TaxTMI 
TaxTMI 
TaxTMI 
1996 (8) TMI 512
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....nvestment 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 set up as a contributory trust (hereinaf....
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....ce 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 contributors on the one hand and the trustees and the IM on th....
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....nefit 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 follows: (a) as regards the initial settlement as specified in the second schedule to dist....
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.... 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 the parties wish to do it in the form of a trust which, under the trust act, merely represents certain obligations ....
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.... 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 all persons actually or prospectively interested under this settlement. 17. Decisions, etc., of the trustee.. . . . (d) The fo....
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.... 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 takedown notice (draw down) in accordance with this agreement (notice clause) within 21 calendar days in advance of the date on which the capital contribution shall ....
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....tor'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 which such defaulting contributor defaulted, which corresponds to such defaulting contributor's contributed capital percentage as of such date; and (f) appropriate adjustments shall be ....
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....me 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 and capital expenditures as the investment manager shall reasonably determine will be distributed as follows: (a) First, to the contributor until 100 per cent. of capital contribution has been deemed to ha....
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.... 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 account." 3. Investment management agreement (I. M. A.): The management of the trust funds is to be entrusted by the CT to the IM under an agreement entered into with it. The IM is a limited life company incorporated in Mauritius. It is a 1....
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....duct 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 portfolio investment and the entrepreneurs and if necessary to assist in the administration of the trust fund." Article XIII dealing with delegation of duties envisages an investment committee (paragraph 13.01), an advisory board (paragraph 13.02) and advisory ....
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....ments." 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 of income earned by the contributory trust as per the provision of section 161 of the Income-tax Act, 1961 (the Act) ? 2. Based on the facts and circumstances of the case, whether the contributory trust would be....
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....o 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 ? 2. Based on the facts and circumstances of the case, will the applicant be liable to tax in respect of the management fees received from the CT ? 3. Based on the facts and circumstances of the case, will the applic....
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....spect 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 business, tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum marginal rate: Provided that the provisions of this sub-section shall not apply where such profits and gains are receivable under a trust declared by any person by will exclusively for the benefit of any relative....
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....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 (iia) of clause (24) of section 2 or which is of the nature referred to in sub-section (4A) of section 11, tax shall be charged on so much of the relevant income as is not exempt under section 11 or section 12, as if the relevant income not so exempt were the income of an association of persons:. . . Explanation 1. For the purposes of this sect....
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....he 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 entertained from it under Chapter XIX-B. The Department's objection is that this is a question which really affects the CT-a resident Indian company-and that the IC, though a non-resident, cannot avail of the benefits of Chapter XIX-B for getting clarifications about a resident assessee's liability to income-tax merely because they have some mutual conn....
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....e 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 ineffective. It can be by-passed by the trust or the Department whichever was aggrieved by it. Such a ruling, it is said, should be avoided. This contention is also without force. If the view of the Authority on this application and the view of the officer assessing the trust coin-cideand it may be reasonably presumed, that though the ruling of the authority i....
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....arned 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. The shareholders of the IC are three subsidiaries of the American company located in Bermuda, Hongkong and the U. S. and Mauritius was considered centrally located for all of them. Hence, the IC was located at the same place. An additional reason for this, it was said, was that, due to foreign exchange restrictions in India, it will be difficult to secure dir....
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.... 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 in an equally effective manner by investing funds of the off-shore tranche in the CT and secured the same advantages that are now sought. But due to the difficulty pointed out and with a view to keep the contributions of the American company to the CT distinct from its contributions to the off-shore tranche it became necessary to establish the IC and, for the locational advantages already referred to, it was got inco....
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....nies 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 India. However, there is no guarantee that absence of a permanent establishment will be maintained." It then proceeds to refer to section 161 of the Income-tax Act and says: "The Indian trust will be regarded as a transparent entity and the character of income in the hands of the beneficiaries but each of the beneficiaries will be taxed in respect of their income from the trust. The Indian revenue authorities may choose t....
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....ncome-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 Authority to which reference has been made, the foreign tranche could not be treated as just a benami or dummy for the American company for the funds invested through it will be flowing from several international sources. The tax advantages suggested now could have been obtained then also. It is, therefore, difficult to characterise the setting up of the IC and the provision of a contribution by it as designed for the avoidance of in....
