy-five thousand rupees, under section 115BB ofthe Income-tax Act, the income-tax computed shall be increased by asurcharge calculated at the rate of fifteen per cent. of such income-tax.'' This not only makes section 112 applicable in such a case and pro-vides for a surcharge in addition, where the assessee is a domestic com-pany, to the rate of 30 per cent. Where, however, the assessment is onemade under section 164, the choice has to be between the maximum rateprescribed under that section and the lower rates specified in section 112.Section 2(3) of the Finance Act does not meet this situation. It does notsolve the issue of priority as between a provision contained in ChapterXII (section 112) and section 164 both of which are specifically mentionedin it. Perhaps the correct solution would be to give weightage to section164 which is designed to meet the issue of liability in special cases andto counter a strategy of tax avoidance as mentioned earlier. Fortunately, the Authority is not constrained to express a concludedopinion on the two questions discussed above in paragraphs 59 to 61 inview of its conclusion that section 161 applies to the ....
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....ctive management is situated." Clause (2) of this definition is not relevant for the present purposes.The residential criterion has to be decided only with reference to clauses(1) and (3). Taking up clause (1), it is argued by the AR that the companiesare liable to tax in Mauritius. They are incorporated there-the certificatesof incorporation as well as tax residency certificates to the effect that thecompanies are resident in Mauritius under the Income-tax Act, 1995, ofthat country have been filed and they are, therefore, resident in Mauritius.They are not liable to tax in India. The mere fact that they are liable, evenas non-residents, on the income accruing or arising or deemed to accrueor arise in India is not sufficient, according to counsel, to make themresidents in India under clause (1). Hence, they are entitled to claim benefitsunder the DTAA. On the other hand, the DR urges that the companies cannot be saidto be residents of Mauritius as they are not liable to income-tax in Mauritiusunless they choose to submit themselves to assessment and pay tax there.On the other hand, they are certainly liable to tax on their Indian income.Even if they can be said to be resident....
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....se: (i) a person seeks relief under the DTAA in India onlywhen he is subjected to tax here and so there would be no error in sayingthat he is liable to tax in India within the meaning of article 4(1); and(ii) the article itself provides for the eventuality of a person being residentin both countries and prescribes tie-breaker tests to meet the situation.Hence, his contention that the IC and the IM are not resident in Indiacannot be accepted. Nor can the interpretation by the DR of article 4(3)be accepted. In the case of the investor company, its registered office isin Mauritius and its only transaction is the investment in India. In anapplication made in January, 1996, to the Mauritius Offshore BusinessActivities Authority (MOBAA) for a residency certificate-there is also alike letter on behalf of the investment manager-certain features of theinvestor company which show that its place of management will be inMauritius have been set out. This letter can be usefully quoted here: "The following steps are to be taken to ensure Mauritian placeof management, in particular: 1. The company has two resident directors of appropriate calibreto exercise independence of mind and judgment.....
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....es fora tax at the maximum rate on the income from business in the hands ofa trust but the beneficiary here being eligible for the benefit of the DTAA,that benefit can be availed of under section 90(2) of the Act. The Authority,therefore, accepts the plea of counsel for the investor company that incase there are any business profits earned by the CT and an aliquot sharethereof is distributed to the investor company, such distribution will notbe liable to income-tax in India. The discussion thus far disposes of the issues raised by the IC in itsapplication. To turn to the application filed by the investment manager, the fourquestions raised by the applicant have already been set out and asmentioned earlier, the principal question sought to be raised is whetherthat company can be said to have a permanent establishment in Indiawithin the meaning of the DTAA. Reference has earlier been made to theargument of the DR that the investment manager cannot seek to avail ofthe provisions of the DTAA since that company cannot be said to be aresident of Mauritius within the meaning of the DTAA. This argument hasalready been dealt with in so far as IC is concerned. In the case of theIM, how....
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....nvestment advisorsmay function with the help of service units. But these only appear to beadvisory bodies in no way controlling the decision of the board. The provisions of the investment management agreement, however,contain certain provisions which require consideration. Reference may befirst made to paragraph 2.01 under which the investment manager agreesto provide and be responsible for day to day management and adminis-trative services to the trust fund in accordance with the provisions of theagreement and any directions and instructions of the trustees. Likewise,paragraph 3.03 makes the responsibility of the IM subject to any direc-tions, instructions and guideliness provided by the trustees. It was pointedout to learned counsel for the applicants that the words in italics mightlead to the conclusion that the control and management of the affairs ofthe management company would rest ultimately in India where the trusteecompany is located. Shri Dastur thereupon agreed that the applicants wouldbe willing to drop the offending words from paragraph 2.04 and to deleteparagraph 3.03 altogether. The position is, therefore, considered on thefooting that that these provisions are no....
