AAR DETERMINES THE TAXABILITY OF OFFSHORE MERGER AND INDIRECT TRANSFER OF ASSETS IN INDIA
By Vinita Krishnan (Associate Director) and Sneh Shah (Associate)
The Authority for Advance Rulings (AAR), in the recent judgement of Banca Sella SpA,1 held that capital gains arising on amalgamation of a non-resident company, having a branch in India, with its non-resident group entity would not attract capital gains tax in India in view of the non-discrimination clause of the India-Italy Double Taxation Avoidance Agreement (DTAA).
The Applicant, Banca Sella SPA, Italy (Banca Italy) and Sella Servizi Bancari SCPA, Italy (Sella Italy) were part of the Italy based Banca Sella group. Sella Italy also had a branch in India.
The Banca Sella Group carried out a business restructuring, in the course of which, Sella Italy was merged into Banca Italy.
As a result of the merger:
- The shareholders of Sella Italy (except Banca Italy) were allotted shares in Banca Italy. All the shareholders including Banca Italy were based in Italy.
- Banca Italy's investment in Sella Italy got cancelled as it could not have issued shares to itself, hence no shares were allotted to it pursuant to the merger.
- Sella Italy, being the merging company, ceased to exist and all its assets and liabilities were vested with Banca Italy.
The applicant approached the AAR for the determination of the following tax issues that arose on the merger of Sella Italy with Banca Italy:
- Whether transfer of the Indian branch of Sella Italy to Banca Italy as a consequence of the merger would be a transfer under section 2(47) (which defines transfer) of the Income-tax Act, 1961 (IT Act) and whether such transfer would be taxable in India?
- Whether by virtue of the non-discrimination clause of the DTAA, Sella Italy would also be eligible to the capital gains tax exemption under section 47(vi) of the IT Act, which is otherwise available to an Indian company in a scheme of amalgamation/merger?
- Whether Banca Italy and other shareholders of Sella Italy would be taxable in India due to extinguishment of its shareholding in Sella Italy as a result of merger?
- Whether the above merger attracted transfer pricing provisions under the IT Act?
The AAR held as under:
Gains in the hands of Sella Italy
The AAR held that merger of Sella Italy with Banca Italy was a transfer under Section 2(47) of the IT Act.
However, applying the non-discrimination provision under the DTAA (Article 25), the AAR held that capital gains tax exemption under Section 47(vi) of the IT Act, which is otherwise available to an Indian company in a scheme of amalgamation when the amalgamated company is an Indian company, should also be available to Sella Italy upon transfer of its assets to Banca Italy. The AAR held that if an amalgamation resulted in special benefits to a local company and its shareholders by virtue of the non-discrimination clause, there was no reason to deny similar benefits to a foreign company and its shareholders in a similar case of amalgamation. In light of the above, the exemption under section 47(vi) would be available to Sella Italy.
The AAR further observed that no consideration was flowing to Sella Italy with respect to transfer of the Indian Branch. In the absence of consideration, the computation mechanism under section 48 of the IT Act would fail and thus, there would not be any capital gains tax arising in India2.
Gains in the hands of shareholders of Sella Italy
The AAR held that due to merger, shares held by the shareholders in Sella Italy had been extinguished and such extinguishment was also considered a transfer under the IT Act.
However, with respect to Banca Italy, in the absence of any consideration received by it, the AAR held that there were no capital gains chargeable to tax in India.
As far as the remaining shareholders were concerned, while consideration (in the form of allotment of shares of Banca Italy) was received by such shareholders due to the favourable DTAA provisions, such gains were held to be not taxable in India.
In relation to the above, the Applicant contended that due to a specific deeming provision under the IT Act, only when Sella Italy shares are deemed to be situated in India and derived substantial value from Indian assets, gains on transfer of Sella Italy shares would be taxable in India in the hands of the shareholders. Further, the applicant contended that the term 'substantial' would mean 'close to whole'. In this regard, disagreeing with the applicant's interpretation on the term 'substantial', the AAR held that substantial would always mean at least 50%. The AAR also considered the dictionary meaning of substantial, wherein it was defined as 'of considerable importance, size or worth'. The AAR relied on the Delhi High Court judgement in the case of Copal Research3 on this point.
