Tax Hotline July 23, 2012

Breather for investment from Mauritius: AAR allows benefit of Mauritius treaty

In the latest ruling, the Authority for Advance Ruling (“AAR”) in Dynamic India Fund I1 upholding the dicta of the Hon’ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan2 ruled the benefit of the capital gains clause of the India-Mauritius tax treaty would have to be allowed. It further went on to state that the controversy of the General Anti-Avoidance Rules (“GAAR”) provisions overriding the Double Taxation Avoidance Agreements (”DTAA”) could only be answered once the GAAR provisions come into force.

The Background

Dynamic India Fund I (“DIF I”) a company incorporated in Mauritius, a 100% subsidiary of another Mauritius Company, Dynamic India Fund II (“DIF II’) is registered as a Foreign Venture Capital Investor with the Securities and Exchange Board of India and holding a valid Tax Residency Certificate (“TRC”) from Mauritius Revenue Authority made investments in shares of Indian Companies with the intention of generating long term capital appreciation.

DIF I approached the AAR to seek an advance ruling regarding the taxability of capital gains arising out of the sale of shares of the Indian companies.

DIF I holding a valid TRC claimed that the capital gains that may arise out of the sale of shares of the Indian company should be taxable only in Mauritius under paragraph 4 of Article 13 of the DTAA between India and Mauritius (“India-Mauritius DTAA”) and capital gains being exempt in Mauritius, the buyer would not be required to withhold any tax on the payments made to DIF I.

According to the Revenue, the structuring of the investment through Mauritius was a way to evade the capital gains tax earned from the sale of shares of the Indian company as only four out of fifty investors were from Mauritius and hence, the decision in the case of Azadi Bachao Andolan should not be accepted. Further, the Revenue argued that the control and management of DIF I was in India making it a tax resident of India as three out of five directors on the Board of Directors of DIF I were from India. In this regard DIF I, asserted that the decisions are taken by the Board of Directors from Mauritius and the control of affairs of DIF I lies in Mauritius.

Ruling

The AAR held that as capital gains tax arising from the proposed sale of shares of the Indian companies by DIF I would be covered under para 4 of Article 13 of the India-Mauritius DTAA, the same shall be exempt from tax and no tax is required to be withheld. On account of DIF I holding a valid TRC and placing reliance on the decision of the Indian Supreme Court in the Azadi Bachao Andolan case, wherein it was held that if the taxpayer had a valid TRC, it would be eligible to treaty benefits under the India-Mauritius DTAA, the AAR ruled that DIF I would be a tax resident of Mauritius and the capital gains arising out of the sale of shares will not be chargeable to tax in India.

The AAR rejected the Revenue’s contention of control and management of DIF I being in India on the ground that the majority of directors are non-residents comprising of two local resident directors in Mauritius and all others being non-resident directors. The view of the Revenue that four out of fifty five investors were from Mauritius and that routing the investment by the investors through Mauritius was a scheme to evade tax on the capital gains was also rejected by the AAR.

With regard to the controversy of GAAR provisions overriding the DTAAs, the AAR ruled that since GAAR provisions were to come into force from April 1, 2013 currently they have no relevance and can be dealt with by the Revenue only when they come into force.

Analysis

By re-confirming the Mauritius route and upholding Azadi Bachao Andolan as still law of the land, the AAR has brought some respite to the various stakeholders including the investors confirming that the gains arising from the transfer of shares of an Indian company by a Mauritian resident should not be taxable in India under the India-Mauritius DTAA once the Mauritian resident has a valid TRC issued by the Mauritius Revenue Authority in place. This clarity was needed considering some of the earlier judgments3 of the AAR, wherein it re-characterized income in the hands of the investor from capital gains to interest and dividend income thereby denying exemption in respect of capital gains under the India-Mauritius DTAA and disregarded the legal form of the transaction, alleging the transactions to be sham and imputing on the investors the intention to avoid Indian taxes, due to which there has been some concern on the availability and applicability of the DTAA benefit.

Till the time the proposed provisions by the Finance Act, 20124 comes into effect5, the benefits under the DTAAs will be available to the taxpayers, confirming this position the AAR observed that there is no need to invoke the GAAR provisions6 nor treat it as a scenario of treaty override7 or question the TRC based on the new provisions prescribed8 for a non-resident to claim benefit of tax treaty in India.

The AAR has refused to be drawn into the debate on the applicability of the GAAR provisions once the same comes into effect. Considering the amount of hue and cry that has been raised and the constitution of a new Committee to lay out the GAAR guidelines, this approach seems preferred at this point in time. A strong resistance has come from various stakeholders including the foreign investors expressing their concerns in relation to the introduction of GAAR. However, till such time the GAAR provisions take effect, the AAR has made it clear that all benefits out of DTAAs are allowed and the taxpayer is free to make best use of them.


Ashish Sodhani, Ankit Mishra & Rajesh Simhan

You can direct your queries or comments to the authors


1 AAR No. 1016 of 2012, decision dated July 18, 2012.

2 263 ITR 706 (SC)

3 Case Z (A.A.R. No.1048 of 2011) and Case A (A.A.R. No. P of 2010) (Our analysis on the two cases can be viewed here)

4 Section 41 of the Finance Act, 2012

5 The Government has postponed the application of GAAR to income accruing or arising to the taxpayers on or after April 1, 2013

6 Chapter X-A of the Income Act, 1961. This provision has been deferred by the Draft guidelines regarding implementation of GAAR in terms of Section 101 of the Income Tax Act, 1961.

7 Section 90(2A) of the Income Tax Act, 1961

8 Section 90(4) of the Income Act, 1961


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