KPMG FLASH NEWS. Background. Facts of the case KPMG IN INDIA. 22 August 2012

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1 KPMG FLASH NEWS KPMG IN INDIA Transfer of shares in Indian company by a Mauritius holding company to a Singapore company as a part of internal re-structuring is not liable to capital gains tax under the India-Mauritius tax treaty. Further the MAT provisions are applicable to a foreign company 22 August 2012 Background Recently, the Authority for Advance Rulings (the AAR) in the case of Castleton Investment Limited 1 (the applicant) held that transfer of shares in an Indian company by a Mauritius holding company to Singapore company as a part of internal re-structuring is not liable to capital gains tax under the Article 13(4) of India-Mauritius tax treaty (tax treaty). The pictorial presentation of the entities and their shareholdings is depicted below: The AAR held that since the Minimum Alternate Tax (MAT) provisions under the Income-tax Act, 1961 (the Act) does not make distinction between Indian and foreign companies, MAT provisions are applicable to the foreign companies. Further, the AAR also held that the Transfer Pricing (TP) provisions are applicable to the facts of the present case even though share transfers are not taxable under the tax treaty. 1 Castleton Investment Limited (AAR No. 999 of 2010, dated 14 August 2012) Taxsutra.com Facts of the case The applicant, a company incorporated in the year 1993 in Mauritius and is a tax resident of Mauritius. The shares of the applicant are held by Wellcome Limited, UK. The applicant is a part of Glaxo Smithkline group of companies (GSK group).

2 Glaxo Smithlkine Pharmaceuticals Limited (GSKPL), an Indian company is also a part of the GSK group. It is listed in the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) in India. The applicant had acquired 600,000 shares in GSKPL in the year It also acquired 1,680,170 shares in Burroughs Wellcome (India) Limited in the year GSKPL and Burroughs Wellcome (India) Limited were merged. In the year 2004, the applicant received in lieu of the shares held by it in Burroughs Wellcome (India) Limited shares in GSKPL. Thus, the holding of the applicant in GSKPL rose to 3,192,238 shares amounting to 3.77 percent of the paid up share capital in GSKPL. The applicant had held the shares of GSKPL as investment so as to benefit from the profits accruing in the long term. It was shown as non-current assets in the books of accounts of the applicant and not as stock in trade. Glaxo Smithlkine (Pte) Limited (GSK Pte) is a company incorporated in Singapore and it is also a part of the GSK Group. It is the Asia Pacific regional office of the GSK group of companies. As a part of reorganisation of the group structure, GSK and the applicant proposes to transfer the shares of GSKPL to GSK Pte. The transfer of 3,192,328 shares in GSKPL by the applicant to GSK Pte, will be for cash consideration at Fair Market Value (FMV). The transfer of shares is proposed off the market and not through a recognised stock exchange, without attracting Securities Transaction Tax (STT). The applicant does not have Permanent Establishment (PE) in India. Further the applicant being a foreign company, not obliged to maintain books of accounts in India as prescribed under the Companies Act, Issues before the AAR Whether the investment held by the applicant in equity shares of GSKPL would be considered as capital asset under Section 2(14) of the Act? If yes, whether capital gains arising from transfer of shares of GSKPL by the applicant to GSK Pte would be subject to tax in India? If the transfer of shares by the applicant to GSK Pte is not taxable, whether the provisions of Section 92 to Section 92F of the Act relating to transfer pricing would be applicable? Whether the sale consideration receivable by the applicant is liable for withholding of tax as per Section 195 of the Act? If the transfer of shares of GSKPL is not taxable in India, whether the applicant is required to file return of income under Section 139 of the Act? If the transfer of shares of GSKPL is taxable in India, when such transfer is not carried out through a recognised stock exchange, whether the applicant will be liable to pay tax on long term capital gains at the rate of 10 percent under Section 112(1) of the Act? Whether the provisions of Section 115JB of the Act are applicable? Applicant s contentions The applicant contended that it had no intention to trade in the shares held and they were held as investments. The transfer of shares of the Indian company would be taxable under Section 45 of the Act. However, as per Article 13(4) of the tax treaty such capital gains are not taxable in India. There is no dispute that the transaction entered is an international transaction under Section 92 of the Act. However, Section 92 of the Act is applicable only to a transaction chargeable to tax under the Act. If the transaction is not chargeable to tax in India in view of Article 13(4) of the tax treaty, Section 92 of the Act does not apply. In order to support its contentions the applicant relied on the AAR rulings in the case of Praxair Pacific Limited 2 and in the case of Vanenburg Group BV 3. Since the income is not taxable in India under the Act, there is no obligation to file a return of income under Section 139 of the Act. Section 115JB is applicable only to domestic companies. Tax department s contentions It is an attempt to avoid the payment of legitimate taxes in India. The whole scheme devised by the group is one for avoidance of capital gains tax in India by taking advantage of the tax treaty. Any scheme to avoid tax should be discountenanced by the AAR, or Court or the Income-tax authorities and in the present case, there is round tripping as well as treaty shopping. 2 Praxair Pacific Limited [2010] 326 ITR 276 (AAR) 3 Vanenburg Group BV v. CIT [2007] 289 ITR 464 (AAR)