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....ved. (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". He points out that the CT does not just invest in portfolio investments and equity shares of companies (including listed companies).Its activities are much wider and far-reaching. He draws attention to paragraph 5.01 of the C.A., the relevant part of which may be extracted here: "5.01. The trust fund's investment objective will be to seek to achieve long-term capital appreciation by primarily making direct investments in a portfolio of Indian co....
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....3F) 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 invest in any listed security in the primary or secondary market. By their letter dated June 27, 1996, counsel for the applicant have informed the Authority that the last sub-paragraph of paragraph 5.01 of the draft I.M.A. (italicised in the extract in paragraph34 above) have been deleted. Paragraph 8 of the Regulation only provides for temporary investment in other debt instruments and not to make quick profits. He says that section 10(23F) does not in....
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....o 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. (c) The words "income . . . will be distributed annually or at such direct intervals as the trustees may in their absolute discretion think fit "confer an absolute power on them to distribute dividends in their absolute discretion. The result, the DR says, is that the distributions can be made by the trustees in their absolute discretion. In other words, it is a purely discretionary trust under which the trustees have complete liberty to distribute any part o....
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....ome 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 that the determination of the shares of the contributors becomes indeterminate because the trustees have been empowered to add further contributors (clause 7 of TD) and because of the formula set out in paragraph 6.02 of the contribution agreement. The first of these causes no difficulty as, after the modification of clause 7made at the hearing and agreed to by counsel (see paragraph 8 (at page487) above), the trustees can admit as contributors-cum-beneficiaries only instituti....
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....he 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 trustees that such expenses should be met out of the income of the trust to the extent the trustees consider necessary is one they are empowered to make under clause 14 of the trust deed. It may result in the diminution of the distributable income available to the beneficiaries but does not render the shares of the beneficiaries in any way uncertain or unknown. The DR also next raised three points based on paragraph 6.04 which provides for an allocation among the investors of all ....
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....ead 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 be part of the distributable income like the capital expenses on repairsand would affect the quantum of income available for distribution butnot the mode of its distribution. It will also be seen that clause 17(d) isnot a clause conferring any special power on the trustees in this behalf:it only provides that the decision regarding such application, even if arrivedat in conformity with the other provisions of the trust deed, shall not beeffective unless voted for by a majority of the di....
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....ribute 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 respectively callingfor interest and the writing down of their capital contributions. In essence,the distribution rule is that distribution should be in the proportion ofthe capital contributions of the respective members. We may add that, inview of the criticism made by the DR on these aspects, we called uponlearned counsel for the applicant to explain by means of clear illustrationshow the income distributions will take place in cases where default occurs.In compliance with the instructions of the Aut....
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....rredto 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 'representative assessee', who receivesincome for the benefit of more than one person whose shares in suchincome are indeterminate or unknown, will be chargeable to income-taxon such income at the flat rate of 65 per cent. or the rate which wouldbe applicable if such income were the total income of an association ofpersons, whichever course would be more beneficial to the Revenue." When the Explanation was added in 1980, the Central Board ofRevenue issued the following circular (see [1980] 123 ITR (St.) 15....
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....ourt 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 only in cases where the consideration has been understated bythe assessee; or, in other words, the full value of the consideration inrespect of the transfer is shown at a lesser figure than that actually receivedby the assessee and has no application where the consideration receivedby the assessee has been correctly declared or disclosed by him. The courtobserved (headnote): "A statutory provision must be so construed, if possible, thatabsurdity and mischief may be avoided. Where the plain literal interpre-tat....
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.... 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 specifically in defined shares on behalf of known beneficiaries and they have absolutely no discretion to distribute the income otherwise than to such persons or in accordance with such shares. As explained by the Supreme Court in the cases cited, the proper way in which to understand a section is to avoid absurd and inequitable and unintended results even if it means some strain on the language. In the opinion of the Authority, however, it is not even necessary to invoke these principles of extended construction in the ....
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....t 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 out expressly the manner in which the beneficiaries are to be ascertained and also the share to which each of them would be entitled without ambiguity. The persons as well as the shares must be capable of being definitely pin-pointed and ascertained on the date of the trust deed itself without leaving these tube decided upon at a future date by a person other than the author either at his discretion or in a manner not envisaged in the trust deed. In any event, such a practical interpretation, in the light of the objects o....
