Delhi ITAT rules on principal purpose test

In the facts of this case, Taxpayer (SC Lowy P.I. (LUX) S.A.R.L, Luxembourg^[1] ) was set up as an LLC in Luxembourg in March 2015 and was registered as a Category II – Foreign Portfolio Investor (FPI) with Securities and Exchange Board of India (SEBI) and earned income from its investments in various securities in India (alternate investment funds, bonds issued by Indian company and pass-through certificates issued by securitization trusts). 

The Taxpayer’s shares were held by two Cayman feeder funds which pooled money from investors globally. 

The Taxpayer claimed tax treaty benefit in respect of interest, capital gains and business income earned from its Indian investments under India-Luxembourg (I-L) tax treaty (tax treaty) which was denied by the tax authority. During assessment proceedings, the Taxpayer submitted Articles of Association, Tax Residency Certificate (TRC), SEBI registration certificates and return of income filed in Luxembourg for the years 2015 to 2019 etc.

The Tax Authority denied I-L tax treaty benefits to the Taxpayer on the ground that the said arrangement is for the purpose of avoidance of tax through treaty shopping as the Taxpayer is just a conduit company and the real owners are the investors from Cayman Islands. The Tax Authority further noted that TRC is not a sufficient proof to establish tax residency and there is no commercial rationale for establishing the Taxpayer company in Luxembourg. The Tax Authority also contended that the Taxpayer is not the beneficial owner of income as the control of fund was not with it. Further, the Delhi High Court (HC) decision in the case of Tiger Global International Holdings^[2]  which granted treaty benefit is related to the India-Mauritius tax treaty and, thus, is distinguishable and not applicable to the given facts.

The issue before the Delhi Income Tax Appellate Tribunal (ITAT) was whether Taxpayer is eligible to claim treaty benefits. 

The Delhi ITAT evaluated principal purpose test (PPT) clause of I-L tax treaty (i.e. Article 29) as amended by Multilateral Instrument (MLI) and observed that it requires to bring on record the relevant facts and circumstances to prove that principal purpose of arrangements and transactions are only for the purpose of availing tax treaty benefit. Relying on the Delhi HC ruling in case of Tiger Global (supra), the ITAT held that the Taxpayer satisfies the PPT and, thus, is eligible for treaty benefit on account of following reasons:

• The Taxpayer was established in Luxembourg in 2015 as an investment holding company and continues to exist and hold several investments till date.
• The Taxpayer submitted valid TRC and the revenue did not raise any red flag on the validity of the TRC.
• It was incorporated in Luxembourg in year 2015 as an investment holding company and invested mainly in distressed assets across various jurisdictions including India, which shows that the Taxpayer has existence beyond the source country (i.e. India).
• It filed tax returns in Luxembourg and paid taxes on its global income, i.e. income earned from investments made in India and in different jurisdictions.
• It incurred substantial operational expenditure relating to investments in Luxembourg like consulting fees, legal fees, other professional fees, other administrative expenses such as rent paid for office premises, bank charges, accounting fees, etc.
• It is stand-alone entity and does not depend on the conduct of the holding company.
• It is not a conduit company as it holds substantial investments and controls the assets as well as income on its own.
• The tax authority was not able to bring on record any other conditions to deny the benefit under the tax treaty.

Consequently, the ITAT granted I-L tax treaty relief on all incomes as claimed by the Taxpayer which was denied by the tax authority on the basis of non-eligibility of availing tax treaty benefit. The ITAT also held that the tax authority cannot recharacterize the business income earned by the Taxpayer from securitization trust as interest income and in the absence of PE, such business income is not taxable in India as per Article 7 of the tax treaty.

^[1] ITA No.3568/DEL/2023, AY: 2021-22, order dated 30 December 2024
^[2] [W.P.(C) 6764/2020]