3 The applicant has not been properly clarified as to from where the funds proceeded for the acquisition of the shares. The applicant has been brought into existence only for the purpose of taking advantage of the tax treaty, since capital gains is not actually taxed or taxable in Mauritius. On the wording of Section 92 of the Act, the TP provisions will apply. The earlier AAR rulings were related to transactions involved in them and they cannot be treated as precedents to govern all cases. Whatever may be the position emerging out of the tax treaty, the applicant is bound to file a return of income as mandated by Section 139 of the Act. The tax department relying on the earlier ruling of the AAR contended that the MAT provisions are applicable to the facts of the present case. AAR ruling Taxability of capital gain Since the tax department has not argued on the issue of capital asset, the shares held by the applicant would be considered as a capital asset and once it is held to be a capital asset, the proposed sale would qualify to be capital gains under the Act and under the tax treaty. Accordingly, the transfer of shares would fall under Article 13(4) of the tax treaty and it is taxable in Mauritius and not in India. The investments in the shares were made in the years 1993 and 1996 and they had been held for all these years. Though the applicant is a part of the GSK group and could be said to be under the vertical control of Wellcome Limited, UK, the fact remains that it is a legal entity in the eye of law and there is no adequate material to rebut its ownership over the shares. It is not possible to hold that the beneficial owner of the shares is some other entity and the materials produced by the applicant cannot be said to have been discredited. Even if there was a treatyshopping, that has been held to be not taboo as held in Azadi Bachao Andolan 4 Court. by the Supreme Even if it is taken that the Vodafone International Holding B.V. 5 decision of the Supreme Court has indicated that the presumption arising out of a Tax Residency Certificate (TRC) is capable of being rebutted, it cannot be said that the presumption has been rebutted in the present case. Thus, it could not be said that the tax department has established that it is an attempt of tax avoidance. It is not shown that a company holding shares in another company cannot sell the shares otherwise than through the Stock Exchange. Therefore, the argument of the tax department that the proposed sale would involve avoidance of STT cannot be accepted. It is not a case where a so-called gift of shares is proposed, but it is a case of sale of shares. The argument of the tax department that unless the applicant is actually taxed in Mauritius or is liable to be actually taxed on the capital gains that would arise in Mauritius, the tax treaty is attracted since a tax treaty can apply only when there is a actual taxation in two countries cannot be accepted. Though the view was taken by the AAR in the case of Cyril Eugene Pereira 6 that unless there is real double taxation, the tax treaty cannot be invoked, the said view was disapproved by the Supreme Court in the case of Azadi Bachao Andolan. The AAR is bound by the decision of the Supreme Court and if the tax department wants to persist in this line of argument, it has to raise it in the Supreme Court and not before the AAR. As far as a prior ruling of the AAR is concerned, no doubt the AAR should be slow in disagreeing with a proposition of law unrelated to facts, enunciated therein. When the AAR is convinced that a view already expressed may not be correct, it should not deter from expressing itself. If a view different from the one taken earlier is taken, the controversy can obviously be set at rest only by the Supreme Court stepping in and rendering a binding decision. 5 UOI v. Vodafone International Holding B.V. [2012] 19 taxmann.com 217 (SC) 6 Cyril Eugene Pereira, In re [1999] 105 Taxman 273 (AAR) 4 UOI v. Azadi Bachao Andolan [2003] 132 Taxman 373 (SC)

