TaxTMI 
TaxTMI 
2019 (10) TMI 1163
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.... not taxable in India, without appreciating the fact that the assessee, being a foreign institutional investor, is refrained from undertaking any other business activity and accordingly the receipt on account of foreign exchange fluctuation will be in the nature of income from other sources or other income taxable in India or other income taxable in India as per article 23(3) of DTAA between India and Spain. 3. The issue in appeal lies in a rather narrow compass of material facts. The assessee, a foreign institutional investor, is a company incorporated in, and fiscally domiciled in, the Kingdom of Spain. The assessee had filed a return of income, disclosing taxable income of Rs. 1,745, on 15.11.2013. During the course of ensuing scrutiny assessment proceedings, the Assessing Officer noticed that the assessee had earned a profit of Rs. 12,60,01,800 on account of transactions in foreign exchange but claimed the same as exempt under article 14 of the Double Taxation Avoidance Agreement entered into between India and Spain [(1994) 214 ITR (St.) 197; Indo Spanish tax treaty, in short]. The case of the assessee, in brief, is that since these gains are in the nature of arbitrage, and ....
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....t in India and since investment income of the appellant FII is not taxable in India as per article 14(6) of the India Spain treaty, the gains on forex transactions entered to hedge the investments in the securities is capital gains, and (thus) not taxable in India", that "as the facts of the present case are similar to the earlier years" in which the issue was decided in favour of the assessee by his predecessor and "since there is no change in the position this year, and the issue is identical this year also, I decide the above ground in favour of the appellant". The Assessing Officer is aggrieved and is in appeal before us. 4. This matter was mentioned before us as a covered matter, and learned counsel for the assessee cited a number of orders of this Tribunal, including in assessee's own case, upholding the reasoning adopted by the assessee. A lot of emphasis was placed on the fact that the foreign exchange transactions, resulting in the gains in question, were entered into to hedge the currency risks associated with the investments made in India, and, for this reason, these gains cannot be brought to tax in India. Learned Departmental Representative, on the other hand, defen....
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....relevant provision is as follows: ARTICLE 23- OTHER INCOME 1. Subject to the provisions of paragraph 2, 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 Article 6, 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 a case, the provisions of Article 7 or Article 15, as the case may be, shall apply. 3. Notwithstanding the provisions of paragraphs 1 and 2, items of income of a resident of a Contracting State not dealt with in the foregoing Articles of this Convention, and arising in the other Contracting St....
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....not satisfied, the assessee cannot be taxed in India under these provisions. While we will deal with Article 14 in a detail with other grounds of appeal and the Assessing Officer has not even claimed taxability under article 14, we deem it fit and proper to set out the provisions of Article 7 of Indo Spanish tax treaty which are as follows: ARTICLE 7- BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in that other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in that other State of the same or similar kind as those effected through that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business i....
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....uted to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article. 11. There cannot be any dispute that the assessee has entered into forward exchange contracts in the course of its business. Grievance of the Assessing Officer at best is, to quote his words, "as an investor, the assessee cannot carry out any business activity", and, therefore, it cannot be said to be a business activity. 12. That line of reasoning, however, does not appeal to us. 13. The absence of regulatory approvals, even if that be so, does not alter the character of business activities. The law is very well settled on this issue. Even an illegal business is a business nonetheless. Whether an assessee carries out business with the requisite regulatory approvals, or without such regulatory approvals, the business activities continue to business activities nevertheless. In the case of CIT Vs S C Kothari [(1971) 82....
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....panish tax resident had a PE in India from which such activities were to be carried out, the profits of such an adventure would have been taxable in India under article 7. We may, at the cost of repetition, add that it is not the fact of non taxability of an income under article 6-22, but the nature of income not being inherently taxable under these articles, which brings an income in the ambit of article 23. 18. Once we note that the forward exchange contracts were entered into, with the regulatory approval or without the regulatory approval, in the course of business, such contracts could either be in the revenue field or in capital field. These two paths are mutually exclusive, and we cannot visualize a third path. 19. If a view is taken that these gains are in the capital field, the gains are taxable as capital gains which are governed by article 14 of Indo Spanish tax treaty. The broad thrust of this provision is that except in the cases specified, i.e. under article 14(1) to 14(5), the capital gains are taxable only in the residence jurisdiction. It is not the case of the Assessing Officer that the gains on settlement of forward foreign exchange contracts are covered by....
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....ribunal, it was held that as the gains and losses on the forward foreign exchange contracts were to hedge the investments in question, which were admittedly taxable under section 115AD, "capital loss having direct nexus with the investment of the assessee and hence the assessee is entitled to set off the same". This decision held that such gains will also be covered by taxation under section 115AD, and will take the same colour as the main transaction, in respect of which forward contracts to hedge the investment currency risk were entered into. 23. The judicial precedent, by which it was taken as covered issue, did not even deal with the provisions of any tax treaty, much less Indo Spanish tax treaty, and it has no bearing on the question as to whether the gains on foreign exchange forward contracts could be granted protection of Article 14 of Indo Spanish tax treaty from taxation in the source state or as to whether the gains on foreign exchange forward contracts could be taxed in the source jurisdiction under article 23 of the Indo Spanish tax treaty. Yet, almost mechanically, even after noting the specific case of the Assessing Officer on application of article 23, the matte....
