December 29, 2020
Madras HC holds transfer of shares without consideration is not “gift” absent voluntariness, upholds levy of capital gains tax
In a recent decision,1 the Madras High Court (“Madras HC” or “Court”) held that an inter-company gift of shares made as part of a corporate restructuring exercise was not a valid gift and should be subject to capital gains tax under the Income-tax Act, 1961 (“ITA”). The Court held the transaction to be a circular transaction, undertaken to avoid tax by shifting profits outside India.BACKGROUND
Redington (India) Ltd. (“RI” or “Assessee”), a company incorporated in India, carried out operations in the Middle East and Africa through its wholly owned subsidiary: Redington Gulf FZE (“RG”). In 2008, a private equity firm (“PE firm”) evinced interest in investing in the Assessee’s Middle East and Africa operations. Pursuant thereto, the following steps were undertaken:
The Transaction is depicted below:
The Assessee’s case was selected for scrutiny and was referred to the Transfer Pricing Officer (“TPO”). The TPO passed a draft assessment order proposing inter-alia an addition for long-term capital gain (“LTCG”) arising on transfer of shares of RG to RC. The Dispute Resolution Panel upheld the LTCG addition, that was then confirmed in the final assessment order. On appeal, the Income-tax Appellate Tribunal (“ITAT”) held the transfer of shares without consideration to be a valid gift exempt from capital gains tax under section 47(iii) of the ITA. The Revenue preferred an appeal to the Madras HC against the ITAT’s order on the fundamental question:2 whether the ITAT was correct in holding that the transfer of shares by the Assessee to its subsidiary was to be considered a ‘gift’.MADRAS HC RULING
This is yet another in a line of recent decisions where courts and tax authorities have looked through structures from a pre-GAAR period, increasingly following a ‘substance over form’ approach.
The Madras HC here has carefully analyzed the entire chain of events involved in the corporate restructuring to arrive at its narrative of tax avoidance. The Court has considered the steps involved, their timing, and the purpose of each entity involved, along with documentary evidence in the form of board resolutions, texts of share transfer deeds, and statements from company officials, to piece together a wholistic picture to set the context for the gift of shares. This exercise of the Court is reminiscent of the exercise undertaken by the Authority for Advance Rulings (“AAR”) in Bid Services Division5 where benefit under the India-Mauritius tax treaty was denied to the assessee, based on a review of the purpose of the Mauritius-based taxpayer and the timelines involved in its creation, that led the AAR to conclude that the entity had been set up only to avail of the Mauritius treaty benefits and did not possess the requisite substance.
While High Courts do not typically delve into factual analyses in appeals before them, the Madras HC in this case has placed heavy reliance on the factual analysis undertaken by the lower authorities (specifically the TPO), and has commented on the ITAT’s silence on these factual aspects. Notably, the Madras HC did not simply remand the matter to the ITAT to look into the facts afresh. For multi-stepped corporate reorganizations, it is now more important than ever to evaluate the existence of commercial substance against not only statutory but also judicially developed anti-avoidance doctrine as the law keeps evolving, and to carefully review documentation with a close lens.
On the law on corporate gifts, this decision of the Madras HC adds more dimension to the debate. In a recent decision the Bombay High Court in Asian Satellite Broadcast v. ITO,6 relying on a decision of the Gujarat High Court in Prakriya Pharmacem v. ITO,7 held unequivocally that by operation of section 47(iii) of the ITA, any transfer of a capital asset under a gift could not be taxed as capital gain. The Madras HC has distinguished these High Court decisions on the basis that the main question in Asian Satellite (supra) was the validity of a reopening notice on the allegation that the corporate gift was a colorable device, when the gift had initially been accepted as such by the assessing officer during the original assessments. These cases, the Madras HC held, do not involve fact patterns where the gift has been made in a context that clearly indicated avoidance. It highlighted the findings of the AAR in Orient Green Power Pte. Ltd.,8 which observed that a gift by a corporation to another corporation, though a subsidiary or an associate enterprise which is always claimed to be independent for tax purposes, is inherently a strange transaction. To postulate the idea that a corporation can give away its assets, free of cost or without any consideration, to another entity, even orally, points towards the possibility of dubious attempts at avoidance of tax payable.
While the Madras HC’s blanket cynicism regarding corporate gifts may be critiqued as being too simplistic, its in-depth factual analysis drawn from the conduct of the entities inquiring into the substance of the transaction is the key takeaway. This line of jurisprudence, inquiring into issues with a lens of tax avoidance and profit shifting, has been on the rise since the OECD’s Base Erosion and Profit Shifting measures and allied domestic law changes; and it would be reasonable to assume that courts and tribunals are likely to continue looking through structures, in order to assess their substance, in most cases involving a claim of exemption or a concessional tax treatment.
– Varsha Bhattacharya, Arijit Ghosh & Ipsita Agarwalla
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1 T.C.A Nos. 590 & 591 of 2019 dated December 10, 2020.
2 Other questions were raised before the Madras HC arising out of the ITAT’s order with regard to trademark fee and bank/corporate guarantees.
3 (1985) 156 ITR 509 (SC)
4 (1981) 128 ITR 294 (SC)
5 In Re: Bid Services Division (Mauritius) Ltd., AAR No. 1270/2011, decision dated 10.02.2020.
6  428 ITR 327 (Bombay)
7  238 Taxman 185 (Gujarat)
8 (2012) 346 ITR 557
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