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1 tax planning international asia-pacific focus International Information for International Business >>>>>>>>>>>>>>>>>>>>>>>>>>> April m Reproduced with permission from Tax Planning International Asia-Pacific Focus, Bloomberg Tax, 04/30/2018. Copyright 2018 by The Bureau of National Affairs, Inc. ( )

2 Taxability of Capital Gains Arising from Group Restructuring under India Mauritius Tax Treaty Shailendra Sharma The Authority for Advance Ruling ( AAR ) rulings discussed in the article give both favorable and adverse views on the claim of tax treaty benefit for capital gains of nonresident companies arising from corporate strategy restructuring under Article 13 of the India Mauritius tax treaty. Shailendra Sharma is a chartered accountant with a multinational consulting firm in India The Authority for Advance Ruling ( AAR ) in the case of AB Holdings, Mauritius (AB Holdings, Mauritius II, AAR No of 2011 dated November 8, 2017 ) ( Applicant 1 ) and AB Mauritius (AB Mauritius, AAR No of 2011 dated November 8, 2017) ( Applicant 2 ), clarified on the taxability of capital gains of nonresident companies arising from corporate strategy restructuring under Article 13 of the India Mauritius double taxation avoidance agreement ( tax treaty ). s In the case of Applicant 1 the AAR ruled that, investments by the Mauritius entity in an Indian company were not made to claim tax treaty benefits as the investments were made through appropriate banking channels. Merely, frequent travel of the directors in the Mauritius company is not conclusive evidence to determine that Management and Control of the Mauritius company lies outside Mauritius in the holding jurisdiction. Hence, capi- 2 04/18 Copyright 2018 by The Bureau of National Affairs, Inc. TPAF ISSN

3 tal gains arising on transfer of the Indian company shares by the Mauritius company to its Singapore entity under a corporate restructuring was exempt under the tax treaty. s In the situation of Applicant 2, based on the Share Purchase Agreement ( SPA ), minutes of the meeting of the board of directors ( BOD ), etc., the AAR held that Applicant 2 was incapable of taking independent decisions for the Mauritius company and, hence, could not be treated as the beneficial owner of Indian company shares. The documents proved that besides ownership of holding, even key decisions for acquisition of Indian company s shares was lying with U.S. company. The AAR denied the claim under the India Mauritius tax treaty to conclude that capitals gains were taxable in the hands of the U.S. company under the India U.S. tax treaty. Facts Applicant 1 AB Holdings, Mauritius Applicant 1 is a Mauritius company incorporated in 2008 that holds a Category 1 Global Business License. It is part of a Portfolio Fund held by the U.S. investors. The Mauritius company was incorporated to invest in an Indian business through AB International and other Asian markets by investment companies in the Philippines and Indonesia. The business activities were controlled from Mauritius and managed by its BOD comprising of three directors, of which two were resident in Mauritius actively involved in the investment decisions where considerations were made through normal banking channels. In order to support its Asia-Pacific business, obtain operational efficiency and cost benefits, the group, under a corporate strategy, decided to set-up a regional headquarter in Singapore ( AB Singapore ). The group invested a substantial amount in Singapore since its incorporation, by setting up state of the art biotechnology lab and hiring scientists for research at the Singapore lab. As part of a corporate restructuring strategy, Applicant 1, due to commercial rationale, transferred its shares held in AB International to AB Singapore. Consequently, shares held in the Indian company including other group entities were transferred in exchange of share consideration of AB Singapore. Subsequent to the transfer, owing to corporate strategy the Applicant continued its shareholding in AB International held through AB Singapore. Applicant 2 AB Mauritius On the other side, Applicant 2 is a Mauritius company that holds Category 1 Global Business License and is part of a U.S. investors group similar to Applicant 1 with business functions governed by the BOD based in Mauritius. The Mauritius company has a valid tax resident certificate ( TRC ) and is established to invest in Indian and other Asian markets. The Applicant acquired shares of an Indian company under a SPA executed by Mr S (authorized representative of the U.S. promoters), authorized by the BOD for a consideration. The shares acquired were beneficially-owned and legally held by the Applicant enjoying all rights, obligations and dividends. The Applicant, under a corporate strategy, proposed to transfer its holding in the Indian company to its Singapore subsidiary AB Singapore. Issues for Consideration before the AAR The proposed transaction of transferring Indian investments under a corporate strategy was referred to the AAR in India for taxability and to determine: 1. Whether Applicants 1 and 2 were entitled to tax treaty benefit under Article 13 of the India Mauritius tax treaty on gains arising from the proposed share transfer to its group entity? 