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....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 trust fund according to the terms and conditions set out in the CA. The share of the beneficiaries in the distributable fund will inter se be in the same proportion as the amounts actually contributed by them to the fund as on the date of the distribution, irrespective of the date on which the contribution was actually made by them. There is no uncertainty regarding the beneficiaries and there is no uncertainty regarding the share of income to which he is entitled. The class of persons who become contributories subsequent to the ....
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....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 took the view (which the High Court approved) that (at page 681): ". . . after the execution of the trust deed, the assesse was divested of his ownership of the securities and the trustees became their owners. On that basis . . . though the income was interest on securities in the hands of the trustees, it was in the hands of the assesse only the income which he got from the trustees . . . the character of the income, namely, interest on securities, had changed when it reached the hands of the assesse." The Supreme Court did not agre....
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....come 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 the income of the business the trustees had no beneficial interest, but it was still income chargeable under the head 'profits and gains of business, profession or vocation'carried on by the trustees. Being income chargeable under the head 'Profits and gains of business, profession or vocation' carried on by the trustees, it was earned income in their hands, and to the earned income the special surcharge under the Finance Acts of 1957, 1958, 1959, 1960 and 1961 had no application. The High Court was right in answering the third question refer....
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....ed 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 capital of the company paying the dividends; (b) 15 per cent. of the gross amount of the dividends in all other cases. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid . . . (4) The term 'dividends' as used in this article means income from shares or other rights, not being debt-claims participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the Contracting State of which the com....
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....uated. (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 as defined in paragraph 2 of article6, if the recipient of such income being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the income is paid is effectively connected with such permanent establishment or fixed base. In such case, the pro-visions of Article 7 or Article 14, as the case may be, shall apply.'' Starting from the position earlier explained that th....
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....ectly. 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 case may be) and that capital gains will not be chargeable to tax. The AR next contends that, if dividends and capital gains must be taxed in the hands of the investor company, they should be taxed at five per cent. in the case of dividends and at 20 per cent. in the case of capital gains. He further says that even if an assessment is to be made on the CT under section 164, the amount of CG included in its income can only be taxed at 20 per cent. and not at the maximum marginal rate. To take up the first contention, the rate of five per cent. will be available only where the recipient of the d....
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.... 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 per cent' had been substituted; (c) in the case of a non-resident (not being a company) or a foreign company,- (i) the amount of income-tax payable on the total income as reduced 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 twenty per cent.; (d) in any other case of a resident, - (i) the amount of income-tax payable on the total income as reduced by the amount of long-term capital gains, had the total income as so reduced been its total income; and (ii) the a....
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....ld 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 a direct assessment on the CT, without recourse to section 161, can be made in a status different from what the assesse in fact possesses. Once section 161 is out of the way and the assessment on the trustee is a direct one under section 164,the idea that it is a representative assessment of the income of the beneficiary should be eschewed, except possibly for the fact that tax levied on the trustee may eventually be recoverable from the beneficiary as well.(But there will be difficulties in this course as well as no one beneficiary can be made liable for the tax liability of another beneficiary and the postulate of section 164 is t....
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....otsolve 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 present case and thatthe capital gains received by the investor company will not be chargeableto tax in India by reason of article 13 of the DTAA. The DR, however, raised the contention that neither the investmentcompany nor the investment manager is entitled to avail of the benefitsof the DTAA. It is common ground that these companies cannot claimrelief under the DTAA unless they can be said to be resident in Mauritiuswithin the meaning of the DTAA. That definition is contained in article4 of the DTAA which reads as follows (see [1984] 146 ITR (St) 214, 216): "Article 4 RESIDENTS (1) For the purposes of this Convention, the term "resident o....
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....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 in Mauritius, they are also residentin India and so the tie-breaker provision in clause (3) has to be invoked.But this clause refers not to the place of incorporation but to the placeof effective management and the DR says that there is nothing to showthat the effective management of the companies is exercised fromMauritius. The companies are subsidiaries of the American company and their shareholders are other companies (also the subsidiaries of the samecompany) with registered offices in different countries (except to the extentof 27 per cent. in the case of the investment manager which is with theIndian financial service company and an Asian Bank). They have no....
