Taxability of gains arising to a Mauritius company on buyback of shares
This recent ruling of the Authority for Advance Rulings (AAR), in the case of A Mauritius, is on the issue of taxability of gains accruing to a Mauritius company on the buyback of shares of A Mauritius. The AAR held that the transaction was a tax avoidance device in view of the fact that the buyback by A Mauritius was in lieu of distribution of dividends.
The buyback transaction was disregarded and treated as the distribution of dividend chargeable to dividend distribution tax (DDT) in India under the Indian Tax Laws (ITL) as well as the India-Mauritius Double Taxation Avoidance Agreement (Mauritius DTA).
Background and facts
A Mauritius is a public limited company incorporated in India. The shareholders of A Mauritius are three foreign companies incorporated in the United States (US Co), in Mauritius (Mau Co) and in Singapore (Sing Co) along with the residual shares being held by the general public.
A Mauritius had declared dividends to its shareholders till 2003 and had, thereafter, accumulated reserves on a year-on-year basis.
A Mauritius had offered to buy back its shares from its shareholders twice, in 2008 and 2010. Only Mau Co had accepted the buyback offer and agreed to transfer its shares to A Mauritius.
In respect of the first buyback in 2008, Mau Co had filed its return of income claiming nil liability and the issue was pending before the Tax Authority. As per the ITL, any amount declared, distributed or paid by a domestic company by way of dividends (interim or otherwise) on or after 1 April 2003 shall be charged to additional income tax on distributed profits i.e., DDT.
A Mauritius sought an advance ruling on the taxability of the gains arising to Mau Co on the second buyback of its shares under the Mauritius DTA and on the tax withholding obligation in terms of the ITL.
Ruling of the AAR
According to the AAR, this transaction was designed primarily to avoid payment of tax in India because:
- A Mauritius had not declared nor paid any dividends to its shareholders after the introduction of DDT in the ITL in 2003 in spite of regularly making profits and there was no proper explanation by A Mauritius for this.
- The buyback offer was accepted only by Mau Co. US Co did not accept the buyback because it would have been taxable in India as capital gains under the US DTA and Sing Co did not accept the buy back because its taxability would have depended on certain conditions being fulfilled under the Singapore DTA. The buyback scheme was, therefore, held to be a colorable device to avoid tax on distributed profits under the ITL and to access certain treaty benefits under the Mauritius DTA. When a transaction is found to be colorable, it is not a transaction in the eyes of the law. Thus, once the transaction is ignored, the arrangement can only be treated as distribution of profits from A Mauritius to Mau Co, which would be taxable in India as ‘dividend’ under the ITL as well as the Mauritius DTA, and subject to tax withholding in India.
In this decision, it appears that anti-abuse principles have been applied on buyback transactions even in the absence of the General Anti-Avoidance Rules (GAAR) in the ITL having come into force.
Payments made to a foreign company (FCo) for conducting a geophysical survey amount to fees for technical services
Background and facts
De Beers, an Indian company, was engaged in the business of prospecting and mining for diamonds and other minerals. It secured reconnaissance permits from certain state governments to carry out geophysical surveys for which it entered into an agreement (Agreement) with FCo, a Netherlands based company.
Under the Agreement, FCo performed the surveys using substantial technical skills, knowledge and expertise and processed high resolution data and generated reports for the purpose of helping De Beers select mineral deposit targets. De Beers did not withhold taxes from the payments made to FCo contending that the payments made did not meet the requirement of ‘make available’ under the India-Netherlands Double Taxation Avoidance Agreement (Netherlands DTA).
The Tax Authority, not accepting De Beers’ contention, treated the payments as fees for technical services (FTS) under both the Indian Tax Laws (ITL) and the Netherlands DTAA and also held that the payments were for the development and transfer of a technical plan or design. On appeal, both the First Appellate Authority and the Tribunal ruled in De Beers’ favor and held that FCo had not imparted any technology to De Beers and, accordingly, the requirement of ‘make available’ was not met.
Additionally, since only raw data was supplied, no technical plan or design can be said to have developed or transferred to De Beers. Aggrieved, the Tax Authority filed an appeal to the HC.
Under the ITL, consideration for rendering of any managerial, technical or consultancy services would amount to FTS. Activities carried out by FCo for De Beers were in the nature of services rendered that were technical in nature.
Therefore, under the ITL, such payments are taxable as FTS. Where the DTA provisions are more beneficial, they will prevail over provisions of the ITL.
The relevant provisions of the Netherlands DTA stipulate that only technical or consultancy services would be FTS if they make available technical knowledge, skill, know-how or processes, or consist of the development and transfer of a technical plan or technical design. In terms of the Agreement with De Beers, FCo had provided data in respect of the survey and there was no transmission of technical knowledge, skill etc. from FCo to De Beers.
Unless the technology is also made available, De Beers is unable to undertake the very same survey independent of FCo. Thus, technical services were rendered by FCo without making available such technology.
Therefore, the technical service provided does not meet the requirement of ‘make available’ under the Netherlands DTA. The Agreement was only for provision of services and not for the supply of a technical design or plan. The protocol to the Netherlands DTA makes it possible to adopt a favorable FTS clause found in other DTAs if, subsequent to the signing of the DTA with Netherlands, India signs a DTA with another country which has a narrower or more restrictive scope of FTS.
Thus, the HC applied the provisions of the India-Singapore DTA, which was signed later, in explaining the ‘make available’ concept.