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.... services in India. The AR replied to thisobjection by saying that this clause should be read with paragraph 13.04and that it only envisages the appointment of professionally skilled personsto assist the IM in the discharge of its functions. He also explained thatthe passage at page 40 of the placement memorandum pertains to theinvestor company and not the investment manager. He, however, saw the force of the arguments of the DR. Counsel, bytheir letter dated June 27, 1996, have proceeded to give the followingundertaking: "During the hearing of the captioned company (hereinafter referredto as 'the company') certain concerns were raised as to whether the com-pany would undertake activities that would result in its being construedto have a permanent establishment in India. It is, therefore, submittedthat the company does not intend to undertake the following activities: 1. Open a fixed place of business in India as contemplated underarticle 5(1) of the India Mauritius Double Taxation Avoidance Agreement(DTAA). 2. Undertake any activity or open any place of business as con-templated under article 5(2) of the India Mauritius DTAA. 3. Appoint any agent or broker in India ....
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....ut one cannot anticipate in what manner the investmentmanager will organise its activities. The language of paragraph 10.01 issufficiently wide to enable it to carry on its activities, if not through anoffice in India, at least through its own employees and other personnelfunctioning in India and looking after some or all of its operations. It istrue that some changes in paragraph 10.01 have been made and counselhave given certain assurances in their letter of 27th June, 1996. These areno doubt of some help but the absence of a clause such as paragraph 10.01is not sufficient to prohibit the IM from carrying on the business to bestadvantage in such manner as it considers fit and proper. The undertakingsare also not wholly satisfactory as they repeat the clauses of the DTAAand it may have to be decided on actual facts whether a fixed place ofbusiness exists for the IM in India and whether persons employed to carryout its activities are independent within the meaning of the DTAA. TheAuthority cannot be expected to envisage all possible methods or channelsthrough which the investment manager can function and to give anadvance ruling as to which of them will amount to a permanent establ....
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....ut the changes madeby indicating both the changes and the reasons for them in bold lettersin this order. That apart, the changes in the draft have to be made by theIndian financial service company, the IC, the IM and the trust company,as the case may be. The Authority has been informed by counsel's letterdated June 27, 1996 (in each of the cases), of the precise terms of thechanges effected in the various documents and presumes that these modifi-cations have been by the persons respectively competent to effect thesechanges. The ruling given by this order is based on these changes beingvalidly carried out in the various documents. The second matter to which the Authority would like to refer is this.Before the case was heard, the applicants were asked whether they wouldhave any objection to the publication of the rulings given by the authorityon these two applications. The answer was in the negative initially butlater it was said that there would be no objection if the answers are infavour of the applicants but that, if the rulings are adverse, they wouldhave every objection to such publication. The Authority has consideredthis objection and is of opinion that the objection has to....
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.... of the Act as also ofseveral important treaty provisions of the DTAA with Mauritius, that itis desirable to publish the rulings. The Commissioner of Income-tax onthe Authority is, therefore, directed to have the rulings on these applica-tions also published in due course. However, in doing so, he may carefullyexamine the contents of the rulings and consider the possibility of expunc-tion therefrom of references to persons, figures and other like details ofa personal nature to the extent it can be done without detracting froma proper comprehension of the principles and reasonings contained in theRuling. In the light of the foregoing discussions, the Authority hereby makesthe following rulings on the two applications before it: RULING (i) Application of IC: Question No. 1: Based on the facts and circumstances of the case,and in view of the provisions of India-Mauritius double tax avoidanceagreement, can it be construed that the applicant does not have a perma-nent establishment (PE) in India ? Answer No. 1: On the basis of the documents placed and undertak-ings given by the parties, it can be said that no permanent establishmentfor the applicant is envisaged at presen....
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.... 3: Based on the facts and circumstances of the case,if it is held that the provisions of section 161 do not apply to the incomeof the applicant from the contributory trust because of the power vestedin the trustees to add to the list of the beneficiaries on the terms laiddown in the indenture of trust and the contribution agreement, then ifsuch power is deleted, would the assessment of the applicant in respectof its proportionate share of income of the trust be made in accordancewith section 161 ? Answer No. 3: Yes. As the trustees' power to add to the list ofbeneficiaries has been held not detrimental to the application of section161, the question is hypothetical. But, if this power is altogether deleted,the case for an assessment on the CT under section 161 will becomestronger. Question No. 4: Based on the facts and circumstances of the case,even if it is held that the shares of the additional beneficiaries are indeter-minate whether the capital gains arising to the applicant will be chargedto tax at the rate of 20 per cent. as prescribed in section 112 of the Act ? Answer No. 4: The word "additional" appears to be superfluous. Thequestion does not arise in view of the ....