Volume 3, Issue 4


29th March, 2010


Tax Alert
AAR Ruling: E*Trade Mauritius gets capital gains tax exemption in IL&FS case

In a recent ruling in the case of a Mauritian company E*Trade Mauritius Ltd.1 (ET Mauritius), the Authority for Advance Ruling (AAR) held that ET Mauritius is not liable to pay capital gains tax in India in respect of the transfer of shares held by it in IL&FS Investsmart Ltd., an Indian Company (IL&FS), to HSBC Violet Investment (Mauritius) Ltd. having regard to the provisions of the India-Mauritius DTAA.

Background

ET Mauritius holds a Global Business Company Licence issued by the  Financial
In a recent ruling the AAR held that E*Trade Mauritius Ltd. is not liable to pay capital gains tax in India in respect of the transfer of shares held by it in IL&FS Investsmart Ltd to HSBC Violet Investment (Mauritius) Ltd., having regard to the provisions of the India-Mauritius DTAA.
  Services Authority of Mauritius and is a tax resident of Mauritius. It is a subsidiary of Converging Arrows Inc., USA which in turn is a subsidiary of E*Trade Financial Corporation, USA (ET USA). ET Mauritius sold the equity shares held by it in IL&FS, to HSBC Violet Investment (Mauritius) Ltd. (HSBC), another Mauritian company.

ET Mauritius approached the tax authorities in India for obtaining a “NIL” rate withholding tax certificate under Section 197 of the Income Tax Act (ITA). Instead of issuing a “NIL” rate withholding tax certificate, the tax authorities issued a certificate directing HSBC to deduct tax on the amounts paid to ET Mauritius.

Being aggrieved, ET Mauritius filed a writ petition before the Bombay High Court challenging the said certificate. ET Mauritius contended before the High Court that the order of the tax authorities was contrary to Article 13(4) of the tax treaty with Mauritius and also CBDT Circular No. 682 dated 30 March 1994 and Circular No. 789 dated 13 April 2000 and the Supreme Court’s decision in the case of Union of India vs. Azadi Bachao Andolan2.

The Bombay High Court, without going into the merits of the case, disposed of the writ petition directing ET Mauritius to file a revision application under Section 264 of the ITA, before the Director of Income Tax (International Taxation) (DIT) and also directed HSBC to deposit a sum of INR 245 million which would be withheld from the consideration paid to ET Mauritius, pending disposal of revision petition by the DIT.

The DIT disposed of the revision petition, confirming the view taken by the tax authorities that the transaction prima facie gave rise to capital gains chargeable to tax in India.

ET Mauritius thereafter approached the AAR to determine whether, by virtue of being a resident of Mauritius, it is eligible to the benefits of the India - Mauritius treaty and hence not subject to tax in India on the capital gains realized.

Contentions of Tax Authorities

Though the legal ownership of shares of IL&FS vests with ET Mauritius, the real and beneficial owner is ET USA and hence, ET Mauritius is merely a façade to avoid capital gains in India.

DIT has taken a prima facie view that the capital gains arising from the transaction is taxable in the hands of ET USA.

The real essence of the transaction could be examined to determine whether it is a colourable device to evade tax, despite the Supreme Court’s ruling in the case Azadi Bachao Andolan.

Contentions of ET Mauritius

Determination of beneficial ownership is irrelevant in the context of Article 13 (Capital Gains) of the India-Mauritius tax treaty. ET Mauritius relied on the Circular No. 789 dated 13 April 2000 issued by the CBDT and the decision of the Supreme Court in the case of Azadi Bachao Andolan and argued that the Tax Residency certificate issued by the Mauritian tax authorities should constitute sufficient evidence for accepting the status of residence for applying the provisions of India-Mauritius tax treaty.

Ruling of the AAR

The AAR vide order dated 22 March, 2010 pronounced its ruling. The synopsis of the ruling is given below:

  • As all the legal formalities for purchase of shares and their subsequent transfer had been completed by ET Mauritius and the consideration had been received by ET Mauritius, it is difficult to assume that capital gain has arisen to ET USA and not ET Mauritius.
  • It further held that the fact that ET USA provided the funds and played a role in negotiating the sale transaction did not lead to legal inference that the shares were, in reality, owned by ET USA. The fact that a subsidiary has its own corporate personality and is a separate legal entity needs to be considered. Even though the holding company exercises acts of control over its subsidiary, that did not, in the absence of compelling reasons, dilute the separate legal identity of the subsidiary.
  • The AAR referred to Circular No. 789 and upheld the benefits available under the India- Mauritius tax treaty.
  • The AAR held that the attempted distinction between legal and beneficial owner cannot be sustained on any reasonable basis relying on the decision of the Supreme Court in the case of Azadi Bachao Andolan, the Circular No. 789 and the treaty provisions.
  • Further, the AAR relying on the decision of the Supreme Court in the case of Azadi Bachao Andolan, held that there is no legal prohibition against “treaty shopping”. Tax avoidance is not objectionable if it is within the framework of law and not prohibited by law.

Our Analysis

The AAR ruling affirms that the Indian Tax Authorities are not in a position to levy capital gains tax on the transfer of shares in an Indian company by a Mauritian tax resident in view of the provisions of the India-Mauritius tax treaty, the Circular issued by CBDT and the law laid down by Supreme Court in Azadi Bachao Andolan case.

A ruling by the AAR is binding only on that applicant, in respect of the transaction in relation to which the ruling is sought and on the tax authority. However, it does have persuasive value and the Courts in India, the tax authorities and the appellate authorities do recognize the principles and ratios laid down by the AAR while deciding similar cases. Other taxpayers who would like to achieve certainty on their transactions could consider approaching the AAR for a ruling after evaluating the facts of their respective cases.

As far as the case of ET Mauritius is concerned, the only option available for the tax department now is to file a special leave petition before the Supreme Court against the said AAR ruling.

  

The AAR ruling affirms that the Indian Tax Authorities are not in a position to levy capital gains tax on the transfer of shares in an Indian company by a Mauritian tax resident in view of the provisions of the India-Mauritius tax treaty, the Circular issued by CBDT and the law laid down by Supreme Court in Azadi Bachao Andolan case.

Notes:

1 M/s. E*Trade Mauritius Limited (A.A.R. NO. 826 OF 2009 dated 22 March, 2010)
2 (2003) 263 ITR 706 (SC)