TaxTMI 
TaxTMI 
2001 (3) TMI 1035
X X X X Extracts X X X X
X X X X Extracts X X X X
....icant will not be taxable in India on capital gains (whether long-term or short-term) arising from the transfer of securities it holds in companies incorporated in India (hereinafter referred to as "the portfolio companies") ? 3. Whether, on the facts and circumstances of the case, the activities of the investment adviser will not constitute a permanent establishment of the applicant in India ? 4. Whether, on the facts and circumstances of the case, the activities of the custodian will not constitute a permanent establishment of the applicant in India ? 5. Whether, on the facts and circumstances of the case, would the employees of the investment adviser appointed as "nominee directors" on the board of directors of the portfolio companies on behalf of the applicant constitute the permanent establishment of the applicant in India ? 6. Whether, on the facts and circumstances of the case, if for any reason the activities of the applicant were to constitute a permanent establishment in India, even then, since the securities held by it in India would not form part of the business property of its permanent establishment, the applicant would not be subje....
X X X X Extracts X X X X
X X X X Extracts X X X X
....pplicant will be absolved from filing a tax return in India, under the provisions of section 139(1) of the Income-tax Act if the entire tax payable by it is with held in India under the Treaty provisions and as per the rates prescribed in the Treaty ? 15. Whether, on the facts and circumstances of the case, would there be any penal consequences under the Income-tax Act if the applicant fails to file a tax return provided the entire tax payable by it has been withheld at source ? 16. Whether, on the facts and circumstances of the case, if for any reason, the applicant is found to have a permanent establishment in India, will the profits attributable to such permanent establishment be taxable at the rate of 35 per cent. instead of 45 per cent. based on the provisions of article 24 of the Treaty ? The applicant has stated in the petition before us that it is a private equity fund (similar to a venture capital fund). It has allotted a large number of shares on a private placement basis to a limited number of prospective investors spread over Belgium, France, Germany, Hong Kong, Japan, Kuwait, the Netherlands, Singapore, Switzerland, the United Kingdom and the Unite....
X X X X Extracts X X X X
X X X X Extracts X X X X
....vestors were to apply separately to the RBI or the FIPB for approval to invest in the portfolio companies. In order to avoid the repetitive approvals that each of the investors in the applicant would have to obtain, XYZ and ABC decided to invest in India through a single entity set up outside India. Organising a single entity in India for the purposes of making venture capital investments requires certain regulatory and tax approvals. The guidelines for setting up venture capital funds or companies in India are also very restrictive. Some of the restrictions are briefly set out hereinbelow. Venture capital entities cannot invest in more than 40 per cent. of the paid-up capital of a single company. Furthermore, they cannot invest more than 20 per cent. of their own total paid-up capital in any single company. If the objective of a mutual fund is to invest in the shares of listed companies then all the funds are collected at one go from the investors. In such cases it would be possible to invest 20 per cent. or less than 20 per cent. of the paid-up equity capital in a single company. However, in the case of private equity funds, initially only commitments from global investors ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... in India, would have to fulfil the conditions prescribed by the Ministry of Finance, Department of Economic Affairs, for foreign investment in non-banking financial services companies. According to these guidelines, if the foreign equity holding in a non-banking financial company were to exceed 75 per cent. the Indian company would need to have a minimum capitalisation of US $50 million of which US $7.5 million is to be invested up front and the balance within 24 months. Since the applicant would be making a call for investment from its subscribers as and when it is able to find an investment opportunity, which may not necessarily fall within a period of 24 months, these guidelines would cause the applicant great difficulties. In addition to investing in India, the applicant may invest in companies/entities outside India. Accordingly, if the applicant was organized in India, it would be difficult to invest in companies set up outside India as such investments would require the prior approval of the RBI and the RBI regulations for investments abroad, which are quite stringent would have to be complied with. To date, the applicant has made four investments. Three of the compan....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nsent of the company and where urgent action is required to protect the interests of the company and/or its properties, initiate against any person legal proceedings in respect of the properties and the custodian shall in such cases keep the company informed about such action. The company agrees to keep the custodian idemnified and to hold the custodian harmless against all losses, damages, claims, penalties, expenses, suits or proceedings of whatsoever nature made or suffered or incurred consequent to or arising out of the initiation of such proceedings, provided that the same is not suffered or incurred due to the bad faith, wilful default or negligence of the custodian. The services to be provided by the custodian include the duty to transfer or exchange the deliverance of securities purchased on behalf of the applicant-company- (i) upon sales of such securities and receipt by the custodian of payment, therefore, in accordance with instructions ; (ii) upon receipt by the custodian of payment when in connection with any repurchase agreement related to such securities ; (iii) for receipt by the custodian of payment when such securities are called, red....