India: Availability Of India-Mauritius Tax Treaty Benefits – Fact-Based Analysis Led To Different Outcomes

Last Updated: 20 February 2018
Article by SKP  

The Authority for Advance Rulings (AAR) recently issued two verdicts in case of different companies of the same group dealing with the availability of capital gains exemption in India under the India-Mauritius Tax Treaty. The AAR upheld the availability of capital gains exemption as per Article 13 of the treaty in the case of AB Holdings, Mauritius-II1 and denied the same in the case of AB Mauritius2. The AAR gave different conclusion largely on account of differences in the factual matrix of both the cases.

The taxpayers in both the verdicts have sought Advance Ruling on the availability of capital gains exemption under the India-Mauritius tax treaty.

Facts in the case of AB Holdings, Mauritius-II

  • AB Holdings, Mauritius-II (AB Holdings) is a Mauritian Company holding a valid Tax Residency Certificate (TRC) and a Category 1 Global Business License. 'C' Group3 (Holding Company) together with other individual investors held shares in AB Holdings.
  • AB Holdings was engaged in investment activities in 'S' sector in India and other Asian markets and it was managed by its Board of Directors (BOD) consisting of 3 directors, out of which two directors were tax residents of Mauritius (working for a financial services firm).
  • In line with its business purpose, AB Holdings invested in AB International India Private Limited (AB International) and companies in Philippines and Indonesia which are engaged in 'S' business. The BOD duly backed these investment decisions in their meetings. Also, the original share purchase agreement was signed by the director of AB Holdings and considerations was paid through banking channels.
  • Under a group reorganisation, AB holdings transferred shares of AB International and other Asian companies to a newly incorporated Singaporean company, AB Singapore vides a Share Purchase Agreement (SPA) dated 25 November 2008. This was done solely for business and commercial reasons of obtaining operational and cost benefits from centralising ownership in investments and operations in Asia Pacific region.

Ruling of the AAR

Availability of capital gains exemption under the treaty

  • AAR observed that AB holdings are not a 'fly by night operator''. AB Holding had a valid tax residency certificate and also a Category 1 Global Business License.
  • AB Holdings was set up as an investment holding company which had made investments in AB International on different dates and divested such stake to the Singaporean Company. Also, it was seen that all the investment were made through banking channels and were reported in the financial statements. The transfer of shares from AB Holdings to AB Singapore was done as a part of the business reorganisation which shows long-term business and commercial purpose. Also, the investment was held for a long-term duration which shows that these were not short-term transactions undertaken to avoid tax.
  • AAR also held that it unlikely that the Holding company would not be involved in any important decision making such as funding the taxpayer, deciding its objectives, its target markets and making investments or divestments etc. However, simply basis the Holding company's involvement as mentioned above, the Revenue can neither question the validity of the existence of AB Holdings nor the investments undertaken by it unless its involvement renders AB Holdings a mere puppet.
  • With regards to the physical location of the directors of the taxpayer, the AAR noted that the AB Holdings, as well as the Holding company, had a common director who had made multiple trips to and from Mauritius including the period wherein important decisions of AB Holdings were taken. It was also noted that with technological advancements in communication, it was unrealistic to expect all the directors to be physically present at every meeting(s).
  • As regards other directors who were financial services consultant catering to more than 400 companies, AAR held that such directors had sufficient qualifications so as to engage in meaningful discussions in respect of the taxpayer's business. Thus, the Revenue merely assumed that other Directors had no role in the decision-making process.
  • Concerning office/place of management/staff, the AAR noted that the Mauritian tax authorities had verified the place of business of the applicant at the address given by the taxpayer. Furthermore, the income-tax returns so filed and the board meetings, both took place at this address only as mentioned in the resolutions. The AAR also observed that the taxpayer is an investment company which does not require huge offices and staff unlike manufacturing or a trading concern which requires day to day dealings with various stakeholders.
  • The AAR also observed that the director of AB holdings signed share purchase agreement s and also resolutions of the boards indicate that it was immaterial that AB Holdings received funds required for investing in AB International from the Holding company.
  • In light of the facts above, AAR held that AB Holdings fulfils all the criterion laid out for being a legal and beneficial owner of the shares. Accordingly, AB Holding was eligible to avail the capital gains exemption according to Article 13 of the treaty and hence such gains would not be liable to tax in India.

Facts in the case of AB Mauritius

  • AB Mauritius is a Mauritian Company formed in 2003 holding a valid TRC and a Category 1 Global Business License. "C" Group4 (Holding company), a US entity, together with other individual investors held shares of AB Mauritius.
  • AB Mauritius carried on its business activities from Mauritius and was managed by its Board of Directors (BOD). AB Mauritius sole purpose of incorporation was to invest in 'S' Sector in India and other Asian markets.
  • It acquired the shares of AB India (Indian Co) from AB Inc and US Inc (US sellers) vide a Share Purchase Agreement (SPA) dated 10 November 2003. In this regard, it had obtained relevant approvals from FSC in Mauritius and FIPB in India which clearly stated that the taxpayer was a 99% shareholder of AB India.
  • The SPA above was executed by an authorised signatory (Mr S) representing the promoter group and was fully authorised by the BOD to execute the SPA on behalf AB Mauritius. These shares were taken over along with a liability which the sellers had to pay to the Holding company as per the loan agreement dated 30 November 2003. These facts were recorded in its financial statement for the period ending June 2004.
  • The taxpayer was the legal as well as the beneficial owner of the shares so purchased and since then it has been enjoying all the shareholder rights including dividends.
  • To achieve its objective of business reorganisation, in the year 2011, AB Mauritius had transferred the shares of AB India to a newly incorporated entity in Singapore (i.e. AB Singapore). This was done solely for business and commercial reasons of obtaining operational and cost benefits from centralising ownership in investments and operations in Asia Pacific region.

