India-Mauritius treaty benefits cannot be denied on the ground that assessee is a subsidiary of a USA Corp
The applicant, a resident of Mauritius, was a subsidiary of a USA company. It received capital contribution and loans from the USA parent which were used to purchase shares in ILFS, an Indian company. On sale of the shares, the applicant earned capital gains which were chargeable to tax under the Act. However, under Article 13 (4) of the India-Mauritius tax treaty, such gains were not chargeable to tax in India. The applicant filed an application for advance ruling on the question whether in view of the said Article 13 (4), the gains were chargeable to tax in India. The department resisted the application on the ground that though the legal ownership ostensibly vested with the applicant, the real and beneficial owner of the capital gains was the US Company which controlled the applicant and the applicant was merely a façade made use of by the US holding Company to avoid capital gains tax in India. HELD rejecting the stand of the department:
(i) The effect of Azadi Bachao Andolan 263 ITR 706 (SC) is that there is no “legal taboo” against ‘treaty shopping’. Treaty shopping and the underlying objective of tax avoidance/mitigation are not equated to a colourable device. If a resident of a third country, in order to take advantage of a tax treaty sets up a conduit entity, the legal transactions entered into by that conduit entity cannot be declared invalid. The motive behind setting up such conduit companies is not material to judge the legality or validity of the transactions. The principle that “every man is entitled to order his affairs so that the tax is less than it otherwise would be” is applicable though a colourable device adopted through dishonest methods can be looked into in judging a legal transaction from the tax angle. Tax avoidance is not objectionable if it is within the framework of law and not prohibited by law. However, a transaction which is ‘sham’ in the sense that “the documents are not bona fide in order to intend to be acted upon but are only used as a cloak to conceal a different transaction” stands on a different footing. For an act to be a ‘sham’, the parties thereto must have a common intention not to create the legal rights and obligations which they give the appearance of creating;
(ii) On facts, as all legal formalities for purchase of the shares and their subsequent transfer had been gone through and the consideration had been received by the applicant, it was difficult to assume that the capital gain has not arisen in the hands of the applicant but had arisen in the hands of the USA parent;
(iii) The fact that the USA parent provided the funds and played a role in negotiating the transaction of sale does not lead to the legal inference that the shares were in reality owned by the USA parent. To take such a view would be contrary to the ground realities of mutual business and economic relations between a holding and subsidiary company and the inter-se legal structure. The fact that the subsidiary has its own corporate personality and is a separate legal entity cannot be overlooked. The fact that the holding company exercises acts of control over its subsidiary does not in the absence of compelling reasons dilute the separate legal identity of the subsidiary. It is unrealistic to expect that a subsidiary should keep off the clutches of the holding company and conduct its business independent of any control and assistance by the parent company;
(iv) Consequently, the gains made by the Applicant were not chargeable to tax in India.
Obiter: It looks odd that the Indian tax authorities are not in a position to levy capital gains tax on the transfer of shares in an Indian company. Whether the policy considerations underlying Article 13 (4) of the treaty and the spirit of the CBDT Circular would still be relevant in the present day fiscal scenario is a debatable point.