Issue of Transfer Pricing
The AAR, on the basis of its earlier ruling in the case of Amiantit International Holding Limited4, held that transfer pricing provisions are inapplicable in case there is no charge of tax in India.
The Ruling of the AAR granting capital gains exemption to a foreign company, in case of an offshore merger by applying the provisions of the non-discrimination clause in the Tax treaty provides a ray of hope for other non-residents. Foreign companies have been increasingly placing reliance on non-discrimination clauses contained in the tax treaties and it will be interesting to see to what extent the tax authorities will give effect to such beneficial (protective) provisions. While a ruling given by the AAR, is only binding on the applicant and the tax authorities dealing with the said case, it still has persuasive value and its ratio / observations are used as guiding principles. Thus, the observations of the AAR, in this case would be of relevance to non-residents at the time of transfer of shares of a company that derives substantial value directly or indirectly from assets situated in India, whether the transfer is in the form of a plain vanilla transfer, or forms part of a business restructuring exercise.
AAR RULES THAT MAURITIAN SELLER ENTITLED TO CAPITAL GAINS TAX EXEMPTION
By Ritu Shaktawat (Principal Associate), Aditi Sharma (Senior Associate) and Sneh Shah (Associate)
The Authority for Advance Rulings (AAR) in a recent ruling, allowed the taxpayer, a Mauritian company to benefit from the India-Mauritius Double Tax Avoidance Agreement (DTAA) in relation to the sale of its shares held in Indian companies.
The applicant, Shinsei Investment I Limited, Mauritius5 (Mauritius Co) is a company incorporated in Mauritius and is a wholly owned subsidiary of Shinsei Bank Limited, Japan (Japan Bank). It holds a valid tax residency certificate and does not have any permanent establishment in India. The Japan Bank is the sponsor and settlor of Shinsei Mutual Fund, India, currently set up as an Indian trust (Indian Mutual Fund). Shinsei Asset Management Company Private Limited, India (Indian AMC) manages the assets of the Indian Mutual Fund and Shinsei Trustee Company India Private Limited, India (Indian Trustee) and acts as trustee of the Indian Mutual Fund. Importantly, the Mauritius Co holds 75% of the total share capital of the Indian AMC and 99.99% of the total share capital of the Indian Trustee. The above mutual fund structure was established as a trust in 2008 and duly registered with the Securities and Exchange Board of India (SEBI) in accordance with the SEBI (Mutual Funds) Regulations, 1996.
In March 2010, the Mauritius Co, the Japan Bank and the other shareholders of the Indian AMC and the Indian Trustee entered into a Share Purchase Agreement (SPA) in relation to the sale of shares held in the Indian AMC and the Indian Trustee (Sale) to Daiwa Securities Group Inc., a Japanese resident and its affiliates (Purchasers).
The Mauritius Co approached the AAR to determine the Indian tax implications arising from the sale and the consequent compliances and filings to be undertaken in India.
Arguments Advanced by Parties
It was contended before the AAR that transfer of shares of the Indian Trustee and the Indian AMC should be exempt from tax in India as per the beneficial provisions of Article 13(4) of the India-Mauritius DTAA. Article 13(4) of the India-Mauritius DTAA confers the power of taxation of the gains derived by a resident of a contracting state from the alienation of shares only on the state of residence. The Mauritius Co relied on the decision of the Apex Court in the case of Azadi Bachao Andolan6 and stated that since it was the beneficial owner of shares, it would be entitled to the benefits of the India-Mauritius DTAA.
In response the Tax Authorities contended that the Japan Bank had been in effective control of the transaction and that the Mauritius Co had merely been introduced as the former's nominee. The Bombay High Court in the case of Aditya Birla Nuvo Ltd7, had denied the taxpayer the benefits of the DTAA since it was merely a 'permitted transferee' of its US parent or a nominee / representative as per the specific terms of the SPA. The Tax Authorities drew the AAR's attention to the following provisions in the SPA to buttress its contention:
- Party to SPA: The Japan Bank was made a party to the SPA even though it did not have any shareholding in the Indian AMC or the Indian Trustee;
- Right to notify fulfilment of conditions: The Japan Bank held the rights to notify fulfilment of the conditions to the other shareholders of the Indian AMC and the Indian Trustee while the Mauritius Co had no such right or responsibility;
- Place of arbitration: The place of arbitration had been limited to Japan and / or India only. The absence of Mauritius was conspicuous; and
- Powers in relation to composition of Board and tax claims: The revision in the composition of the board of the Indian AMC and the Indian Trustee, and tax indemnification and claims were to be notified by the Purchasers to Japan Bank only and not the Mauritius Co and the Japan Bank was the sole party with respect to any tax claim liability.