2. Where capital gains are not chargeable to tax in India, are such gains subject to withholding tax obligations in India? 3. Would income of the Applicants in the proposed transaction be liable to Minimum Alternate Tax ( MAT or deemed taxation) in India? 4. Would Indian transfer pricing regulations apply to the proposed transaction where capital gains are not chargeable to tax in India? Ruling of the AAR Applicant 1 AB Holdings, Mauritius The Applicant s incorporation and investments were executed under normal banking channels of Mauritius and duly approved from the Indian bank undertaking requisite filings in India. The initial and subsequent investment in AB International was duly accounted and explained. AB International recognized the Applicant as a registered member and shareholder under Indian Company law. The Applicant had a TRC issued by the Mauritius tax authorities. Even after the transfer of shares from AB International to AB Singapore, AB Singapore did not hold the shareholding in the short-term but was held for a long-term business perspective. The investment was not meant for overnight purpose evidenced from additional investments made in the shares of AB International spread over a long duration for ongoing business activity of the Applicant satisfying the long-term business and commercial goal and not meant to avoid any tax. The AAR observed that, Mr S, a principal investor and Managing Director ( MD ) of the parent company had influence in investment decisions of the company due to common directorship. Mr S was not usually present in Mauritius, where the Applicant was registered, or in India, where the investee company was located. His frequent travel, in and out of Mauritius, simply cannot lead to a conclusion that the control and management of Mauritius company was with the holding company. The AAR, relying on the Delhi High Court ruling in the case of Sanofi Pasteur Holding SA (Sanofi Pasteur Holding SA v. Department of Revenue [2013] 354 ITR 316 (AP)) observed that the parent company was not involved in an important decision-making like fund raising of the subsidiary company, target markets, make investments and disinvestments, etc. It is irrel- 04/18 Tax Planning International Asia-Pacific Focus Bloomberg BNA ISSN

4 evant that the parent company should not play any role in the affairs of its subsidiary, where business activities are suggested to be in line with the overall objectives of the group. Place of Business Numerous decisions were being made in the meetings at the registered office of the Applicant, where the directors are located. In fact other BOD members were qualified and capable to take meaningful discussions for the business. In today s world technological advancement of communication does not require all directors, being directors in other companies, to physically attend every meeting when it can be done through electronic audio and video mode. The AAR accordingly concluded that the Applicant is an investment company that does not require huge offices and staff that is engaged in investment business activities to gain capital appreciation, unlike a manufacturing or trading set-up that requires maintenance of several operations. The tax returns filed indicate Mauritius address and board meetings also take place at Mauritius which makes place of business of the Applicant as Mauritius. Beneficial Owner Conditions The AAR, relying on the Supreme Court ruling in the case of Vodafone (Vodafone International BV v. UOI [2012] 341 ITR 1 (SC)), observed that the Applicant satisfied all the required criteria s for its investments in the Indian company, especially the fund flow for investment to conclude that, it is construed as legal and beneficial owner of the shares and fully competent to take suitable decision. Tax Avoidance The AAR was unable to draw any adverse inference on the Applicant s independent status, its investment decisions and the control and management of its business. The argument of unrecorded investment was unfounded as money sourced internally was invested by the Applicant through its banking channels during initial or subsequent investments. Hence, the plea that investment was unrecorded (benami), or to avoid tax as a colorable device for treaty shopping was untenable. The AAR relying on the facts concluded that, benefit under the India-Mauritius tax treaty is available to the Applicant in absence of any adverse finding, by accepting the principle laid by the CBDT Circular (CBDT Circular No. 789 of 13 April 2000) that, TRC is a sufficient document to claim tax treaty benefit. It was referred by various rulings following the principle of