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Investments into India through favourable jurisdictions
The Authority for Advance Rulings ("AAR") has recently issued two significant rulings concerning the use of favourable tax jurisdictions for investing into India. Under the Tax Treaties entered into by India with Mauritius, Netherlands, Singapore and Cyprus, subject to certain conditions, capital gains arising on alienation of shares in an Indian company is not liable to tax in India. The Supreme Court of India in the case of Azadi Bachao Andolan recognised the prerogative of the Government in entering into beneficial tax treaties with other countries to promote mutual economic relations, trade and investment. However, the Revenue Authorities ("RA") have often sought to disregard the benefit under the Tax Treaties with the intermediate countries on the ground that the shares are beneficially held by a shareholder ultimately in a third country. The rulings by the AAR are significant as they uphold the views laid down by the Supreme Court and bring some certainty to the tax positions of making investments in India. These rulings have been summarised below.
India Netherlands Tax Treaty
Transfer of shares in Indian Company by German Parent to its Subsidiary in Netherlands means the Dutch Subsidiary will be entitled to exemption from capital gains tax.
A German company ("German Co") sold its entire shareholding in an Indian Company ("Ind Co") to its Group Company in Netherlands ("Dutch Co"). The sale was compliant with the pricing guidelines under the foreign exchange regulations in India. Subsequently, the Dutch Co made substantial investment into the Ind Co to facilitate its expansion. The Dutch Co approached the AAR to determine if it would be entitled to an exemption from tax on capital gains under the India Netherlands Tax Treaty, in case the shares were subsequently sold by it.
The RA contended that the transfer of shares by the German Co to the Dutch Co was part of a scheme to avoid tax on capital gains. Since the Dutch Co was ultimately held by the German Co, the RA contended that only the India Germany Tax Treaty was applicable as per which exemption from capital gains tax would not be available.
The AAR noted that the Dutch Co was a distinct legal entity having its own Board of Directors and management systems, even if it was a subsidiary of the German Co. It considered the facts that the Dutch Co purchased the shares in compliance with the pricing guidelines and made substantial investments thereafter. It observed that it was not possible to assume that the Dutch Co would merely act as a conduit to siphon off the gains to the German Co by means of a colourable device. It held that there was no factual or legal basis to conclude that German Co was the real and beneficial owner of the shares in Ind Co and of the capital gains that would accrue. Accordingly, the AAR ruled that the Dutch Co would be entitled to the exemption under the India Netherlands Tax Treaty from the capital gains tax arising on the sale of shares.
India Mauritius Tax Treaty
The capital gains on transfer of shares held in Indian company through a holding company in Mauritius will not be liable to tax in India.
E*Trade Mauritius Limited ("ETM") was a subsidiary of a US Company ("US Co"). ETM had a valid Tax Residency Certificate ("TRC") issued by the Mauritian tax authorities and held shares in an Indian Company, which were subsequently sold resulting in capital gains. As per the India Mauritius Tax Treaty, the capital gains arising to a Mauritius resident from the transfer of shares in an Indian company are not liable to tax in India.
The AAR noted that ETM was a separate legal entity and the shares of the Indian company were registered in the name of ETM. It observed that treaty shopping and the underlying objective of tax avoidance/mitigation cannot be apparently equated to a colourable device. It further observed that a transaction entered into by an entity in order to take advantage of the tax relief which is available in the relevant Tax Treaty cannot be declared invalid. The AAR further observed that the motive behind the setting up of an entity is not material to judge the validity of the transaction and ruled that sale proceeds paid to ETM would not be liable to tax in India and hence, not subject to any withholding tax.
For a more detailed analysis of the India Mauritius Tax Treaty click here
The liability to tax in India on indirect transfer of shares at the off-shore holding company level is still a moot point, In the famous case of Vodafone, a transfer of shares in a company in Cayman Islands, with which India did not have a Tax Treaty, is sought to be made liable to tax in India since the Cayman company primarily held investments in Indian companies through a chain of companies.
The present rulings involved direct transfers of shares in Indian companies and hence, the findings do not provide any clarity on the taxability of off-shore transfers. Yet, these rulings would be of immense comfort to investors who have invested through jurisdictions that have favourable Tax Treaties with India. The ruling of the AAR is binding only in the case of the concerned applicant, although they hold persuasive value in other cases. It is expected that these rulings will encourage other investors to approach the AAR to secure a beneficial ruling in their situation as well.
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