This decision should, therefore, provide useful guidelines in interpreting the ‘make available’ concept in the context of DTAs. This ruling reiterates the principle that the requirement of ‘make available’ for technical services is met only if the service recipient is enabled to independently apply the technical knowledge, skill in future without the aid of the service provider.
Key International Tax provisions as introduced by Finance Act 2012
Draft guidelines for implementation of GAAR
The Finance Act 2012 (FA 2012) which has now been enacted as law introduced a number of far reaching amendments to the (ITL). One key amendment that raised a number of concerns with investors and the business community related to the implementation of a General Anti-avoidance Rule (GAAR).
Accordingly, the application of the GAAR provisions has been deferred by a year to 1 April 2013. In addition, the Central Board of Direct Taxes (CBDT) set up a committee which has submitted a draft report (Report) on formulating the guidelines for implementing the GAAR.
Main features of the GAAR provisions introduced by FA 2012
The GAAR provisions were introduced to counteract aggressive tax planning. An arrangement entered into by a taxpayer in which one of the main purposes is to obtain a tax benefit and which also satisfies any one of the four tests, would be declared by the Tax Authority as an ‘impermissible avoidance arrangement’(IAA). The four tests are that the arrangement:
- Creates rights and obligations which are not normally created
- Results in misuse or abuse of tax law provisions
- Lacks commercial substance
- Is carried out in a manner which is not normally employed
Changes have recently been made to the provisions such that the primary onus of proving that the arrangement is an IAA now vests with the Tax Authority. In addition, the provisions on advance rulings in the ITL have been amended to permit obtaining a decision or determination from the Authority for Advance Rulings on whether a ‘proposed’ arrangement is an IAA.
Further, the GAAR Approving Panel (earlier envisaged to consist of only revenue officers) will now also include an officer of the Indian Legal Service.
Summary of the contents of the draft Report
It is explained that the GAAR provisions have been introduced to ensure that the correct tax base is not eroded due to aggressive tax planning.
- Where there is no business purpose, other than to obtain tax benefit, GAAR provisions would not allow the tax benefit to be availed of.
- GAAR provisions do not deal with the cases of tax evasion, which are already prohibited under the current provisions of the ITL.
- GAAR is not averse to tax mitigation.
When a foreign institutional investor (FII) chooses not to take any benefit under the treaty and subjects itself to payment of tax in accordance with the domestic laws, GAAR provisions may not apply to such an FII or the nonresident investors of the FII.
GAAR is to be used to support Specific Anti-avoidance Rules (SAAR) and to cover transactions not covered by SAAR.
In the procedure for invoking GAAR, the ITL provisions provide for reference by an Assessing Officer to the Commissioner (CIT) and by the CIT to the Approving Panel. To bring in a consistency of approach, transparency and adherence to principles of natural justice in implementing GAAR, the Committee has recommended a format which may be used while making references. This format requires comments on the existence of tax benefits in an arrangement, the quantum/working of the tax benefits, satisfaction of the tests, reasons for treating the arrangement as an IAA and its consequences.
The Committee has also recommended time lines wherever the statute does not provide specific time limits.
The Committee has provided 21 illustrations to explain what is, and is not, covered by GAAR. What is not covered by GAAR:
- Foreign investor investing in India through a holding company in a low tax jurisdiction wherein the holding company has enough substance in that jurisdiction
- Overseas subsidiary of an Indian company making a business choice of not repatriating dividend to its Indian holding company
- Raising funds through equity mode instead of loan
- Intra-group services rendered by a centralized entity of a multinational group on a cost plus basis
- A case of tax mitigation where a taxpayer takes advantage of a fiscal incentive by complying with the conditions of the tax provisions and by submitting to conditions and economic consequences
- A case of transition of losses on account of merger of a loss-making company into a profit-making company
- A choice between leasing an asset versus purchasing the asset
- Transaction of sale/purchase through stock market transactions
What triggers GAAR:
- Legal ownership of an Indian company’s shares being held by a company in a treaty favorable jurisdiction (TFJ) and beneficial ownership vesting elsewhere.
- Interposition of a company in a TFJ without any substantive commercial substance in that jurisdiction.
- Buyback of shares by an Indian company from a shareholder in TFJ when Indian company has accumulated profits without declaring dividends.
- Assignment of a loan given to an Indian company borrowed from a bank situated in a non-treaty favorable jurisdiction to an assignee who then benefits from a nil withholding under a treaty.
- Controlling and executing a transaction in India but recording it in the books of a subsidiary situated in a tax exempt jurisdiction.
- Splitting a sale transaction into many to take the benefit of the exemption condition of the treaty.
- Diversion of production from a unit in non-eligible area to an eligible unit which does packaging to gain the benefits of tax-exempt unit.
- Circular leasing of an asset to gain tax benefit without change in economic substance.
- Transactions in shares between related parties which result into loss or parties coming together to adjust profit and loss between themselves.
- Remuneration to employee in the form of redemption premium on preference shares.
Furthermore, to provide relief to small taxpayers, the Committee has also recommended providing for a monetary threshold.
However, the illustrations in themselves do not appear to satisfactorily address the concerns of all taxpayers. It may be noted that the recommendations are not binding on the CBDT. More activity on this front is expected in the future until the GAAR guidelines are actually finalized.
The concessional capital gains tax rate of 10% on long term capital gains arising from the transfer of unlisted securities will apply to all nonresidents.
Withholding tax on interest on External Commercial Borrowings (ECBs)
Lower withholding rate of 5% proposed by Finance Bill 2012 has now been extended to all businesses. Furthermore, the lower rate would also apply on funds raised by way of issue of long term infrastructure bonds from a source outside India.