Direct Tax Alert

BACKGROUND

Section 90(2) of the Income-Tax Act, 1961 (IT Act) provides that where a Double Taxation Avoidance Agreement (DTAA) have been entered into by the Central Government, the provisions of the IT Act shall apply to the extent they are more beneficial to that taxpayer.  Further, Section 90(2A) of the IT Act has an overriding effect over Section 90(2) of the IT Act. It provides that GAAR1 provisions can be applied to a taxpayer even if such provisions are not beneficial to him. Thus, to deny beneficial treatment as per Section 90(2) of the IT Act, an arrangement entered by the taxpayer may be declared to be an impermissible avoidance arrangement2 and the consequence in relation to tax arising from there may be determined subject to the provisions of Chapter X-A3 of the IT Act.

In this regard, recently the Delhi Tax tribunal4 had an occasion to examine whether a transaction could be declared as an impermissible avoidance arrangement without invoking GAAR provisions. We, at BDO in India, have summarised the ruling of the Delhi Tax Tribunal and provided our comments on the impact of this decision.

FACTS OF THE CASE

  • The taxpayer, a tax resident of Mauritius, acts as an investment holding company and has a valid Tax Residency certificate (TRC). It held a Category 1 Global Business Licence issued by the Financial Services Commissioner, Mauritius.

  • For the Fiscal Year (FY) 2019-20, the Taxpayer derived income from long-term and short-term capital gains from the sale of shares of two Indian Companies.

  • In the return of income for the relevant FY, the taxpayer offered the short-term capital gain to tax. However, the long-term capital gain was not offered to tax since it held a valid TRC and thus was entitled to avail benefits5 under the India- Mauritius DTAA.

  • The Tax Officer rejected the claim of the taxpayer and observed that the taxpayer has been set up through a scheme of arrangement to avoid taxes by adopting a colourable device hence the scheme has to be regarded as an Impermissible Avoidance Arrangement. Therefore, the tax officer held that the taxpayer will not be entitled to India-Mauritius DTAA benefits.

  • Aggrieved, the taxpayer filed an appeal before the Dispute resolution panel (DRP) which affirmed the order passed by the tax officer. Further aggrieved, the taxpayer filed an appeal before the Delhi Tax Tribunal.

TRIBUNAL RULING

The Delhi Tax Tribunal made the following observations while ruling in favour of the taxpayer by allowing its claim to exempt long-term capital gains under India-Mauritius DTAA:

  • TRC issued by the competent authority of a particular country determines the tax residency of a particular person/entity. The aforesaid position has not only been accepted by the Revenue in Circular No. 78, dated 13 April 2000, but also while upholding the validity of the aforesaid Circular, the Hon’ble Supreme Court in the case of Azadi Bachao Andolan6 has held that the person/entity holding a valid TRC would be entitled to the DTAA benefits. Subsequently, the aforesaid legal position has been followed in many decisions, including the recent decision of Blackstone Capital Partners (Singapore)7

  • Though the tax authorities have made various allegations to conclude that the taxpayer is a conduit entity, however, such conclusion is not backed by any substantive and cogent material brought on record. In sum and substance, the tax officer has made mere allegations and has failed to substantiate that the taxpayer is a conduit company through clinching evidence.

  • Though the tax officer has alleged that the taxpayer is a conduit company and has been set up as a part of an impermissible avoidance arrangement, he has not invoked GAAR provisions.  Further, the Tax Authorities have also not invoked the LOB clause8 as provided under Article 27A of India – Mauritius DTAA.

  • Thus, facts on record indicate that the tax authorities were accepting the fact that the shares in the Indian companies had been acquired prior to 1 April 2017, hence the capital gain derived from the sale of such shares would be exempt from tax in India in terms of India-Mauritius DTAA.

  • Therefore, the TRC issued by the competent authority in Mauritius would not only determine the residential status of the taxpayer but also its entitlement under the DTAA provisions.

BDO COMMENTS

This is a welcome ruling for the taxpayer. Firstly, because it re-emphasises the importance of TRC and other supporting documents relevant to establishing the economic substance of taxpayers for the purpose of availing DTAA benefits. Secondly, it enunciates that tax authorities cannot merely allege a taxpayer as a conduit company and have been set up under a scheme of impermissible avoidance arrangement without substantiating it through cogent evidence on record. There is a set procedure to invoke GAAR and the same should be followed by tax authorities.

 

1 General Anti-Avoidance Rule (GAAR) is effective from FY 2017-18 and applies to an arrangement if it is declared as impermissible avoidance arrangement.

2 An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit, and it- (a) creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length (b) results, directly or indirectly, in the misuse, or abuse, of the provisions of IT Act (c) lacks commercial substance or is deemed to lack commercial substance, in whole or in part; or (d) is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

3 Chapter X-A of the IT Act pertains to applying GAAR.

4 Accion Africa-Asia Investment Company vs. ACIT, ITA No. 1815/Del/2023 (Delhi Tax Tribunal)

5 In terms of Article 13(4) of the India-Mauritius DTAA, long term capital gain arising at the hands of tax resident of Mauritius can only be taxed in Mauritius and not in India.

6 Union of India vs.  Azadi Bachao Andolan [2003] 263 ITR 706 (Supreme Court)

7 Blackstone Capital Partners (Singapore) VI FDI Three Pte. Ltd. vs. ACIT [2023] 452 ITR 111 (Delhi High Court)

8 Limitation of Benefit (LOB) Clause attempts to exclude shell/conduit companies from claiming tax exemption by invoking DTAA if its affairs were arranged with the primary purpose to take advantage of such benefits. Gains from transfer of shares of an Indian resident company acquired on or after 1 April 2017 may be taxed in India.