India: DTAA Vindicated: Sign Of Times To Come?

Last Updated: 26 March 2013
Article by Ashutosh Chandola

Introduction

The interpretation and implementation of the provisions of a Double Tax Avoidance Agreement ("DTAA") has been controversial since the Vodafone-Hutch deal in 2007. In that case, the Income Tax Department ("IT Department") introduced retrospective amendments in order to tax transactions with an Indian nexus, which, foreign companies viewed as a retroactive measure in the path to greater liberalization and a deterrent to investing in India. However, the recent decision of the Andhra Pradesh High Court ("the Court") where they disallowed a claim of INR 7 billion (USD 130 million)1 by the IT Department against Sanofi Pasteur Holding SA ("Sanofi"), the apprehensions of foreign investors post-Vodafone will, hopefully, stand alleviated to a certain extent.

The present newsletter discusses the facts leading up to the case, the rationale for the decision of the Court and the implication for other foreign companies contemplating acquisitions overseas, having an India component. Please note that at the time of preparing this Newsletter, the judgment of the Court was not available for review and reliance has been placed on the contents of the order of the Authority for Advance Ruling as well as media reports on this case.

1. Factual Matrix

In 2006, two French companies, Merieux Alliance and Groupe Industriel Marcel Dassault ("the Sellers") formed a joint venture in France named ShanH, which, shortly after its incorporation, acquired 90% stake in Hyderabad based Shantha Biotechnics Limited ("Shantha"). Thereafter, in August 2009, Sanofi acquired ShanH from the sellers in France for approximately USD 736 million, and indirectly, acquired 90% stake in Shantha. In essence, this was a transfer of shares between two non-residents. In August 2008 itself, the IT Department carried out a survey under section 133A2 of the Income Tax Act ("IT Act"). From the information culled out during the survey, the IT Department formed an opinion that by the transfer of shares from the Seller in France, Sanofi acquired ownership of Shantha in India. Accordingly, it notified Sanofi that it had an obligation to deduct and deposit tax before making the payment for acquisition of ShanH since the underlying assets, i.e., shares of an Indian company, were being transferred and, therefore, the deal was subject to Indian tax laws.

In response, Sanofi stated that the transaction has been consummated in France and no tax liability arose in India due to the transfer of shares between two non-resident companies. The IT Department issued a show-cause notice to Sanofi demanding why Sanofi should not be proceeded against as an assessee-in-default under section 201(1) of the Act and also asked the Sellers to provide relevant documentation to ascertain the tax obligation in India. On receiving the show-cause notice, the Sellers filed an application for advance ruling from the Authority for Advance Ruling ("AAR")3 on the question of whether the transaction is taxable in India, specifically on the following issues:

i. In terms of the provisions of the Double Taxation Avoidance Agreement ("DTAA") between India and France, read with section 90 of the IT Act, whether capital gains arising from the sale of shares to Sanofi is liable to tax in France or in India?

ii. Without prejudice to the above, whether controlling interest (assuming while denying that it is a separate asset) is liable to be taxed in France under Article 14(6) of the DTAA?

After hearing the Sellers and the IT Department, the AAR decided in favor of the IT Department holding that ShanH's only assets were the shares it held in Shantha. Therefore, the sale of its shares essentially led to change in control and ownership in an Indian company. The AAR observed that the purpose for formation of ShanH appeared to be only to hold shares in Shantha, leading it to believe that ShanH was a façade created for avoiding capital gains tax in India. Subsequently, Sanofi approached the Court challenging the decision of the AAR.

2. Contentions of the parties

2.1 Sanofi's arguments

Sanofi contended that pursuant to the Indo-French DTAA, the transaction is not taxable in India. As per Article 14(5) of this DTAA gains on transfer of shares in a company, representing more than 10% of shares in that company, is to be taxed in the contracting state to which the company belongs.4 Sanofi relied on the provisions of section 90 of the IT Act and argued that the provisions of the IT Act itself provide for application of the DTAA, and, therefore, the claim of the IT Department is bad in law. Opposing the contentions put forth by the IT Department during the AAR proceedings touting ShanH as being a tool for avoiding tax in India, Sanofi mentioned that ShanH was incorporated to streamline investments of the Sellers into India and participate in the managerial and technical aspects of Shantha.

Furthermore, it was formed in 2006 when the sale of 2009 was not contemplated. Sanofi tried to establish that ShanH was essentially an independent functioning company in France. A part of its argument was that it is legally permissible for two companies to form a joint venture for the purpose of making fresh acquisitions and that this was not an attempt to avoid or evade tax in India. It further mentioned that this was not a case of treaty shopping as the tax payable in France on capital gains is disadvantageous since in France, shares had to be held for two years prior to sale to qualify as long term capital gains whereas this period is only one year in India. Sanofi argued that it was seeking its lawful benefit under the DTAA and not attempting to evade or avoid tax.