Ruling of the AAR

  • AAR observed that it is important to establish that AB Mauritius was acting on its behalf and was not merely lending its name or was a benami of the ''C'' Group.
  • Applicant's reliance on minutes of board meeting dated 15 August 2003 was not relevant as the same only reiterated the intention of the Holding company as stated in the application made to FSC. Similarly, the FIPB approval also at best showed the intent of the Holding company and not any decision was taken by AB Mauritius regarding the proposed investment and/or its source.
  • The AAR observed that an important document like the SPA was signed by Mr 'S' who was a director of the Holding company and not by any director of the taxpayer although it was a party to this agreement. AAR rejected the argument of the applicant that Mr 'S' was authorised to sign the SPA on its behalf as the relevant document was only submitted in 2016 and it appeared to be an afterthought. Also, there was no mention in this agreement as to how AB Mauritius was going to fund this acquisition. These aspects indicated that the taxpayer had no role whatsoever in the decision with regards to the of shares of the Indian from the US sellers.
  • The AAR observed that in today's dynamic global scenario, decisions pertaining to large-scale investments are made after substantial deliberations at the Board level. Also, the parties involved in such decisions are fully aware of the relevant details such as consideration to be paid, ownership of shares so transferred etc. However, in the present case, AB Mauritius was not aware of the above-mentioned details. Thus, AB Mauritius was a mere puppet in the hands of its Holding company was evident from the fact that the taxpayer was informed about the investment in India more than a year later after such investment took place. Furthermore, the taxpayer was directed to incorporate these transactions in its books of account by Mr. 'S' which points out that the said acquisition of shares in Indian company was for and on behalf of the taxpayer by its Holding company In light of the above, it was very clear that the taxpayer was neither managing nor controlling crucial investment decisions for which it was stated to be set up.
  • The SPA indicated that the Holding company of AB Mauritius acquired 1% of the shares in the Indian company instead of its debt due from the US sellers. AB Mauritius, on the other hand, acquired 99% of the shares in the Indian company without paying any consideration. Since the SPA itself stated that the shares would be transferred in the name of the entity which paid the consideration, the AAR concluded that AB Mauritius was only a 'name lender' of the Holding company.
  • The contention of the applicant that it had vide a separate loan agreement with Holding Co and its directors taking up a liability amounting to USD 380,160 being a consideration for the acquisition of shares of AB India. The AAR observed that this loan agreement was only submitted in 2016 which had no mention of shares allotted to AB Mauritius. Further, such loan agreement was signed by the director of AB Mauritius, while the SPA was signed by Mr 'S' even though both the transaction took place around the same time. Further, AAR also observed that SPA did not have any mention of the loan agreement which ideally would have been the right place to mention the same.
  • AAR observed that Holding company had signed collusive agreements of the subsidiary (i.e. AB Mauritius) on its behalf and paid the consideration for the same, the subsidiary could not be considered as an owner of the shares transferred to it, even though entries have been made in the books.
  • In light of the above aspects, the AAR concluded that AB Mauritius was not the beneficial owner of the shares acquired. It was held that in essence, the Holding company comprising of two US companies had acquired the shares in 'AB India' and hence such gains should be chargeable to tax in India as per the provisions of India-USA Tax treaty.

Footnotes

1 AAR No. 1129 of 2011

2AAR No. 1128 of 2011

3Holds 87.56% of shares of the taxpayer

4 Holding 79.62% shares of the taxpayer

SKP's comments

At the outset, it would be imperative to note that AAR rulings are binding only on the Applicant but the same may still have persuasive value. Both these rulings once again touch upon the delicate issue of ''substance over form''. These rulings once again lay emphasis on the fact that place of decision making and authority of board is an important aspect to claim tax treaty benefit and merely obtaining a tax residency certificate may not be sufficient.< p/>

A key differentiator for availing tax treaty benefits in the above rulings are as follows:

  • Authority and decision making powers with the board of directors of Mauritian company;
  • Routing of transaction through appropriate banking channels;
  • Signing of agreements by director of the company;
  • Minimal involvement of parent company in the affairs of Mauritius Company.

India has recently introduced General Anti-Avoidance Rules (GAAR) which are applicable from 1 April 2017 with grandfathering provisions up to 31 March 2017. GAAR confers additional powers to the Indian Revenue Authorities to examine these kinds of structures and verify the substance of form test. It also vests vast powers to the Indian Revenue Authorities like disregarding the corporate structure, deny tax treaty benefits, etc. Accordingly, it is imperative that Multinational Companies including Foreign Portfolio Investors (FPI) have a re-look at their structures and evaluate as to whether they meet the business/commercial test.

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.

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