Double Tax Avoidance Agreement

8/3/2019 Double Tax Avoidance Agreement

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SUCHISMITA PATI

UNIVERSITY OF PETROLEUM AND ENERGY STUDIES, DEHRADUN

Vth [email protected]

29.07.2011

ANALYSIS OF RECENT AAR RULINGS ON

NON-RESIDENT TO NON-RESIDENTTRANSFERS


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Capital Gains under IT Act Gains which arise from the transfer of capital assets, are

subject to tax under the Income-tax Act. Section 14 of theIncome-tax Act has classified Capital Gains as a separateHead of Income.

The computation of capital gains depends upon the natureof capital asset that is transferred, i.e., whether it is ashort-term or a long-term capital asset.

Capital gain, arising on transfer of a short-term capital

asset, is short-term capital gains whereas Capital gain,arising on transfer of a long-term capital asset, is long-term capital gains.

As compared to long-term capital gain, the tax incidence

is higher in the case of short-term capital gain.


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Capital Gains

Article 13 of DTAA deals with capital gains and provide that

gains from the alienation of immovable property may be taxed

in the contracting state in which the property is situated.

According to Art 13(2) gains from alienation of movable

property forming part of the business property of the

permanent establishment that am enterprise of the contracting

state has in other contracting state, or immovable property

pertaining to a fixed base available to a resident of a

contracting state in the other contracting state for the purposeof performing independent personal services, including such

gains from the alienation of such permanent establishment or

fixed base may be taxed at other state.

Article 13(4), gains derived by a resident of a contracting statefrom the alienation of an ro ert will be taxable at that state


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UNION OF INDIA AND ANOTHER VS. AZADI BACHAO

ANDOLAN AND ANOTHER (263 ITR 706 ,2003)

The following questions were raised in the above case:-

The respondent urged that treatyshopping is both unethicaland illegal and amounts to fraud on the treaty.

The Court held that if it was intended that a national of a third

State should be precluded from the benefits of the DTAC, thena suitable term of limitation to that effect should have beenincorporated therein, as mentioned in Article 24 of the Indo US Treaty on Avoidance of Double Taxation, it held that inabsence of a limitation clause, such as the one contained in

Article 24 of the Indo- U.S. Treaty, there are no disabling ordisentitling conditions under the Indo-Mauritius Treatyprohibiting the resident of a third nation from deriving benefitsthere under.


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E*TRADE MAURITIUS LTD. VS. DIT,

MUMBAI

Facts of the Case:-

- The applicant, E*TRADE Mauritius Limited is a company

incorporated in Mauritius .

- The Applicant held equity shares in IL&FS Investment Limited

(IndianCompany)which are listed on Stock Exchange in India.

- The Applicant transferred 30,625,692 shares of the Indian

Company to HSBC Violet Investment (Mauritius) Limited, a

company in Mauritius .

- Being a tax resident of Mauritius, the Applicant is governed by the

provisions of the India-Mauritius DTAA in respect of its tax

liability in India. So, the Mauritius Co. get tax benefits on capital

gains in India.


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The Applicant had approached the Assistant Director of

Income-tax, Mumbai to obtain the nil rate withholding tax

certificate under section 197 of the IT Act but ADIT denied the

request and determined that the capital gains tax of 21.11%

would be applied to the total sale consideration of the shareswithout deduction for the cost of acquisition.

The Applicant approached the Bombay High Court by way of a

Writ Petition but the H.C directed the Applicant to approach

the Director of Income-tax (International Taxation)for arevision of the Certificate under section 264 of the IT Act .


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Questions Formulated by The Applicant

(i) Whether the Applicant, a tax resident of Mauritius, is

exempted from payment of capital gains tax in India

under the Double Taxation Avoidance Agreement (or

DTAA) between India and Mauritius (India-Mauritius

DTAA) in respect of the transfer of shares in IL & FSInvestment Ltd. an Indian Company to HSBC Violet

Investments (Mauritius) Limited?

(ii) Will the Applicant be liable to pay tax on long term capital

gains at 10% under the proviso to Section 112(1) of theIncome-tax Act, 1961 (ITAct)?


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Issues Raised by the Revenue:

The stand of the Revenue is that there is scope and sufficientreason to infer that the capital gains from the transaction arises in

the hands of the US entity which holds the applicant company.

Though the legal ownership ostensibly resides with the applicant,

the real and beneficial owner of the capital gains is the USCompany which controls the applicant and the applicant

company is merely a faade made use of by the US holding

Company to avoid capital gains tax in India.

Revenue contended that despite setting up a subsidiary inMauritius, if US holding company factually does the business in

India and exercises rights of ownership in shares, the US entity

cannot get out of tax net.

It put forth that the tax benefit applies in respect of income fromcapital gains arising from sale of shares of Indian companies.


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Decision by the Court

The AAR analyzed the decision in Azadi Bachao, and ruled,the Supreme Court found no legal taboo against treaty

shopping and gave the following decision-

- if a resident of a third country, in order to take advantage of the

tax reliefs and economic benefits arising from the operation ofa Treaty between other countries through a conduit entity set up

by it, the legal transactions entered into by that conduit entity

cannot be declared invalid.