2.2 IT Department's contentions

The IT Department's primary contention was that ShanH was a façade created for avoiding capital gains tax in India. The fundamental contention was that the only asset of value that ShanH has is its shareholding of Shantha, inferring that creation of an investment company was done mainly as a façade to avoid tax. The IT Department argued that where the underlying asset for any transfer taking place abroad is in India, such a transaction is liable to tax in India. According to the IT Department, ShanH was merely a paper company with no employees or office space and was created only to act as a vehicle to avoid taxation in India. If shares of an Indian company are transferred freely between two non-residents leading to change in control and ownership of an Indian company and without attracting any tax in India, this, would defeat the purpose of section 195. Under section 195 of the IT Act, any person whether in India or abroad (including a company), makes a payment to a foreign company, for a transaction taxable in India, is under an obligation to deduct withholding tax payable in India before making the payment and, thereafter, deposit the tax so deducted with the IT Department. The IT Department felt that since this transaction clearly related only to the assets in India, it is taxable in India and, accordingly, Sanofi should be held in violation of section 195.

Responding to Sanofi's arguments on the application of the DTAA, the IT Department contended that the gains from transfer of more than 10% of a company may arise in France; however, the situs of the underlying assets is in India and must not be ignored. Since the assets transferred are located in India, the capital gains arise and are taxable in India. The IT Department tried to take support from the amendment to the IT Act under the Finance Act, 2012, making all transactions since 1964 involving transfer of underlying assets in India taxable and reiterated that the underlying assets is in India and, as a result, the transaction must be taxed in India.

3. The Court's ruling and rationale

After hearing both parties at length, the two judge bench of the Court decided in favor of Sanofi and quashed the ruling of the AAR. Based on the facts, the Court determined that ShanH is in fact an independent entity which actively participates in the management of Shantha and was not created as a façade to evade tax. The Court also accepted that ShanH was incorporated in 2006, the sale took place in 2009 and held that there was no intention to avoid tax in India. For arriving at this conclusion, the Court examined whether there was intent to avoid tax by the companies and the genuineness of the claims re the participation in Shantha was legitimate. This decision establishes that courts need to assess the intention of the parties and whether the underlying intention of parties it to transfer an asset in India or whether the international transaction contemplated simply touches an aspect in India.

On the question of capital gains, the Court held that as ShanH is an independent foreign entity, transfer of its shares outside India does not attract any tax in India. It set aside the contention of the IT Department vis-à-vis applicability of the IT Act which brought within its purview all transactions since 1964. Section 90(2) clearly prescribes that the provisions of the IT Act will apply to an assessee who falls under a double tax avoidance agreement only to the extent to which they are beneficial to the assessee. In this case, section 90(2) read with Article 14(5) of the DTAA clearly prescribes that tax on capital gains is taxable in France, and the Court accordingly overruled the order of the AAR and quashed the order of the IT Department against Sanofi demanding INR 7 billion.

Conclusion

The decision of the Court provides relief to Sanofi and similarly positioned foreign companies anticipating overseas transactions with an Indian component. This judgment clearly establishes the superior status of the DTAA against the provisions of the IT Act, and to a certain extent, also provides additional parameters based on which an overseas transaction will be scrutinized. These include ascertaining the intent of the parties as well as whether the foreign entity owning Indian assets is a mere paper company or an independent and functioning unit.. While it is open for the IT Department to file an appeal before the Supreme Court, considering the decision of the Court is well reasoned, it will be interesting to see if the IT Department appeals and, if yes, then the grounds on which it prefers the appeal.

Footnotes

1 1 USD = 55 INR approximately

2 Section 133A of the IT Act provides the tax department with the power to enter and carry out a survey at the premises of a person of company within its jurisdiction and to seek any information which may be relevant for any proceeding under the IT Act, including seeking and inspecting the books of accounts and or any documents present

3 In India, a company has the option to approach the AAR in order to get a tax issue determined before partaking in a transaction or carrying out an activity on which, the tax implication is not certain

4 Article 14(5): Gains from the alienation of shares other than those mentioned in paragraph 4 representing a participation of at least 10 per cent in a company which is a resident of a Contracting State may be taxed in that Contracting State

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
SKP Business Consulting LLP
Singh & Associates
JSA Advocates & Solicitors
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
SKP Business Consulting LLP
Singh & Associates
JSA Advocates & Solicitors
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions