India: A - Authority For Advance Ruling (AAR), New Delhi

Last Updated: 13 November 2012

A – Authority for Advance Ruling (AAR), New Delhi

Applicant, a tax resident of India, is a public limited company with 25.06% of its shares held by a Mauritian company. Applicant proposed a scheme of share buy-back from all its shareholders which was accepted by the Mauritian company only. Thus, applicant approached AAR on the question whether capital gains arising in the hands of Mauritian company on account of such share buyback is chargeable to capital gains tax in India under India-Mauritius DTAA and whether applicant is liable to withhold Income-tax under section 195 of the Income-tax Act, 1961 (IT Act).

Applicant argued that the proposed share buy-back is strictly in terms of Indian corporate laws & tax laws and any gains arising on account of such buyback are liable to tax as capital gains in India under the IT Act. However, India-Mauritius DTAA provides a beneficial treatment and such gains are taxable only in Mauritius and not in India. Indian tax authorities highlighted that applicant had not declared or paid any dividends to its shareholders till date and has allowed its reserves to grow substantially to build value in the company. The tax authorities further contended that share buy-back scheme was adopted to avail the beneficial capital gains tax treatment under India-Mauritius DTAA and is designed only to avoid payment of tax in India.

AAR observed that other shareholders of the applicant namely the US company and the Singaporean company did not accept the share buy-back scheme as income arising from such transactions would have been taxable in India in the absence of beneficial treatment under respective tax treaties. Thus, AAR held that the primary purpose of share buy-back scheme is avoidance of tax in India and considered such buyback as distribution of dividend subject to tax in India under Article 10(2) of the India-Mauritius DTAA. AAR also held that applicant is liable to withhold tax on such payments under section 195 of the IT Act. It seems that AAR has effectively applied the principles of general anti-avoidance rules (GAAR) introduced in the Finance Bill, 2012 by re-characterizing the share buy-back scheme as distribution of dividend even before such provisions could come into force.

A.A.R. No. P of 2010. Ruling delivered on March 22, 2012

Z – AAR, New Delhi

Applicant, a Mauritian tax resident, was holding equity shares and compulsory convertible debentures (CCDs) in an Indian company. It approached AAR on the question whether gains arising on sale of such shares and CCDs will be exempt from capital gains tax in India under India- Mauritius DTAA. Applicant argued that consideration received was for the sale of shares and CCDs. However, the Indian tax authorities argued that CCDs are external commercial borrowings i.e. a debt carrying a fixed rate of return and the present transaction is a sham and a mere design to avoid payment of tax by presenting 'interest income' as capital gains.

AAR observed that CCD creates or recognizes existence of a debt and remains a debt till it is repaid or discharged. AAR lifted the corporate veil after going through various terms of the CCDs and other terms of the shareholder agreement. AAR held that the applicant and shareholder are parent and subsidiary only on paper and actually they are one and the same entity. AAR accepted the contentions of the tax authorities and held that appreciation in the value of CCDs is clearly a payment of "interest" and taxable in India under Article 11 of the India-Mauritius DTAA.

AAR relied heavily on the recent ruling by the Supreme Court in the matter of Vodafone International Holdings [341 ITR 1] where it was held that one has to 'look at' entire transaction as a whole and not to adopt a dissecting approach to ascertain the true legal nature of the transaction. It appears that AAR has again applied the principles of GAAR while re-characterizing the 'capital gains' as 'interest income' in the present matter even such provisions could come into force.

AAR No. 1048 of 2011. Ruling delivered on March 21, 2012

Linde AG, Linde Engineering Division, Germany – AAR, New Delhi

Applicant, a German tax resident, and Samsung Engineering Company Limited, Korea (SEC) (collectively as Consortium Members) entered into a Consortium Agreement (Consortium Agreement) for bidding and taking up the design, engineering, procurement, construction, installation, commissioning and handing over of the plant on a lump sum turnkey basis (Works) to ONGC Petro Additions Limited (ONGC Petro).

Applicant approached AAR on the question whether Consortium is taxable as an association of persons (AOP) and whether payments receivable/received for Works are subject to Income-tax in India under Income-tax Act, 1961 (IT Act) or India-Germany double tax avoidance agreement (India-Germany DTAA).