4 Transfer pricing Section 92 of the Act is a machinery provision and it does not indicate that the expression income has to be given a restricted meaning. The word income according to the Concise Oxford English Dictionary means money received, especially on a regular basis, for work or through investments. The definition under the Act does not restrict its meaning. In fact, it expands it by including within it. The tax treaty also does not define the expression income. Whether the gain or income is taxable in India or not, Sections 92 to 92F of the Act would apply if the transaction is coming within those provisions. On an anxious consideration of the purpose for which Sections 92 to 92F of the Act are enacted and on an interpretation of its provisions under the golden rule of construction, the AAR is satisfied that the applicability of Section 92 of the Act does not depend on the chargeability under the Act. In the present case, the capital gains are taxable under the Act. However, in view of the benefit of Article 13(4) of the tax treaty and the ratio of the decision in Azadi Bachao Andolan it was not taxable even if actually there is no double taxation. Therefore, the provisions of Section 92 to 92F of the Act are applicable. Withholding of tax The Supreme Court in the case of GE Technology Centre P. Ltd. 7 held that in cases where there is no chargeability to tax under the provisions of the Act, there will be no obligation to withhold taxes. Therefore, there is no obligation on the applicant to withhold tax in the present case. Income-tax return A taxpayer, who earns income which is taxable under the Act, has to make a claim by invoking Section 90(2) of the Act for getting the benefit of a tax treaty. Even if it would be entitled to seek relief under the tax treaty. The taxpayer has to seek relief and that would be during the consideration of its return of income or while filing its return of income. 7 GE Technology Centre P. Ltd. v. CIT [2010] 327 ITR 456(SC) The obligation under Section 139 of the Act cannot disappear merely because a person may be entitled to claim the benefit of a tax treaty. In terms of Section 90(2) of the Act, it has to be shown that tax treaty benefit is being claimed. The tax treaty benefit has to be shown before the assessing authority and this emphasizes that such a person need to file a return of income to claim such a relief. Therefore, the applicant in the present case needs to file a return of income under Section 139 of the Act. Section 112(1) of the Act Section 112(1) of the Act would be attracted when the income of the taxpayer includes income chargeable under the head capital gains under the Act. In the present case, the income of the applicant would be capital gains and if the income gets taxed under the Act, Section 112(1) of the Act would also be attracted. The scope of Section 48 read with Section 112 of the Act has been dealt in the case of Cairn U.K. Holdings Ltd. 8. The principle of that ruling is applicable in the present case also. Therefore, Section 112 of the Act will be attracted. Section 115JB of the Act The AAR has discussed its own ruling where it has been observed as follows: Section 115JB of the Act does not make a distinction between Indian company and a foreign company. The definition of a company in Section 2(17) of the Act means an Indian company or any company incorporated by or under the laws of a country outside India. There is no lack of clarity or ambiguity in Section 115JB of the Act to warrant the undertaking of an interpretative exercise, by referring to extraneous material to understand the meaning of the Section. If the language is clear and explicit, the Court must give effect to it and the intention of Parliament must be deduced from the language used. 8 Cairn U.K. Holdings Ltd., In re [2011] 12 taxmann.com 266 (AAR)

5 Section 10(38) and Section 115JB of the Act refer to a company and the term company as per definition in the Act, takes in an Indian company and a foreign company. As far as a company is concerned, the proviso exhorts that the income by way of long-term capital gain of a company shall be taken into account in computing the book profit and income-tax payable under Section115JB of the Act. Even though the ruling of the AAR is legally binding only on the parties involved in a particular case, the ruling would have a persuasive value in similar matters before the Indian tax authorities and Courts. Section 115JB of the Act by its wording, overrides Section 10(38) and Section 115JB(1) of the Act, leads to the position that as far as a company is concerned, its total income has to be computed based on its book profit in juxtaposition to the prescription in Section 115JB of the Act. Section 115JB of the Act overrides Section 34 to 48 of the Act. Therefore, by reading Section 115JB of the Act as confined in its operation to domestic companies alone, one may be doing violence to the special scheme of taxation adopted for taxing certain companies. Unless there are compelling reasons no such interpretation is justified and therefore, Section 115JB(1) of the Act would apply to the applicant. Our comments In the present case the AAR has upheld the applicability of India-Mauritius tax treaty. Further, merely because the transaction is not routed through the Stock Exchange and has avoided the payment of STT, cannot be held as tax avoidance. The AAR also observed that the India-Mauritius tax treaty would apply irrespective of liability to actually pay the tax in Mauritius. The AAR also dealt with MAT provisions under Section 115JB of the Act and held that these provisions do not distinguish between an Indian company and a foreign company and therefore such provisions are also applicable to a foreign company. While the ruling of the AAR in connection with applicability of the India-Mauritius tax treaty is in line with Supreme Court decision in Azadi Bachao Andolan case as well as the AAR s own earlier decision, the observations regarding the applicability of the TP and MAT would have far reaching impact.

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