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... company" or in such other name as the company may direct. The custodian shall not be required to make any payment hereunder or permit any withdrawal from the cash account unless free and clear monies are held in the cash account. Records and inspections : The custodian shall keep or cause to be kept such records and statements as may be necessary to give a complete record of all properties held and transactions carried out by it on behalf of the company. Such records may be maintained in the form of computer records and the company agrees that the custodian is entitled to produce copies or reproductions of each computer records and documents during the course of any legal proceedings or as required by any statutory or regulatory authority. The custodian's records and documents pertaining to their actions under this agreement and the securities shall be open to inspection by the company, at reasonable periods. The custodian will perform a physical verification and reconciliation of holdings at least quarterly and more regularly in relation to certain property against the records kept pursuant to the custodian's duties hereunder. These are the basic facts. We shall....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e with paragraphs 2 and 4 of article 13. Under paragraph 2, gains from transfer of shares which form part of the business property of a permanent establishment of a Mauritius-based company in India may be taxed in India. Likewise, gains from shares pertaining to a fixed base available to a Mauritius-based company in India for the purpose of performing independent personal services may also be taxed in India. But if the shares are not of the kind mentioned in paragraph 2 then gains derived from transfer of such shares by the Mauritius-based company could only be taxed in Mauritius under the residuary provisions of paragraph 4. The crux of the question, in this case, is whether the petitioner-company comes within the ambit of paragraph 2 or is exempt from tax in India by virtue of the provisions of paragraph 4 of article 13. Before we deal with this question in detail a subsidiary question raised on behalf of the Revenue has to be noted. It has been contended that there is no tax on capital gains in Mauritius and, therefore, the benefit of article 13 is not available to the applicant. In support of this proposition reliance has been placed on the judgment of this authority in the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ived from Mauritius, whether the person was resident in Mauritius or elsewhere ; or (b) the income was derived at a time when the person was resident in Mauritius, whether the income was derived from Mauritius or elsewhere. (2) Subject to the other provisions of this Act, income shall be deemed to be derived by a person when- (a) it has been earned or has accrued ; or (b) it has been dealt with in his interest or on his behalf, whether or not it has become due or receivable. (3) Earned income derived from outside Mauritius shall be deemed to be derived by a person when- (a) it is received in Mauritius by him or on his behalf ; or (b) it is dealt with in Mauritius in his interest or on his behalf." By virtue of section 5(1)(b), the income received by a person at a point of time when he was resident in Mauritius will be deemed to be derived by him even if the income was actually derived elsewhere. That means the applicant-company being a resident of Mauritius will be liable to pay tax on the income which was derived in India. The next question is the scope and meaning of "income" as provided in the Mauritius Act. Th....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... "(2) for the purposes of sub-section (1)(b), the gross income derived from a business shall include : (a) any sum or benefit, in money or money's worth, derived from the carrying on or carrying out of any undertaking or scheme entered into or devised for the purpose of making a profit, irrespective of the time at which the undertaking or scheme was entered into or devised ; (b) any sum or benefit derived from the extraction, removal or sale of any mineral, tree or wood ; (c) any sum or benefit, in money or money's worth, derived from the sale of any immovable property or interest in immovable property, where the property was acquired in the course of a business the main purpose of which is the acquisition and sale of immovable property ; (d) any increase in the value of trading stock on hand at the time of transfer by sale or otherwise of a business or on the reconstruction of a company ; and (e) any subsidy derived in the carrying on of a business." From all these provisions it is abundantly clear that a company has to pay tax on its "gross income derived from any business" and also "any other income derived from any other source". ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sale is an important aspect for deciding the question whether a transaction in shares is a business transaction or not. But then again it is well settled that frequency of sale though a relevant factor is not decisive. It is well settled that a single plunge may amount to a business venture if the surrounding circumstances so indicate. For example, if a man borrows money to buy shares with a view to make profit and after some time sells the shares at a profit, the inference may be legitimately drawn that the purchaser of the shares had ventured into a business transaction. On the other hand, if a man having surplus fund employs it in shares instead of keeping it in the bank, profit from sale of such shares may be capital gain. Here we have a company which has been formed with an object of purchasing and selling of shares. The very objects clause of the memorandum of association of the company lists the objects for establishment of a company as : (a) To carry on business as an investment company and to acquire, invest in and hold securities of all kinds (including units) created, issued or guaranteed by any Government, sovereign, ruler, commissioner, public body or autho....
