EY Tax Alert. Executive summary

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1 01 September 2016 EY Tax Alert AAR affirms availability of India-Mauritius treaty benefit on sale of shares of Indian company, distinguishes Bombay High Court ruling of Aditya Birla Nuvo Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Authority for Advance Rulings (AAR) in the case of Shinsei Investment Ltd.[1] (Taxpayer), a Mauritian company, on the issue of availing benefit under the India-Mauritius Double Taxation Avoidance Agreement (DTAA) from capital gains arising on transfer of shares of Indian companies (I Cos). The Taxpayer, along with its Japanese parent company (Parent Co), entered into a Share Purchase Agreement (SPA) for transfer of shares of I Cos in which the Taxpayer held more than 75% stake. By placing reliance on the Bombay High Court (HC) ruling in the case of Aditya Birla Nuvo [2] v. DCIT (Aditya Birla Nuvo case) and based on the involvement of Parent Co in the SPA, the Tax Authority contended that Parent Co was in effective control of the transaction and the Taxpayer was merely a permitted transferee as stated in the SPA. Accordingly, the Tax Authority challenged that the benefit of the DTAA should not be available. The AAR distinguished the Aditya Birla Nuvo case on facts. It noted that the Taxpayer had subscribed to shares of I Cos in its own name and had also made payment for the shares from its own account. The Parent Co was made a party to the SPA only in its capacity as sponsor and settler of the mutual fund, to comply with the applicable regulations. Accordingly, the Taxpayer was eligible to claim the benefit under the DTAA, based on which capital gains arising to it from sale of shares of an Indian company was taxable only in Mauritius. Furthermore, in view of exemption, the Taxpayer is not required to file a return of income in India. Also, provisions of minimum alternate tax (MAT) under the Indian Tax Laws (ITL) do not apply to foreign companies. [1] [TS-473-AAR-2016] [2] [342 ITR 308]

2 Background and facts Under the DTAA, capital gains arising to a resident of Mauritius from sale of shares of an Indian company are taxable only in Mauritius and exempt from tax in India (capital gains exemption). In this regard, Administrative Circulars [3] were issued in India clarifying that gains from sale of shares arising to a Mauritius company holding a valid Tax Residency Certificate (TRC) from the Mauritian Tax Authorities, are taxable only in Mauritius. The above Circulars were validated by the decision of the Supreme Court (SC) in the case of CIT v. Azadi Bachao Andolan [4]. The above fact pattern is pictorially depicted below: - The Taxpayer is a Mauritian company holding a valid TRC from the Mauritian Tax Authorities. It neither has a Permanent Account Number nor any permanent establishment in India. The Taxpayer is a wholly owned subsidiary of Parent Co which is a Japanese bank. The Taxpayer owns shares of two I Cos: (1.) 75% stake in an asset management company (AMCo) and (2.) 99.99% stake in a trustee company (Trustee Co). AMCo and Trustee Co (collectively referred to as I Cos) are the asset management and trustee of a mutual fund in India. Parent Co is a sponsor and settlor of the mutual fund. For FY , an SPA was entered into between the Taxpayer, Parent Co, AMCo, Trustee Co and the Purchaser for transfer of shares of both I Cos. The Taxpayer made an application before the AAR to ascertain the availability of capital gains exemption in India under the DTAA. Other issues raised before the AAR were in relation to obligations to withhold taxes, return filing in India and application of MAT to the Taxpayer in India under the ITL. Tax Authority s contentions before the AAR The investments in I Cos are, in effect, made by Parent Co (a Japanese company), and not the Taxpayer. Hence, capital gains exemption under the DTAA would not apply. The Administrative Circulars will not apply in the instant case as the Transferor is a non-mauritian company. [3] Circular No. 682 dated 30 March 1994 and Circular No. 789 dated 13 April 2000 [4] [263 ITR 706] Parent Co has been in effective control of the transaction and it holds all rights and obligations in respect of the sale transaction. The Taxpayer has no control over the sale and it has merely given its name to it.