Pacta Sunt Servanda, to confirm that tax treaty should be honored in good faith. The AAR, on considering the documents and the facts on record, concluded that the transaction was not a colorable devise designed to avoid tax. Withholding Tax, Transfer Pricing and MAT Relying on the Supreme Court decision in the case of GE Technology (GE Technology Centre P. Ltd v. CIT [2010] 327 ITR 456 (SC)) the AAR held that, there is no withholding tax obligation in the present case as, capital gains was exempt from tax under Article 13(4) of the Indian Mauritius tax treaty. The AAR agreeing with its own ruling in the case of Castleton (Castleton investment Ltd [2012] 348 ITR 537 (AAR)) confirmed that, though income is not chargeable under Indian domestic tax laws due to tax treaty claim, the share sale transaction in AB International would require benchmarking under Indian transfer pricing regulations. The AAR also dealt with MAT provision to state that, MAT is not applicable to foreign companies, as per the amended MAT provisions of the Indian domestic tax laws. Applicant 2 AB Mauritius The AAR observed that investment decisions are made after due deliberation by the BOD before approving share acquisition. Further, SPA arrangements have full details of the consideration payable by the buyers, names of the proposed shareholders, etc. The Applicant s BOD merely reiterated what the parent decided or directed pursuant to the proposed investment and its source without any material decision or inputs of the Applicant. This makes intent of the parent evident from the approvals inferring that, Mauritius BOD was neither managing nor controlling the crucial investment decisions, for which it was referred to be set up. The AAR acknowledged that SPA was signed by MD of the parent and not by the BOD or representative of the Applicant, though regarded as a buyer in the SPA, evidencing that the Applicant had no significant role to play in the decision of share acquisition in Indian company from U.S. sellers. The Applicant was a mere spectator, as per the minutes of the BOD meeting Mr S informed and BOD simply took note of the investments. In absence of any material to prove the Applicant s role, funding, the share acquisition, corporate reorganization in the group, it was established that the Applicant was not a substantive party to the decision in the SPA. The AAR noted that the Applicant s beneficial ownership claim of shares in the Indian company, which subsequently led to the capital gains, is through support of parent by waiving of its debt as a consideration for share acquisition, resulting the Applicant to be a substantial owner in the Indian company, without payment of any consideration. The financial statements only recorded entries in the books, where the loan had no connection with the seller s debt, acquired by the Applicant. The SPA also provides that shares were transferred in the name of parent who paid the consideration hence, the Applicant was not regarded as the beneficial owner of the shares. The AAR concluded that the Applicant was not making decisions like an independent entity with a separate legal status in a foreign territory, for the India investment, though it was an Investment Holding company and also that the manner and accounting followed in the share acquisition only reflects that, they were taken on its books on hindsight, as per the directions of the Holding company. Accordingly, as the U.S. parent acquired the shares in Indian company from two other U.S. companies, the gains arise 4 04/18 Copyright 2018 by The Bureau of National Affairs, Inc. TPAF ISSN

5 in India in the hands of the parent on transfer of such shares and are taxable in India under the India U.S. tax treaty. Planning Points The AAR rulings issued both favorable and adverse views on the claim of tax treaty benefit for capital gains by analyzing the facts in detail before arriving at its conclusion. The rulings pertain to the period prior to the General Anti-Avoidance Rule ( GAAR ) regime is effective or the principal purpose test ( PPT ) proposed to be introduced under the tax treaty through the OECD multilateral instruments, to disregard transaction or arrangement following the substance over form rule, in cases where the commercial purpose test is not satisfied with respect to the tax treaty claim. The obligation of transfer pricing regulations appears to be inconsistent with the earlier positions of inapplicability of transfer pricing rules to the nonresidents where capital gains tax exemption is available in India. The AAR ignored an earlier ruling in the case of Amiantit (Amiantit International Holding Ltd 322 ITR 678) which held that transfer pricing regulations are not applicable to cases of income arising from corporate restructuring that are not chargeable to tax in India. Shailendra Sharma is a chartered accountant with a multinational consulting firm in India. 04/18 Tax Planning International Asia-Pacific Focus Bloomberg BNA ISSN