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....dismissed. 27. In ground nos. 2 to 6, which we will take up together, the appellant Assessing Officer has raised the following grievances: 2 Whether on the facts and circumstances of the case and in law, the ld. CIT(A) erred in treating the Capital loss of Rs. 71,00,01,126 on sale of shares of companies engaged in real estate development activities classified under BSE Realty Index as exempt under Article 14(6) of the India-Spain DTAA and not taxable in India without appreciating the fact that Article 14(4) of the DTAA is very clear & unambiguous on the issue & sale of such shares should have been held as taxable in India as per the same. 3. Whether on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in not appreciating the fact that the Assessing Officer has rightly held that right to occupy immovable properly is nowhere mentioned in Article 14(4) of the DTAA and India is not a signatory to the UN Model. 4. Whether on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in not appreciating the fact that the A.O. is not required to consider the commentary on Article 13(4) of the UN model....
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.... in the source jurisdiction. He thus concluded that the capital gain on sale of these shares in Indian real estate companies is taxable in India under article 14(4) of the Indo Spanish tax treaty. An addition of Rs. 11,31,51,216 was, accordingly, made to the income returned by the assessee. Aggrieved, assessee carried the matter in appeal before the CIT(A). The CIT(A) noted the plea of the assessee that there is no indirect transfer of ownership of immovable properties by transfer of these shares, and that, in terms of the UN Model Convention commentary, the provisions of Article 14(4) come into play only in the cases of indirect transfer of ownership of immovable property by the transfer of shares owning these properties. He then referred and relied upon decisions of his predecessor, upholding the plea of the assessee, which stand approved by coordinate benches of this Tribunal. It was noted that while the assessee has invested in the shares of real estate companies "but the holding of immovable property developed by them remaining unsold is in the nature of stock in trade" and that "the value of these shares in the stock market is based not just on the extent of the immovable ....
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....ies holding immovable properties in India. Be that as it may, the conclusions of the coordinate bench were in favour of the assessee and that's what apparently mattered at the end of the day. The learned CIT(A) found support from the same, and, thus reversed the action of the Assessing Officer. Accordingly, the gains on sale of shares in real estate companies was held to be not taxable in India. The Assessing Officer is aggrieved and is in appeal before us. 30. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. 31. As we deal with these grievances, we consider it appropriate to begin with reproducing article 14, the interpretation of which is at the core of controversy requiring our adjudication. This provision is as follows: ARTICLE 14- CAPITAL GAINS 1. Gains derived by a resident of a Contracting State from the alienation of immovable property, referred to in Article 6, and situated in the other Contracting State may be taxed in that other State. 2. Gains from the alienation of movable property forming part of the business property of a permanent ....
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....lienation of shares in other contracting state (i.e. in India in this case); (b) the property of such a company, shares in which are sold by the assessee, must consist of "principally" of immovable properties; (c) such a holding of, principally, the immovable properties may be direct or indirect (i.e. through a step down subsidiary or under any other arrangement). Under article 14(4), thus, it is only on satisfaction of these conditions that the gains, in the hands of a tax resident of Spain, on alienation of shares in Indian company can be brought to tax in India. 35. Article 14(4), in the present case, is a provision allocating the taxing right to source jurisdiction in certain situations as an exception to the general rule of taxation of capital gains in the residence jurisdiction adopted in this tax treaty, and, it is, therefore, on the source jurisdiction to demonstrate that these conditions are satisfied. It is only elementary that no one can be expected to prove a negative, and, therefore, the onus cannot be on the assessee to demonstrate that these conditions are not satisfied. As observed by Hon'ble Supreme Court, in the case of K P Varghese Vs ITO [(1981) 131 ITR 59....
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....d exception, which is only an extension of the first exception, is that the gains on sale of a company, property of which mainly, even if directly or indirectly, consists of the immovable properties, is also taxable in the source jurisdiction. The second exception, in a way, takes colour from the first exception. It is a widely known fact that on many occasions, the companies are floated mainly to hold the immovable properties, and the transfer of ownership in these companies is far easier, less expensive and smooth a process than the transfer of ownership of the underlying immovable properties. It was for this reason, and to effectively implement the underlying principle on which foundation of article 14(1) rests, i.e. the gains on appreciation of value of immovable properties must be taxed in the source jurisdiction, that article 14(4) has come into existence. That is what is borne out of the unmissable ground realties as also of literature on international tax treaty policy development. 39. With this backdrop in mind, we have to attempt to interpret the scope of Article 14(4). Let us, however, take note of certain ground rules of the principles of interpretation of treaties. ....
