The recent advance ruling in the case of Canoro Resources Ltd.¹ examines a number of interesting issues concerning the applicability of domestic anti-avoidance provisions to transfers between partners and foreign partnerships.

The Petitioner, a Canada-based company, engaged in the business of exploration and production of petroleum and natural gas, held participating interests in certain oil blocks in India. As part of a business restructuring project, the Petitioner proposed to transfer its participating interest in one of the blocks as capital contribution to a partnership to be formed in Canada between it and its wholly owned Canadian subsidiary. The restructuring was undertaken with a view to attracting other potential investors.

The tax authorities contended that the proposed restructuring was essentially a tax avoidance device and as such, did not merit an advance ruling. It was argued that the proposed structuring would allow the Petitioner to exit from its Indian operations by merely transferring the Canadian partnership interest, without the same having any tax implications in India. The AAR, however, affirming the bona fides and commercial prudence behind the Petitioner’s business objective, did not agree that the transaction was prima facie designed for tax avoidance purposes. The possibility that the Petitioner may in future exit from the proposed partnership firm would not by itself render the present transaction a tax avoidance device, especially considering that the Petitioner was willing to pay tax on any capital gains accruing from the transfer made to the Canadian firm. Relying on the Supreme Court decision in Azadi Bachao Andolan², which upheld the validity of investments made into India through Mauritius, the AAR held that the taxpayer is free to use any legal method to plan his tax liability with a view to generate more beneficial outcomes.

With respect to the argument that the proposed Canadian partnership be assessed as a company under domestic tax provisions, the AAR noted the similarities between the Partnership Act of Alberta, Canada and the Indian Partnership Act, and held that as long as the shares of the respective partners are ascertainable (though not specifically mentioned in the Partnership deed), the said partnership would be assessed as a firm. It may be noted that, assuming there is a permanent establishment in India, business profits earned by a non-resident firm would be taxed at the rate of 30% as opposed to 40%, which would apply to non-resident companies.

On the issue of residential status of the proposed Canadian firm, the AAR held that it was question of fact to be determined by the assessing officer at the relevant point of time after ascertaining the situs of management and control.

The Petitioner also argued that the domestic transfer pricing provisions would not apply to the proposed transaction since section 45(3) of the Income Tax Act, 1961 provides a specific mode of computing the value of consideration received by a partner making a transfer to a firm by way of capital contribution. Section 45(3) states that such consideration would be deemed to be the value of the transferred asset as recorded in the books of the partnership. The AAR however, did not agree with this interpretation. Highlighting the policy behind the two apparently conflicting provisions, the AAR held that while section 45(3) was primarily intended to cover domestic transfers, the transfer pricing provisions were specifically introduced to take care of international transactions between associated enterprises, whether individuals, companies or firms.

In this regard, the AAR also rejected the Petitioner’s reliance on the non-discrimination clause in the India-Canada tax treaty to assert that since the transfer pricing provisions did not apply to transactions between residents, the same was discriminatory. It held that such provisions merely envisage differential rules between resident and non-residents without fostering any nationality-based discrimination and hence would not fall foul of the non-discrimination clause.

Since the apprehension of price manipulation is real even in international transactions between associated persons such as partners and firm, the transfer pricing provisions were held to apply to the Petitioner’s transfer of participating interest to the proposed Canadian partnership firm.

Analysis

The above ruling lays re-emphasis on the landmark Supreme Court judgment in the case of Azadi Bachao Andolan³ and reasserts that the Revenue cannot raise an objection to the taxpayer resorting to legal ways to plan his tax liability, the result of which would be more beneficial to the taxpayer. This is important especially in the context of the recent ongoing controversy in case of E*Trade, where this landmark judgement has not been given due consideration. Further, the mechanism adopted by the AAR to analyze whether a certain entity should be treated as a partnership under Indian law will also be useful to analyze the tax status of hybrid entities such as LLCs, LLPs, etc.

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1. 2009-TIOL-10-ARA-IT
2. 263 ITR 706 (SC)
3. supra