AAR observed that the main contract between ONGC and Consortium was a composite contract for the Work and could not be divided into two contracts to be entered into with each Consortium Members individually. AAR ruled that the Consortium acquires an AOP status when the Consortium Members come together to bid for the Works and their bid is accepted for the completion of Works. Merely because the Consortium Members first entered into a memorandum of understanding between themselves and then into a Consortium Agreement to separate their area of operations does not alter the AOP status of the Consortium. AAR further ruled that the separate payments payable to the Consortium Members for their respective work also does not affect the AOP status of the Consortium.

AAR observed that the internal division of responsibility by the Consortium Members between themselves and recognition of such division by ONGC Petro will also not affect the AOP exposure. Accordingly, the Consortium is subject to tax as AOP and payments receivable/received for Works are subject to tax in India under the IT Act.

A.A.R. No. 962 of 2010. Ruling delivered on March 20, 2012

SREI Infrastructure Finance Ltd vs Income-tax Settlement Commission – Delhi High Court

Taxpayer, an Indian tax resident, is a public limited company engaged in project financing through term loans and leasing in specific sectors. During tax year 2008-2009, taxpayer transferred its project finance business and asset based financing business to its subsidiary namely SREI Infrastructure Development Finance Limited (SIDFL) (Transaction) in consideration of INR 37.5 million under a scheme of arrangement sanctioned by the jurisdictional High Court under the relevant provisions of the Companies Act, 1956.

Settlement Commission ordered that the consideration received for the Transaction was taxable as capital gains under section 50B of the IT Act. Section 50B of the IT Act is a special provision for computation of capital gains in case of a 'slump sale'. Taxpayer filed a writ petition against the order claiming that a transfer under a scheme of arrangement approved by High Court is not a sale and thus not liable to be taxed as 'slump sale' under section 50B of the IT Act.

Delhi High Court refused to read the provisions relating to slump sale in a narrow manner and held that any type of 'transfer' which is in the nature of 'slump sale' comes under the purview of section 2(42C) of the IT Act. Delhi High Court further held that use of the word 'sale' in the term 'slump sale' does not and is not intended to narrow down the concept of 'transfer' as defined and understood under IT Act. Accordingly, all transfers in the nature of 'sales' i.e. 'slump sales' including High Court approved business transfers are covered by the definition on section 2(42C) of the IT Act and taxable as 'slump sale'.

Writ Petition (Civil) No. 1592/2012. Judgment delivered on March 30, 2012

Commissioner of Income-tax vs Career Launcher India Limited – Delhi High Court

Taxpayer, an Indian tax resident, is engaged in the business of providing education and training for various preparatory examinations held by educational institutions such as Indian Institute of Management, Indian Institute of Technology etc. The education and training facilities were provided across the country through education centres run either by the taxpayer itself or by its franchises.

Under a Franchisee Agreement, the taxpayer allowed the franchisees to use the trade name, trade mark and course material belonging to it. However, other arrangements such as finding suitable premises, enrolling students, collecting fees etc. were made by the franchisees. The fees collected by the franchisees from the students were deposited in the taxpayer's bank account and subsequently 75% of such fees were shared with the franchisees. Taxpayer claimed such payments as tax deductible revenue expenditure while computing its taxable income.

Tax Officer rejected the said claim on account of non-withholding of Income-tax from the franchisee payments for carrying out the work in pursuance of a contract which is subject to tax withholding under section 194C of the IT Act. Section 194C of the IT Act provides that any person responsible for paying any sum to any contractor for carrying out any 'work' in pursuance of a contract is liable to withhold Income-tax at 2%.

Delhi High Court observed that the franchise agreement is not a simple case under which a person is engaged to carry out any work for the other. Essence of the agreement appears to be one under which the trade name or reputation or knowhow belonging to the taxpayer in the business of running learning centres is permitted to be used by the franchisees across India for a monetary consideration. The Delhi High Court further observed that a franchisee agreement cannot be broken up into several parts to bring it within the withholding tax provisions and that the dominant intention of the parties to the agreement should be respected and given effect to, as gathered from the composite agreement. Accordingly, the Delhi High Court held that the arrangement between the taxpayer and its franchisees did not fall within the purview of the term "work" under section 194C of the IT Act. Accordingly, taxpayer was not liable to withhold Income-tax on such payments and claim of tax deductibility of such expenditure could not be rejected.

ITA No. 939/2010, 911/2011 and 926/2011. Judgment delivered on April 19, 2012

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