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....sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create...." [Emphasis, by underlining, supplied by us now] 41. When such are the views of the Hon'ble Supreme Court on the interpretation of taxing statutes, essentially the tax treaties, which are to be subject to much less rigid rules of interpretation, cannot be subjected to literal interpretation in isolation with the context in which the words have been employed. On a similar note, Hon'ble Supreme Court, in the case of Union of India v. Azadi Bachao Andolan [(2003) 263 ITR 706 (SC)]has observed that the principles adopted in the interpretation of treaties are not the same as those adopted in the interpretation of statutory legislation. Their Lordships quoted, with approval, a passage from the judgment of the Federal Court of Canada in the case of N. Gladden v. Her Majesty the Queen 85 DTC 5188, at page 5190 wherein the emphasis is on the 'true intentions' rather than 'literal meaning of the words employed'. This quote was "Contrary to an ordinary taxing statu....
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.... on Law of Treaties (VCLT), our judicial forums, right upto Hon'ble Supreme Court, have consistently referred to, and relied upon, Vienna Convention on Law of Treaties (VCLT), e.g. in the case of Union of India Vs Azadi Bachao Andolan [(2003) 263 ITR 706 (SC)]. Elaborating upon the principles governing interpretation of tax treaties, Lord Denning, in Bulmer Ltd. v. S.A. Bollinger [1972] 2 AER 1226, has observed that ".......... The treaty ...... is quite unlike any of the enactments we have been accustomed... It lays down general principles. It expresses aims and purposes ...... what are English Courts to do when they are faced with a problem of interpretation? They must follow the European pattern. No longer must they examine the words in meticulous detail. No longer must they argue about the precise grammatical sense. They must look to the purpose or intent........." Echoing these views and justifying his departure from the plain meaning of the words used in the treaty, Goulding J. in IRC v. Exxon Corpn. [1982] STC 356 at page 359, observed that "In coming to the conclusion, I bear in mind that the words of the Convention are not those of a regular Parliamentary draughtsman bu....
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....panish tax treaty that we are dealing with. However, the underlying principle- as discussed above, is the same, and that is what is clearly borne out of UN Model Convention Commentary. 46. The thrust of this provision is that the property of such companies, transfer of shares of which leads to taxability of gains in the source jurisdiction, consist "principally" of immovable property. 47. The common thread in the UN Model Convention Commentary and the OECD Model Convention Commentary is that the threshold to trigger this taxation on alienation of shares of a company where underlying assets constitute immovable property is of fifty percent or more of the aggregate value of assets. 48. In the OECD Model Convention, in the place of "principally", the threshold test itself is prescribed at fifty percent of the aggregate value of asset. The expression "principally" was clearly defined, until the 2017 update, in the UN Model Convention itself as such. In the 2017 update, the UN Model Convention provided for a specific minimum threshold trigger to be decided between the contracting state, but then that's an event much later to not only the Indo Spanish tax treaty but also to the ....
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.... property of which consists, directly or indirectly, principally of immovable property situated in a Contracting State may be taxed in that State", it must essentially remain confined to the shares which, taken on standalone basis or as a cumulative effect of the related transactions, lead to the control of the company or, in any other way, give right to enjoy or occupy the underlying immovable property owned by the company in question and such property must be what the company in question principally holds. In our considered view, this is the only way in which we can harmonise this provision, as mandated by article 31 of VCLT, "in the light of its object and purpose", and, in our humble understanding, there cannot be better guidance on the intent of the object and purpose of a treaty provision than the understanding shared by the very multilateral institutions which have conceived and developed the said provision. 52. The wordings of UN and OECD Model Convention do differ from the provision in the treaty before us, and, but then, it is not, nor can it be, revenue's case that the intent and purpose for which article 14(4) was introduced was any different. 53. Even keeping the....
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....st 10 per cent in a company which is a fiscally domiciled in a jurisdiction. In all these cases, common thread is substantial presence and control, by the assessee, in the taxation jurisdiction. The alienation of shares in a realty company does not belong to the genus of these provisions. There is no other conceptual justification for the same. Quite to the contrary, as the scheme of the treaty clearly shows, the justification for this treaty provision is entirely different- as we have discussed above. If we are to do by the interpretation as canvassed before us by the revenue, it will result in a situation in which the gains on sale of shares, held as an investor in the company rather than a de facto investor in the immovable property, with the intent of enjoying or controlling the underlying immovable properties, in companies owning immovable property will become taxable in the source state. That position does not fit in the scheme of the treaty provisions under article 14, and is clearly an incongruous result. 55. In the present case, while the assessee has sold no more than 2% shares in any of the six realty companies, namely Anant Raj Limited, DLF Limited, Indiabulls Rea....