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....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. 2. The company's secretary is resident in Mauritius; 3. The registered office is Mauritius; 4. Banking transactions will be channelled through theHongkong and Shanghai Banking Corporations; 5. Accounting records will be maintained in Mauritius in accord-ancewith the Companies Act, 1984; 6. Board meetings will be held in or chaired from Mauritius; 7. All statutory records, such as minutes and members' register,will be kept at the registered office; 8. The company has an ordinary status." Firstly, it is difficult to say that the effective management of theaffairs of the company is not in Mauritius in the above situation unlessthere are facts to at least prima facie i....
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....entioned 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, however, there are certain additional facts which need considerationon this issue. These will be dealt with now. The investment manager is a company incorporated in Mauritius.It is proposed that 73 per cent. of the shareholding of this company willbe with the American company while Indian financial service companyand an Asian Bank will have shareholdings of 22 per cent. and five percent., respectively. It is the responsibility of this company to manage theaffairs of the CT. The investment proposals are to be finally approved anddecided upon by the board of directors of the company which paragraph13.01 of the IMA specifically says will be done at its meetings outside ofUnited States and India. But ....
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....s. 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 longer in the IMA. Apart fromthese provisions, there is nothing in the IMA which would indicate thatthe functions of the IM are not completely independent or that its businessis subject to any control from India. Reference has already been made toparagraphs 3.04 and 13.01 under which the decisions of the board ofdirectors will be taken at locations outside the United States and India.Though the IM has certain restrictions placed on its functioning by theintroduction of other bodies such as the investment committee, the invest-ment advisor, the advisory board, and the service units, it appears clearthat the last word and decision on any of the functions of the investmentmanager rests with its own bo....
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.... 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 who has the authorityto conclude contracts in the name of the company and who is not of anindependent nature." They have also intimated the change effected in paragraph 10.01(a)(iii)of the IMA by rewording it thus: "10.01(a)(iii) to engage professionally skilled and/or experiencedpersonnel to provide the necessary advisory support and investmentmanagerial entrepreneurs and if necessary to assist in the administrationof the trust fund." Having considered the pros and cons of these arguments, the Autho-rity is of the view that it is not possible to give any ruling on the questionwhether the investment manager has a permanent establishment in Indiaor not, unless more details are available regarding the actual f....
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....olly 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 establish-ment and which not. All that can be stated now is that if the investmentmanager functions purely outside in India and does not get any assistancefrom India, except by way of advice from the various bodies envisagedunder the agreement, it cannot be said to have a permanent establishmentin India. However, if the business of the investment manager is so carriedout that it necessitates an office in India or the employment of personnelin India or the carrying out of systematic operations in India in somemanner or the other, then it may be necessary to consider, on the factsas they emerge, whether a permanent establishment has been created inIndia or not. The other three questions raised by the applicant depend for th....
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....ard, 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 be overruled.The confidentiality that once attached to proceedings under the Income-tax Act, 1961, has since been abolished. Section 138 no doubt refers tosome situations in which details of assessment records could be given tooutsiders at their request. But the proceedings of this Authority are notassessment proceedings and there is no statutory rule of confidentialitythat prevents publication of the rulings given by it. It is true that, underthe statute, the rulings of the Authority are binding only in respect of thetransactions on the basis of which the questions have been raised by boththe applicants and the income-tax authorities. But this will not be decisiveof the present issue. The scheme of advance rulings has be....
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....e 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 present. However, this answer to thequestion will be subject to the manner in which the applicant company'sactivities are actually carried on. Question No. 2: Based on the facts and circumstances of the case,will the applicant be liable to tax in respect of the management fees receivedfrom the CT ? Question No. 3: Based on the facts and circumstances of the case,will the applicant be liable to tax in respect of the carried interest receivedfrom the CT ? Question No. 4: Based on the facts and circumstances of the case,if the answer to above question is yes, will there be a withholding taxliability on the CT, in respect of the payment of management fees andcarried interest to the applicant ? Answer Nos. 2, 3, 4: The answer to these ques....
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....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 finding that the beneficiaries arenot indeterminate and the Authority wishes to express no ruling on theissue. Question No. 5: Based on the facts and circumstances of the case,will there be any tax withholding by the investee companies at the timeof distribution of income to the CT ? Answer No. 5: At the end of the question, the words "and if so towhat extent" were requested to be added. So far as the investee companiesare concerned, they will be required to withhold tax from the amountspaid to the CT at the rates appropriate in the case of an Indian companyon all payments made by them in accordance with the provisions of therelevant Finance Act. It may, however, be open to the CT or to the applicantto apply to the Assessing Officer praying that tax may ....