3 The Taxpayer is introduced in the transaction of sale as a permitted transferee by Parent Co and it does not possess any rights and obligations as regards the sale. If this were a case of sale simplicitor of Indian shares, the presence of Parent Co in the SPA is unclear. The following clauses of the SPA support the above contentions: Parent Co has the sole responsibility to conduct the transaction and the Taxpayer is a mere nominee shareholder. Place of arbitration is either Japan or India, and not Mauritius. Tax claims and indemnifications are required to be notified by the Purchasers to Parent Co only, which is the sole party as regards the tax claim liability. Revision in board of I Cos is required to be notified by the Purchaser to Parent Co, and not to the Taxpayer. Reliance was placed on the Aditya Birla Nuvo case wherein the HC denied application of the capital gains exemption of the DTAA, where the transferor Mauritius company was seen as a permitted transferee selling shares on behalf of its parent US company, the absolute owner of the Indian shares [5]. Taxpayer s contention before the AAR The Taxpayer holds a valid TRC of Mauritius. Accordingly, capital gains arising to it from transfer of shares located in India will be taxable only in Mauritius as per the DTAA. Support of the view can be drawn from the Administrative Circulars (supra) and the SC decision in the case of Azadi Bachao Andolan. The present transaction is distinguishable from the Aditya Birla Nuvo case [6], as given below: [5] Refer to EY Tax Alert Bombay HC rules on taxation of crossborder transactions involving India-Mauritius DTAA and indirect transfer of shares of an Indian company dated 16 July 2011 [6] This case is presently before the SC for adjudication In the Aditya Birla Nuvo case, the US parent company of the Mauritius transferor company had paid for and subscribed to the shares of an Indian company and the Mauritian company was merely introduced as a permitted transferee. As against this, in the present case, the Taxpayer subscribed to shares of I Cos in its own name and account and not on behalf of Parent Co. The funds utilized for subscription of shares were also from the bank account of the Taxpayer. In the Aditya Birla Nuvo case, as per the terms of the agreements, the US parent company was the owner of the Indian shares and all rights in respect of the Indian shares absolutely vested in the US parent company. This was distinguished from the present case as there was no such clause and the Taxpayer was accepted as the beneficial and real owner of the shares as per the SPA. In the Aditya Birla Nuvo case, the Joint Venture Agreement (JVA) mentioned that the entire obligation rested with the US parent company and that the Mauritian company was a mere representative of the US parent company. Furthermore, the arrangement would remain till the telecom licenses remained, which showed that investments were routed through the Mauritian company merely to avail the DTAA benefits. Such facts are not present in the instant case of the Taxpayer. AAR s ruling: The Tax Authority s claim of treating the Taxpayer as a permitted transferee was rejected. The Aditya Birla Nuvo case is distinguishable based on the following facts, the clauses of the SPA and the documents filed by the Taxpayer: The Taxpayer paid for and held the investment in Indian shares on its own account. Parent Co was a party to the SPA because it was the sponsor and settler of the mutual fund in India, which is also required under mutual fund regulations. As per mutual fund regulations, the Parent Co is subject to certain requirements and responsibilities, and on sale of shares for which it is required to be released from its obligations and

4 responsibilities. This is the reason that the SPA contained such provisions. The matters regarding place of arbitration, sharing of responsibility to obtain the tax withholding order etc., are not relevant, particularly in view of the fact that the shares had been subscribed to by the Taxpayer in its own name and the bank statements filed showed that the Taxpayer had paid for such subscription of shares. Hence, capital gains arising to the Taxpayer, a resident of Mauritius having a valid TRC, are taxable only in Mauritius under the DTAA. Since the capital gains are exempt from tax in India, the Taxpayer is not required to file a return of income in India. Furthermore, provisions of MAT under the ITL do not apply to foreign companies. Comments The present ruling gives a favourable view on claiming the DTAA benefit by distinguishing the HC ruling in the Aditya Birla Nuvo case. The facts that the Transferor itself funded the investment and the involvement of Parent Co mainly due to the statutory requirement under the regulations, were noted by the AAR to come to the conclusion that the Taxpayer earned capital gains in its own right and, being eligible for the DTAA benefit, was not required to pay tax in India. While the DTAA has been amended, by way of the 2016 Protocol permitting source taxation in respect of gains arising from transfer of shares of an Indian company, this ruling is relevant in respect of grandfathered investments made before 1 April 2017, as also in respect of investments between 1 April 2017 to 31 March 2019, which qualify for 50% tax relief from source taxation in India.

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