India's first ruling on treaty 'beneficial ownership': Dutch company held not to be a conduit
The Authority for Advance Rulings (“AAR”) recently held that a Dutch company earning capital gains income from certain proposed India-based divestments would not be subject to tax in India under the provisions of the India-Netherlands tax treaty. It also held that the Dutch company was the beneficial owner of such gains and could not be considered a mere conduit of its German parent company.
Briefly summarizing the relevant facts, a German company having a wholly-owned subsidiary in India sold its entire shareholding in the Indian company to KSPG Netherlands Holdings BV (“KSPG BV”), a Dutch resident which was the subsidiary of another German company. The Indian company now became the wholly-owned subsidiary of KSPG BV. Subsequent to the acquisition, KSPG BV made further investments into its Indian subsidiary with a view to broaden its capital base. It then sought an advance ruling on the Indian tax implications of a proposed divestment of its shares in the Indian company. A ruling was also sought in relation to other questions concerning its existing investments.
KSPG BV relied on the exemption provided in the India-Netherlands treaty for gains arising from the sale of shares of an Indian company. An ordinary interpretation of Article 13(5) of the treaty would suggest that gains derived by a Dutch resident from the alienation of shares of an Indian company would not be taxable in India if the alienation is made to another non-resident. However, the exemption may not be available in all cases where the alienation is made to a resident of India. On this basis, KSPG BV argued that any gains earned by it from a proposed transfer of shares of the Indian company to another non-resident should not be taxable in India.
While the AAR agreed with this interpretation of the treaty, it had to firstly address a more fundamental assertion made by the tax department that the ‘interpolation’ of the Dutch company was directed towards tax avoidance and hence it was neither entitled to a ruling nor would it be eligible to tax treaty benefits. The department also argued that it was the German parent rather than its subsidiary, KSPG BV that beneficial owned any gains that may accrue from the transfer of shares of the Indian company.
Rejecting the department’s position, the AAR held that KSPG BV cannot be considered a sham entity deliberately set up to avoid capital gains tax liability. It specifically stated that the Dutch company is not a conduit set up “to siphon off the gains to the ultimate holding company by means of a colorable device contrary to its corporate status.” Therefore while declaring the Dutch company to be the beneficial owner of the capital gains the AAR noted that it was a distinct legal entity having its own board of directors and management systems. It also acknowledged the fact that KSPG BV initially acquired the shares of the Indian entity on an arm’s length basis and had itself made significant direct investments into the Indian company after that. Hence, there was nothing to suggest that the beneficial ownership over the gains from the alienation of shares by KSPG BV would vest with its German parent.
The evolving jurisprudence of treaty ‘beneficial ownership’
The ruling may possibly be viewed as India’s first contribution to the limited worldwide jurisprudence on the concept of ‘beneficial ownership’ as applied in the tax treaty context.1 The landmark decisions of the Canadian Federal Court of Appeals in the case of Prevost2 and the UK Court of Appeals in Indofoods3 are known to provide the most authoritative guidance on the scope of the expression, ‘beneficial owner’. In Prevost, adopting an international fiscal meaning of ‘beneficial ownership’, it was held that the beneficial owner is the person who enjoys and assumes all attributes of ownership and exercises complete discretion over the disposition of the income. However, if it is a mere conduit, agent or administrator acting on behalf of another entity it cannot be said to be the beneficial owner of the income it receives. A similar interpretation was adopted in a recent circular issued by the Chinese Government4 which states that a beneficial owner is one who has ownership and control over the income, rights or assets that generate such income.
From an analysis of the AAR’s decision, a significant jurisprudential take-away is the importance of legal form, at least in the Indian tax context. The fact that the non-resident entity has a distinct corporate legal personality with an independent board of directors governed by the terms of its charter documents should mitigate the possibility of it being treated as a conduit. It may, therefore, be proposed that only in cases where there is an overt legal arrangement requiring the non-resident to act in the capacity of an agent or administrator, would it be possible to question its beneficial ownership over a certain income. While such a view is yet to be tested, one tends to marvel at how the evolution of international tax jurisprudence in relation to issues such as beneficial ownership is so closely subject to the cross-influence of legal principles, systems and judicial expositions from around the world.
1 At the outset, it may be noted that in most treaties, ‘beneficial ownership’, is used in connection with a non-resident’s entitlement to reduced tax withholding rates for income in the nature of dividends, interest, royalties and fees for technical services. The AAR in this case, has proceeded with its analysis on the assumption that beneficial ownership may even be relevant in the context of capital gains income.
2 Her Majesty the Queen v. Prevost Car Inc, 2009 FCA 57.
3 Indofood International Finance Ltd. v. JP Morgan Chase Bank NA,  EWCA Civ 158.
4 Circular Guoshuifan (2009) 601, issued by the Chinese State Administration of Taxation, effective from October 27, 2009.
* Nishith Desai Associates was engaged to represent the Dutch company, KSPG Netherlands Holding BV before the Authority for Advance Rulings.