Part-III
(Continued from last month)
VIH’s obligation to withhold tax — Section 195
3.14 As stated in Part II of this write-up, the Apex Court held that the capital gain in question is not chargeable to tax u/s.9(1)(i) of the Act and as such, question of deduction of TAS does not arise.
3.15 While deciding the issue relating to withholding tax obligation of VIH, the Court analysed the provisions of section 195 and the implications thereof and made certain observations such as: if, in law, the responsibility for payment is on a Non-Resident (NR), the fact that the payment was made under the instructions of NR to its agent/ nominee in India or its PE/Branch Office, will not absolve the Payer of his liability to deduct Tax At Source (TAS) u/s.195; the liability to deduct TAS is different from the assessment under the Act, etc. The Court then took a view that in the present case the transaction is of ‘outright sale’ between two NRs of a capital asset (share) situated outside India and the transaction was entered into on a principal-to-principal basis. Therefore, no liability to deduct TAS arose.
3.15.1 On the issue of withholding tax obligation of VIH, the Court effectively held that since the capital gain arising on transfer of share of CGP is not chargeable to tax in India, question of deduction of TAS u/s.195 does not arise. The Court also further stated that Tax Presence has to be viewed in the context of the transaction that is subjected to tax and not with reference to an entirely unrelated matter. The Tax Presence must be construed in the context, and in a manner that brings the NR assessee under the jurisdiction of the Indian Tax Authorities. The investment made by VG Companies in Bharati did not make all the entities of that group subject to the Indian Income Tax Act and the jurisdiction of the tax authority. The Court also noted that in the present case, the Revenue has failed to establish any connection with section 9(1)(i). Under these circumstances, the Court concluded that section 195 is not applicable.
3.15.2 Even the concurring judgment concludes that there was no obligation on the part of VIH to withhold tax. However, this judgment has gone a step further and considered the issue of applicability of section 195 extra-territorially. After considering the hosts of statutory compliance requirements for a tax deductor, apart from deducting tax and paying to the Government, other provisions relating deduction of TAS, such as 194A, 194C, 194J, etc. and the normal presumption of applicability of the provisions of Indian law to its own territory, this judgment took the view that section 195 is intended to cover only Resident Payers who have presence in India. The tax presence has to be considered in the context of the transaction that is subject to tax and not with reference to entirely unrelated matter. Finally, this judgment interpreted the expression ‘any person responsible for paying’ to mean only person resident in India and accordingly, took a view that section 195 “would apply only if payments made from a resident to another non-resident and not between two non-residents situated outside India”.
Applicability of section 163
3.16 In view of the fact that the transaction relates to transfer of capital asset situated outside India between two NR’s, both the judgments took a view that the VIH cannot be considered as representative assessee for HTIL u/s.163.
Mauritius Tax Treaty
3.17 Since the issue before the Court did not invoke the application of treaty, the majority judgment has not specifically dealt with the impact of Mauritius Tax Treaty in the case under consideration. However, the concurring judgment specifically dealt with the Mauritius Tax Treaty and in that judgment certain observations have also been made in that context after referring to the judgments of the Apex Court in the case of Azadi Bachao Andolan (supra).
3.17.1 In this judgment, principles laid down in the case of Azadi Bachao Andolan (supra) governing the application of Mauritius Tax Treaty have been reiterated. Accordingly, it is held that in the absence of Limitation of Benefit (LOB) Clause and in the presence of the Circular No. 789, dated 13-4-2000 and the TRC, the Tax Department cannot deny the benefit of Mauritius Tax Treaty to Mauritius companies, on the ground that: principal company (foreign parent) is resident of a third country; or all the funds were received by the Mauritius company from a foreign parent; or the Mauritius subsidiary is controlled/managed by the principle company; or the Mauritius company had no assets or business other than holding the investments/shares in Indian company; or the foreign principal of the Mauritius company had played a dominant role in deciding the time and price of the disinvestment/sale/transfer; or the receipt of sale proceeds by the Mauritius company was ultimately remitted to the foreign principal, etc. Setting-up of a WOS in Mauritius for substantially long-term FDI in India through Mauritius, pursuant to Mauritius Tax Treaty, can never be considered to be set up for tax evasion.