- It is difficult to assume that the capital gains has not arisen inthe hands of the applicant, more so when according to the

binding pronouncement of the Supreme Court, the motive of

tax avoidance is not relevant so long as the act is done within

the framework of law, the treaty shopping through conduit

companies is not against law.


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The AAR upheld the contention of the applicant that by virtue

of Article 13.4 of India-Mauritius DTAA, capital gain tax is not

liable to be charged in India.

The motive behind setting up such conduit companies and

doing business through them in a country having beneficial taxtreaty provisions was held to be immaterial to judge the legality

or validity of the transactions.


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D B ZWIRN MAURITIUS TRADING NO. 3 LTD.

FACTS:

The appellant was a company incorporated in Mauritius

(MCo). Mauritius tax authority had issued Tax Residence

Certificate (TRC) to MCo. MCo held equity shares of an

Indian company. MCo sold the shares to another Mauritiuscompany resulting in capital gains.

M Co sought ruling of AAR on the following questions:

Whether M Co was liable to tax on capital gain under Income-

tax Act and India-Mauritius DTAA?

Whether the sale of shares was subject to withholding tax u/s.

195 of Income-tax Act?


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MCo contended that in terms of Article 13(4) of India-MauritiusDTAA, capital gain arising from sale of shares was not liable to

tax in India and that TRC constituted valid and sufficient

evidence of residential status under India-Mauritius DTAA.

MCo also relied on Supreme Courts decision in Union of Indiav. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC) and Circular

No. 789 of 2000 of CBDT.

Decision of the Court:

In terms of Article 13(4) of India-Mauritius DTAA, power oftaxation of gains is vested only in the state of residence (i.e., in

this case, Mauritius). If the provision in DTAA is more

beneficial, the taxpayer is entitled to seek benefit under DTAA.

Hence, MCo was not liable to pay tax in India on capital gains.

Sale of share is not subject to withholding tax u/s. 195 of T I


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The cases mentioned above favored the tax payers and they

got tax benefits but in the Vodafone case, the Supreme Court

dismissed the appeal of the Company and it had to pay tax for

the capital gains in India.

The case is about withholding tax but the underlying

argument arose was whether overseas M&A transactions with

underlying Indian assets are taxable in India.


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VODAFONE CASE

Vodafone International Holdings BV (Vodafone), a

company registered in the Netherlands, acquired the entire

share capital of CGP Investments (Holdings) Ltd (CGP); a

Cayman Islands based company, from Hutchison

International (HTIL).

Vodafone received a tax bill from the India Income Tax

Department, which said that Vodafone was liable to pay CGT

as most of the assets it bought were based in India.

.


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___________________

Outside India

___________________________________ India 67% 33%

VodafoneU K Company

(Hutchison EssarGroup)

Series of Tax Haven Cos.

Investments Holding Ltd.

Cayman Is.

HTIL(Cayman Is.)

Essar ( India)


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After the sale, Indian Income-tax department served a notice on

Vodafone and asked it to show cause why tax was not deducted

at source as required under S. 195. Instead of responding to the

notice, Vodafone filed a writ petition in the Mumbai High Court

challenging the jurisdiction of the Income tax department. TheHigh Court dismissed the writ petition with costs.

Vodafone filed appeal before the Supreme Court. The Supreme

Court has referred the matter to the Income tax department with

specific instructions to examine facts & determine whether thedepartment had jurisdiction in the present case or not.


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Key contentions by Vodafone

Since the transfer is of a capital asset situated outside India, the

gains arising there from should not be liable to tax in India in the

hands of the non-resident seller entity.

The Income Tax Act, 1961 (ITA) does not have any look

through provisions hence, the same cannot be enforced throughjudicial interpretation.

The Foreign Investment Promotion Board (FIPB) Approval

was a routine process required to be complied with and section

195 of the ITA do not apply to offshore payments as it could betriggered only if it is established that the payment under

consideration is ofa sum chargeable under the ITA.


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A disinvestment of its right, title or interest preceded

disinvestment ofcontrollinginterest. HG relinquished its assets,

namely its interest in Hutchison Essar Ltd, so as to fall in the

ambit oftransfer as defined under section 2(47) of the ITA. In respect of the liability to deduct tax, the expression person as

provided in section 195 of the ITA could be applied to a non-

resident. Further the provisions would apply to all payments

which wholly or partly represent a sum chargeable to tax and

once the income is chargeable, the nexus will exist both with

regard to payee and the payer. Since the transaction under

consideration had a substantial nexus, it would result in an

obligation being cast on Vodafone to deduct tax at source under

section 195 of the ITA.


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Ruling of the Bombay High Court

The High Court held that "the very purpose of entering into

agreements between the two foreigners is to acquire the

controlling interest which one foreign company held in the Indian

Company, by other foreign company. This being the dominantpurpose of the transaction, the transaction would certainly be

subject to municipal law of India, including the Indian Income-

tax Act". From the Hutchison Groups perspective, it had carried

on Indian mobile telecommunications operations which was

being discontinued as a result of the transaction.

The High Court remarked that "the present is a case of tax

evasion and not tax avoidance". It is apparent that in the present

case a chain of foreign companies located in full or part tax haven

countries was used to avoid payment of tax in India.


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THANK YOU

Documents

Double Tax Avoidance Agreement