In our earlier
hotline, we analyzed the decision of the Bombay High Court
in E*Trade Mauritius Limited v. ADIT & Ors.1,
and whether the recent stir created by this decision is
warranted. We now go on to analyze the revisional order passed
by the Director of Income Tax (“DIT”) refusing
to grant a nil withholding certificate for the sale of an Indian
company’s shares between two Mauritian companies.
While the key issue, i.e., whether the sale of an Indian
company’s shares between two Mauritian companies would be
subject to tax in India will be decided only upon the conclusion
of assessment proceedings, an understanding of the DIT’s order
would still be useful. Particularly as the DIT’s observations
are indicative of the revenue’s stand on the applicability of
treaty benefits when using intermediary jurisdictions for
investing in India.
Recap
E*Trade Mauritius Ltd. (“ETM”) is a wholly
owned subsidiary of US based Converging Arrows Inc (“CAI”),
which is in turn a wholly owned subsidiary of E*Trade Financial
Corporation (“ETFC”), also a US company. ETM
had sold its stake in IL&FS Investmart (“IL&FS”,
an Indian company to HSBC Violet Investments (“HSBC”),
also based in Mauritius.
In connection with the sale, ETM sought a certificate from the
tax authorities (“AO”) under section 197 of the
Income Tax Act, 1961 (“ITA”) authorizing
payment of consideration by HSBC sans any withholding of tax.
As the AO refused to grant the nil withholding tax certificate,
a writ petition was filed before the Bombay High Court. On the
basis of the consent of the parties, the High Court directed ETM
to file a revision application before the DIT and disposed the
writ in September 2008.
The DIT in its revisional order, upheld the order of the AO in
not granting a nil withholding certificate. We have provided
below our analysis of the factors that were considered by the
DIT to question the already settled legitimacy of the
India-Mauritius route.
DIT’s Order
In its order, on the basis of the facts and circumstances of
this case, the DIT after examining various documents and filings
made by ETFC and its subsidiaries as well as by IL&FS chose to
disregard ETM as an intermediate shareholder company and
conclude that the investment was in actual fact held and sold by
ETFC.
ETFC's Control Over IL&FS
First, the DIT has closely examined the members of the board of
directors of ETFC, CAI, ETM and IL&FS prior to the sale of ETM’s
stake in IL&FS. Some directors were found to be common between
ETFC and IL&FS. Further, the DIT ascertained that the former
Vice President of ETFC was serving as the CEO and Managing
Director of IL&FS finding this to be a significant link between
ETFC and IL&FS. Additionally, several personnel of ETFC were
being deputed to IL&FS. Thus, the DIT was of the view that ETFC
was exercising rights directly in IL&FS not only through
appointment of directors but also through the deputation of
managerial and senior executives. In this regard, the DIT even
went so far as to conclude that ETFC has a ‘permanent
establishment’ in India under the India-US Tax Treaty.
Source of Funding
The DIT also scrutinized the source of ETM’s funds for its
periodic acquisitions in IL&FS. It was found that only when
funds were infused in ETM by either ETFC or CAI did ETM acquire
shares in IL&FS. ETFC’s funding of acquisitions in IL&FS was yet
another reason for the DIT to believe that it was ETFC acquiring
shares in IL&FS and not ETM.
Additionally, certain undertakings provided by IL&FS under the
shareholders agreement with ETM and other shareholders of IL&FS
were also analyzed. The undertakings to furnish information and
statements to facilitate ETFC’s compliance with US tax
requirements (i.e., ‘Passive Foreign Investment Corporation’
norms) were factored in to bridge the link between ETFC and
IL&FS.
Public Disclosures & Filings
As in the Vodafone controversy, in this case as well, several
non tax declarations and
regulatory filings (i.e. prospectus, offer letter, annual reports
etc) were also studied. As examples:
-
The ‘Public Announcement’ filed by ETM under the SEBI
Takeover Code while setting out the reasons for the open
offer also stated that ETFC’s resources will be deployed to
India allowing IL&FS to leverage ETFC’s expertise to achieve
growth and efficiency.
-
The extracts of the Annual Report of IL&FS state that IL&FS
had inducted ETFC as a strategic partner being one of the
largest retail broking and banking entity with ETM holding
shares on behalf of ETFC in India.
All
these documents were analyzed to support the DIT’s contention
that the shares of IL&FS were truly held by ETFC and not ETM.
Decision
Despite what the DIT believed to be ‘overwhelming facts
indicative of the ownership of shares resting with the US
Company’, the key question of whether the India-Mauritius Tax
Treaty or the India-US Tax Treaty would be applicable was
ultimately not answered by the DIT. The DIT was instead of the
view that such a finding can only be made in the assessment
proceedings upon a greater analysis of further facts and
circumstances.
Analysis
The
DIT, in its order, appears to have kept the option of
challenging the validity of Circular 789 (the circular issued by
the tax authorities which allows Mauritian companies having tax
residency certificates to benefit from the India-Mauritius tax
treaty) open. This stems from the judgment of the Supreme Court
in Central Excise v. Ratan Melting & Wire Industries Ratan2
which gives the revenue the right to challenge their own
circulars.
The
DIT has clearly gone to great lengths (in terms of factual
enquiries and analysis) to disregard an intermediate
shareholding company. However, the fact remains that as the law
stands today in light of decision of the Supreme Court of India
in Union of India v. Azadi Bachao Andolan3
which had upheld the validity of Circular No. 789, the sale of
shares of an Indian company by a Mauritian company should not
attract capital gains tax in India. Further, there are settled
principles of law when it comes to lifting the corporate veil
and the circumstances under which it may be lifted. Looking
through corporate entities purely to bring transactions to tax
is not one of them.
Conclusion
Learning from the hard line approach being taken by the
revenue in recent times, be it with Vodafone or E*Trade, the
deal documentation should be carefully drafted from an Indian
tax perspective so as to avoid being unreasonably hauled up by
the Indian tax authorities. Similarly, due care should be taken
when making any declaration or filing (for regulatory and other
purposes) in connection with the transaction.
The story does not end here. As highlighted
above, this is not a final determination of the taxability of
the transaction but is only a provisional determination of tax
for withholding tax purposes. Interestingly, the High Court has
not gone into the merits of the case since the parties had
consented to approach the DIT for a revisional order. Thus, the
chargeability of such transactions to tax in India is yet to
stand the test of judicial scrutiny.
._____________________________
1. WP. No. 2134 of 2008
2. 2008 (13) SCC 1
3. 263 ITR 706 (SC)