3.17.2 According to this judgment, the LOB and look through provisions cannot be read into Mauritius Tax Treaty. However, the question may arise as to whether the TRC is so conclusive that the Tax Department cannot pierce the veil and look at the substance of the transaction. In this context, the judgment further observed as under (page 102):
“. . . . . DTAA and Circular No. 789, dated 13-4-2000, in our view, would not preclude the Income-tax Department from denying the tax treaty benefits, if it is established, on facts, that the Mauritius company has been interposed as the owner of the shares in India, at the time of disposal of the shares to a third party, solely with a view to avoid tax without any commercial substance. Tax Department, in such a situation, notwithstanding the fact that the Mauritian company is required to be treated as the beneficial owner of the shares under Circular No. 789 and the Treaty is entitled to look at the entire transaction of sale as a whole and if it is established that the Mauritian company has been interposed as a device, it is open to the Tax Department to discard the device and take into consideration the real transaction between the parties, and the transaction may be subjected to tax. In other words, TRC does not prevent enquiry into a tax fraud, for example, where an OCB is used by an Indian resident for round-tripping or any other illegal activities, nothing prevents the Revenue from looking into special agreements, contracts or arrangements made or effected by Indian resident or the role of the OCB in the entire transaction.”
3.17.3 Referring to the issue of round tripping, based on the reports which are afloat that millions of rupees go out of the country only to be returned as FDI or FII, it is stated that round tripping can take many formats like under-invoicing and over-invoicing of exports and imports. It also involves getting the money out of India, say, Mauritius, and then bring back to India by way of FDI or FII in Indian company. With the idea of tax evasion, one can also incorporate a company off-shore, say, in a Tax Haven, and then create WOS in Mauritius and after obtaining a TRC may invest in India. Large amounts, therefore, can be routed back to India using TRC as a defence. If it is established that such an investment is black money or capital that is hidden, it is nothing but circular movement of capital known as round tripping; then TRC can be ignored, since the transaction is fraudulent and against the national interest.
3.17.4 Accordingly, in view of the above, the concurring judgment takes further view that though the TRC can be accepted as a conclusive evidence for accepting status of residence as well as beneficial ownership for applying the Mauritius Tax Treaty, it can be ignored if the treaty is abused for the fraudulent purpose of evasion of tax.
Conclusion
In view of the above judgment of the Apex Court the following principles governing tax implications of an offshore transaction of transfer of share between two NRs may emerge or get re-iterated:
4. Section 9(1)(i) of the Act is not a ‘look through’ provision to include the transfer of shares of a foreign company holding shares in an Indian company by treating such transfer as equivalent to transfer of shares of an Indian company on the premise that section 9(1)(i) covers direct and indirect transfer of capital asset. Accordingly, section 9(1)(i) does not cover indirect transfer of capital asset situated in India.
4.1 Section 195(1) is attracted only if the sum in question is chargeable to tax. According to the concurring judgment, in case of a NR Payer, the obligation of withholding tax u/s.195(1) does not arise if NR Payer does not have any tax presence whatsoever in India. For this, support can also be drawn from the observations made in the majority judgment. However, there is no clarity as to the meaning of tax presence in India. It seems that if the entity has tax presence in India that should suffice. If the entity has permanent establishment or branch office, etc. in India, it is desirable to treat the entity as having tax presence in India.
4.1.1 In the concurring judgment, a view is taken that section 195(1) applies only in cases where Resident makes a payment to NR and the same is not applicable to payments between two NRs outside India. This view may have a great persuasive value for the lower authorities/courts. However, it seems advisable not to take recourse to this view to avoid deduction of TAS. This could, of course, be a good defence in case of a default.
4.2 In view of the fact that the transfer in question in the above case was of a capital asset situated outside India, the NR Payer (VIH) was also not to be treated as representative assessee u/s. 163 of the Act.