X X X X Extracts X X X X
X X X X Extracts X X X X
....any, or for any other purpose which may seem directly or indirectly calculated to benefit the company and to pay all the expenses of or incidental to such promotion. (c) To carry out all or any of the objects aforesaid in any part of the world, and as principals, agents, contractors, trustees, sub account of a Foreign Institutional Investor ("FII") registered with the Securities and Exchange Board of India ("SEBI") or otherwise, and by or through trustees, agents, attorneys or otherwise, and either alone or in conjunction with others. (d) To do all such other things as the company may deem incidental or conducive to the attainment of any of the aforesaid objects of the company. Having regard to the objects clauses of the memorandum there is little doubt that the purchase of shares of the company in India was part of the company's business operations. The business of the applicant-company is "to carry on business as an investment company and acquire, investment in and hold securities of all kinds . . . and from time to time to sell, deal in, vary or dispose of any of the foregoing." Therefore, the company has been formed with the object of carrying on the busine....
X X X X Extracts X X X X
X X X X Extracts X X X X
....tects to its customers to do what they wanted to be done. The company was not carrying on a profession but was carrying on a trade or business in the ordinary sense of the term even though it was engaging professionals for the purpose of its business. In the case of Rellim Ltd. v. Vise [1952] 22 ITR (Suppl.) 51 (CA), the assessee-company by its memorandum of association was empowered to purchase, manage and sell land and buildings and other properties. In 1939, the company acquired some houses and garages and about 13 acres of land and in 1944 it purchased 47 acres of farming land. All these properties were let by the company to the tenants at rents which were its only income. The company was treated as an investment company up to 1946- 47. During the years 1945-47 the company sold two houses, 13 acres of land and also a farm. The profits made by the company were assessed as trading profits on the ground that the company was a trading company. The Court of Appeal declined to interfere with the finding made by the Commissioner that the company was a trading company which had made trading profits. Whether the company's activities will amount to trading is basically a question o....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... : "Article 5 : Permanent establishment : 1. For the purposes of this convention, the term 'permanent establishment' means a fixed place of business through which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' shall include :- (a) a place of management ; (b) a branch ; (c) an office ; (d) a factory ; (e) a workshop ; (f) a warehouse in relation to a person providing storage facilities for others ; (g) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources ; (h) a farm, plantation or other place where agricultural, forestry, plantation or related activities are carried on ; (i) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or supervisory activity continues for a period of more than nine months. 3. Notwithstanding the preceding provisions of this article, the term 'permanent establishment' shall be deemed not to include : (a) the use of facilities solely for the purpose of storage or display....
X X X X Extracts X X X X
X X X X Extracts X X X X
....hat Contracting State (whether through a permanent establishment or otherwise) shall not, of itself, constitute either company a permanent establishment of the other." The petitioner-company does not have a place of management or branch or office or a factory or a workshop in India. On behalf of the respondent it has been argued that the shares which are purchased in India are also stored in India. Therefore the petitioner-company must be treated as having a storage facility as a warehouse for storing its goods. This will bring the case of the petitioner within the mischief of sub-clause (f) of clause 2. Now, sub-clause (f), deals with a warehouse in relation to a person providing storage facilities for others. If a non-resident person is providing storage facility for others he may be said to have a "permanent establishment" in India. But, in this case, the petitioner is not providing storage facilities. At the most it can be said that it is availing of or using storage facilities provided by others. Therefore, the petitioner's case will not come within the mischief of sub-clause (f) of clause 2. The other subclauses (g), (h) and (i) are clearly not attracted in the facts of th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....se, is acting in the ordinary course of business in rendering agency service to the Mauritius company. It is not a special business done exclusively for the petitioner-company only. These allegations of facts have not been controverted effectively by the respondent. Under these circumstances, it must be held that the Mauritius company, the petitioner here, did not have a "permanent establishment" in India. Therefore, the profits made by this company if and when made, will have to be taxed as business profit in Mauritius and not in India in view of the provisions of article 7 of the Treaty between India and Mauritius. The next important question is, will the company have to file a return of income in India ? The argument is that if it does not have any taxable income in India it need not file a return of income in India. We find no basis for these arguments. Section 139(1) of the Income-tax Act requires every person to file a return of income in the prescribed form before the due date if his total income during the relevant previous year exceeded the maximum amount which is not chargeable to income-tax. "Total income" is to be computed in accordance with the provisions of the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....stablishment" of the applicant-company. Having regard to the facts, as stated by the applicant, it may be held that the activities done by the investment adviser cannot be converted into "permanent establishment" of the applicant-company in India. Therefore, question No. 3 is answered by saying that the facts stated may not make the investment adviser a "permanent establishment" of the applicant in India. Question No. 4 is answered in the negative. On the facts stated in the application, the activities of the custodian cannot be treated to constitute a permanent establishment of the applicant in India. We do not propose to answer question No. 5. The applicant claims that the nominee director as appointed by the investment director in various portfolio companies could not have any authority to conclude any contracts on behalf of the applicant and they do not constitute a permanent establishment of the Mauritius company in India. The role and functions of the nominee director will have to be examined in depth. Why was this interlinking between various companies necessary or is this a colourable device to avoid payment of tax are questions which must be examined in depth. Theref....