Background
Over the years, different entities have been used by fund
managers as investment vehicles. To suit the preferences of
investors, commonly used jurisdictions had developed innovative
models of these entities. One such instance is the use of a
company with different share classes where each class represents
a separate fund with distinct investment objectives. This
“multi-class umbrella fund” is particularly useful where a fund
manager desires to manage the assets of multiple funds and, at
the same time, market the multiple funds as a single
opportunity. Although the “multi-class umbrella fund” has its
commercial benefits, it does not provide for segregation of
liabilities between the share classes / sub-funds, which is a
major concern among investors. To address this issue of
cross-class liability, several investor friendly jurisdictions,
including Mauritius, introduced the concept of a Protected Cell
Company (“PCC”). A PCC is statutorily
authorized to segregate its assets into cells and a creditor of
one cell can only proceed against the assets of that cell, a
concept known as “ring-fencing”. Over the last decade, PCCs have
evolved as the most popular entity for use as collective
investment vehicles across jurisdictions particularly Europe.
Tax treatment of Protected Cell Companies: The Nicholas
Applegate ruling
Although in law the cells of a PCC are separate from each other,
the same principle is usually not applied in the case of
taxation. Most jurisdictions which have cell company legislation
regard the PCC as a single taxable person and each cell is not
liable to tax separately, a position that also arises from the
fact that the cells of a PCC are not separate legal entities.
However, with regard to jurisdictions that do not have cell
company legislation such as India, it is somewhat unclear as to
whether the same principle will be followed or if each cell will
constitute a separate taxable entity. Recently1,
a fund incorporated under the Mauritius Protected Cell
Company Act was faced with the same puzzling question in
respect of the taxation of its investments in India.
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Nicholas Applegate South East Asia Fund (“Fund”),
a Mauritius PCC, had four cells where each cell represented
a separate fund (“Sub-fund”). The Fund and
each Sub-fund had separate Permanent Account Numbers2
and each Sub-fund had a separate sub-account registration
under the Securities and Exchanges Board of India (Foreign
Institutional Investor Regulations), 1995. The Sub-funds had
incurred short term capital losses in respect of its Indian
investments and intended to carry forward these losses to
the following year as per the provisions of section 74 of
the Indian Income Tax Act,1961 (“ITA”).
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On
account of the uncertainty regarding the tax treatment under
the ITA of cell companies, a separate tax return (“Initial
Return”) for each Sub-fund was filed assuming that
this was the requirement under the ITA. However, realizing
that a single consolidated return may be what is actually
required under the ITA, the same was later filed by the Fund
(“Revised Return”).
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In
order to be eligible to set off losses incurred during the
year against future profits, the Fund was required under the
ITA to furnish the return before a certain period. The
Initial Return was filed within the prescribed time and the
Revised Return was filed sometime later. The Assessing
Officer (“AO”) held that the Initial Return
was “invalid” since the cells of the PCC were not liable to
tax separately and accordingly considered the Revised Return
as the Initial Return. Since the Revised Return had been
filed after the due date, the Fund was not allowed to carry
forward the loss. The first appellate authority rejected the
Fund’s appeal and the second appeal was made to the Income
Tax Appellate Tribunal (“Tribunal”).
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The Tribunal held that the Initial Return was valid in so
far as it fell within the ambit of section 292B. As per
section 292B, a return which suffers from a defect, mistake
or omission is not invalid if it is otherwise, in substance
and effect, in conformity with the purpose of the Act. Thus,
according to the Tribunal, the filing of separate returns in
respect of each Sub-fund was a technical mistake which stood
removed on the filing of the consolidated return and the
Initial Return being valid and within the prescribed time,
the Fund was permitted to set off losses incurred during the
year against future profits.
Remarks
We
believe that although the Tribunal did not directly address the
issue of whether each cell of the PCC is a separate taxable
entity, the very fact that it regarded the Initial Return as
defective seems to indicate that individual cells of a PCC will
not constitute a separate taxable entity. The position is
further strengthened by a plain reading of section 2 (31) of the
ITA which identifies only the company and does not refer to the
cells of a company as a (taxable) person for the purposes of the
ITA.
Thus
we may infer that a PCC, regardless of its jurisdiction of
incorporation, will be liable to tax in India as a single
taxable person, as opposed to each cell being liable to tax
separately. An apparent benefit of this treatment is that losses
of a cell will offset the profits of another, thereby reducing
taxable income, which would not have been the case if the cells
were treated as separate taxable entities. In light of the view
taken by the Tribunal, it would be interesting to evaluate the
tax treatment in India of an Incorporated Cell Company, which is
a further enhancement of the PCC. In an Incorporated Cell
Company each cell is a separate legal entity and taxed
separately in its home jurisdiction. In such a case would the
Indian tax authorities regard each cell as a separate “person”
liable to tax? It is a question which remains to be answered.
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1. Nicholas Applegate South East Asia Fund
Ltd. v. ADIT [2009-TIOL-74-ITAT-MUM-TM]
2. Permanent Account Number or PAN is the tax
identification number issued by the tax authorities