The Tax Authorities strongly relied on the Aditya Birla Nuvo Limited case wherein the shares of the Indian company that were sought to be transferred were held in the name of the Mauritian subsidiary, however, the said shares had been subscribed and paid for by its US parent. Several references in the sale agreement led the court to rule that the Mauritius company was a 'permitted transferee' (i.e., nominee) of the US parent as a result of which the Mauritian company was denied the capital gains tax benefits of the India-Mauritius DTAA. The Tax Authorities, strongly relying on the above case, argued that the current case was no different and that the provisions of the SPA suggested that the Japan Bank was in effective control of the transaction and that the Mauritius Co was only a nominee.
The AAR, distinguishing the current case from that of Aditya Birla Nuvo Limited, ruled in favour of Mauritius Co. The AAR observed that:
- The Mauritius Co had in fact subscribed to and paid for the subscription of shares in the Indian AMC and the Indian Trustee in its own name and account. The Mauritius Co was accepted and approved by all parties to the SPA as the real and beneficial owner of the shares of the Indian AMC and the Indian Trustee.
- There was no clause in the SPA which proved that the Mauritius Co was merely a 'permitted transferee' of the Japan Bank. In fact, the SPA clearly demonstrated otherwise.
- Being the sponsor and settlor of the Indian Mutual Fund, the Japan Bank was required to be a party to the SPA as per the SEBI (Mutual Fund) Regulations, 1996.
- The provisions regarding the place of arbitration, sharing of responsibility for obtaining the tax withholding order etc, were irrelevant according to the AAR in view of the fact that the Mauritius Co was the real and beneficial owner of the shares.
In light of the above observations, the AAR held that the Mauritius Co was eligible for the benefits of the India-Mauritius DTAA and therefore not liable to tax in India. Further, the AAR stated that since the Mauritius Co was not liable to tax in India, there was no need for it to file an income tax return in India. With respect to the applicability of the Minimum Alternate Tax (MAT) provisions, the AAR held that since the Mauritius Co was a foreign company, MAT provisions would not be applicable.
While the ruling does not provide a detailed discussion on the clauses of the SPA, it definitely serves as a guide on the various aspects that may be considered while documenting a share sale transaction, especially when there is a non-resident seller. Needless to say this is also relevant from the perspective of demonstrating 'commercial substance' – a concept that is now assuming centre-stage with the onset of the General Anti Avoidance Rules (GAAR) era. While defining the structure and mechanics of a transaction, it is important to emphasise the role of the transferor as the legal and beneficial owner and limit the role of the transferor's related parties.
It is also important to note that the India-Mauritius DTAA has been recently amended and this ruling relates to a period prior to the amendment of the DTAA. As per the amendment to the India-Mauritius DTAA, the capital gains tax in India on the sale of shares will no longer be exempt for investments made on or after 1 April 2017. Although only persuasive, this ruling is important for Mauritian companies who may look to avail the benefits of the India – Mauritius DTAA in limited circumstances such as investment in debt instruments in India and for the purposes of availing capital gains benefit of 50% of the domestic tax rate during the transition period as per the amendment to the India-Mauritius Tax Treaty.
1. Banca Sella S.p.A in A.A.R. No 1130 of 2011
2. CIT vs B C Srinivas Setty 128 ITR 294
3. DIT(International Tax) v. Copal Research Limited [TS-509-HC- 2014(DEL)]
4. Amiantit International Holding Limited in re: 322 ITR 678
5. Shinsei Investment I Limited in A.A.R. No 1017 of 2010
6. UOI v/s Azadi Bachao Andolan 263 ITR 706
7. Aditya Birla Nuvo Ltd v/s DDIT 342 ITR 308. (currently sub judice)
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