4.3 There is no conflict between the judgments of the Apex Court in the case of McDowell & Company Ltd. (supra) and the judgment in the case of Azadi Bachao Andolan (supra). In this context, the Court has further held that to decide the issue relating to allegation of tax avoidance/evasion, it is the task of the Court to ascertain the legal nature of the transaction and while doing so, it has to look at the entire transaction as a whole and not to adopt dissecting approach.
4.3.1 In the above context, referring to the majority judgment in the McDowell’s case, the Court reiterated the principle that tax planning may be legitimate provided it is within the frame work of law and it should not be a colourable device.
4.4 Carrying on business by a large business group through subsidiaries under the control of a Holding Company (HC) is a normal method of carrying on business. Setting up of such subsidiaries, even in low-tax jurisdiction, by itself should not be regarded as a device.
4.4.1 Such holding structures give rise to tax issues such as double taxation, tax deferrals, tax avoidance, implication of GAAR, etc. In the absence of an appropriate provision in the statute/treaty regarding the circumstances in which judicial GAAR would apply, when it comes to taxation of a holding structure, at the threshold, the burden is on the Revenue to establish the abuse, in the sense of tax avoidance in the creation and/or use of such structure. For this, the Revenue must apply look at test and the Revenue cannot start with the question as to whether the impugned transaction is a tax deferment/ savings device but it should apply the look at test to ascertain its legal nature.
4.4.2 Holding company, as a shareholder, will have influence on its subsidiaries and in that sense, will be in a persuasive position. However, that cannot reduce the subsidiary or its directors’ puppets. The power of persuasion cannot be construed as a right in legal sense. The decisive criteria is whether the parent company’s management has such steering interference with the subsidiaries core activities that subsidiary can no longer be regarded to perform its activities on the authority of its own directors. The concept of ‘de facto’ control, in genuine cases, conveys a state of being in control without any legal right to such a state.
4.4.3 A case of FDI should be seen in a holistic manner and while doing so, various factors enumerated by the Court should be taken into account. Cases of participative investment should not be construed as tax avoidant/device.
4.5 In transactions of divestment of investment of this type, it becomes necessary for the parties to enter into SPA for various commercial reasons and for recording various terms and to give smooth effect to the transaction.
4.6 When the structure is held to be a device/ tax avoidant on the basis of various tests referred to in para 3.5 of Part II of this write-up, the Revenue would be entitled to ignore this structure and tax the actual entity and to re-characterise the transaction appropriately for that purpose.
4.7 For the purpose of entering into any such transaction efficiently, if more than one routes are available, then it is open to the parties to opt for any one of those routes available to them.
4.8 Under such arrangement, call options to acquire shares of a company cannot be equated with interest in share capital of that company. The legal understanding as to acquisition of shares in Indian company for the purpose of compliance with FDI norms and the commercial understanding of the parties in that respect with regard to the transactions could be different.
4.9 In case of transactions involving the transfer of shares lock, stock and barrel for a lump-sum consideration, the same cannot be broken up into separate individual components or rights, such as right to vote, management rights, controlling rights, etc.
The above principles are, now, subject to the follow-ing proposals contained in the Finance Bill, 2012 and accordingly, the same will have to be read with the final amendments which are expected to be carried out by the Finance Act, 2012.
5. In the Finance Bill, 2012, stated clarificatory amendments are proposed in various sections such as: Section 2(14) (to clarify that property includes any rights in or in relation to Indian company, including rights of management, control, etc.), section 2(47) (extending the scope of the definition of the term ‘transfer’ to include disposing of or parting with an asset or any interest therein, or creating an interest in any asset in any manner whatsoever, directly or indirectly, etc. even if, transfer of such rights has been characterised as being effected or dependent upon or flowing from transfer of shares of a foreign company) and section 9(1) to effectively provide that the section is a ‘look through’ provision and also to provide that an asset or capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India if it derives, directly or indirectly, its value substantially from the assets located in India. These amendments are proposed with retrospective effect from 1st April, 1962. These amendments are intended to effectively nullify all the major effects (favourable to the taxpayers) of the judgment of the Apex Court in the above case. Some of these proposals, if enacted in the present form, will also have far-reaching other implications and the same will not necessarily confine to only offshore transactions.
Considering the nature of above proposed amendments and their far-reaching unreasonable consequences and effects, it is difficult to digest that these amendments are clarificatory in nature as claimed by the Government. If the amendments are carried out in the present form, it is likely that the validity of the retrospective effect thereof may come up for questioning. In the past, the Parliament’s power to make retrospective law has been upheld. However, the manner in which these amendments are proposed is matter of serious concern and will have a far-reaching long-term implications in Indian tax jurisprudence. Therefore, we will have to wait and watch as to how this complex constitutional issue gets further developed. But one thing is certain that such an approach of the Government is highly unfair and also raises a question about the respect for rule of law in the tax matters.
5.1 Similarly retrospective amendment is also proposed in section 195 to effectively provide that all persons, including all NRs, will be under an obligation to comply with the requirements of section 195(1). For this purpose, whether the NR has a residence or place of business or business connection in India or any other presence in any manner whatsoever in India or not will not be relevant. Even this amendment, is proposed with retrospective effect from 1st April 1962. One may wonder whether any retrospective amendment of this kind can be made in the provisions dealing with TDS creating an obligation on the ‘person’ to deduct TAS with retrospective effect. The validity of the retrospective provision of this kind could be open to question. Even the validity of prospective operation of the applicability of this provision to NR having no presence whatsoever in India may come up for questioning and will have to be tested on the basis of the principles laid down by the Constitution Bench of the Apex Court in the case of GVK Ind. Ltd. (332 ITR 130). This judgment was analysed by us in this column in the June and July, 2011 issues of this Journal.
5.2 The Finance Bill, 2012 also proposes to introduce set of provisions dealing with the General Anti- Avoidance Rules (GAAR) w.e.f. 1-4-2013. These provisions, inter alia, specifically provide that the period for which the arrangement exists, the fact of payment of taxes, directly or indirectly, under the arrangement in question and the fact that exit route is provided by the arrangement shall not be taken into account for determining whether an arrangement lacks commercial substance or not. It may be noted that this provision was not made in the GAAR proposed in the Direct Tax Code Bill, 2010 (DTC).
The above-referred tests are part of the tests (referred to in para 3.5 of Part II of this write-up) considered by the Apex Court for determining the genuineness of the arrangement of the Hutchison Group in Vodafone’s case to conclude that the arrangement was having commercial substance.
5.3 The introduction of the GAAR provisions will also have a practical impact on the effect and implications of Mauritius Tax Treaty (and, of course, also other such Tax Treaties) and therefore, many of the observations made in the concurring judgment in the above case in that respect will have to be read with the GAAR provisions. It may also be noted that the applicability of the proposed GAAR provisions is not restricted only to offshore transactions, but the same will also apply to all other transactions including domestic transactions. Considering the wide discretionary powers sought to be granted to the assessing authorities, these provisions may also create enormous amount of unintended hardships at the implementation level.
The unrestricted and highly discretionary unguided powers sought to be given to the Government under the provisions relating to GAAR has raised quite a few genuine issues of far-reaching implications and such excess delegation of effectively unguided powers may come up for judicial scrutiny if, such provisions are enacted in the present form.
Vodafone – Part III
5.4 In the context of the manner in which retrospective amendments are proposed in the Finance Bill, 2012 the following observations of the learned authors of the book ‘Nani Palkhivala, The Courtroom Genius’ are worth mentioning:
“……….There is complete absence of any fair-play in the administration of tax laws. If a decision of the court or the tribunal is in favour of the assessee, the relevant statutory provision is promptly amended retrospectively with very little regard for the enormous hardship that it causes to the assessee. One can only conclude with the last passage of the last preface written by Palkhivala:
‘Every Government has a right to levy taxes. But no Government has the right, in the process of extracting tax, to cause misery and harassment to the taxpayer and the gnawing feeling that he is made the victim of the palpable injustice’.”
(Concluded)
