Section 2(22) of the Act, Article 13 of India Mauritius DTAA – Buyback at artificially inflated price would qualify as a colorable device for avoiding tax; consideration in excess of fair market price of the shares could be deemed as dividend

6. 
TS-110-ITAT-2017(Bang)

Fidelity Business Services India Pvt. Ltd. v. ACIT

A.Y. 2011-12, Date of Order: 22^nd February, 2017

Facts

The Taxpayer was an Indian company and a wholly-owned
subsidiary of a Mauritius company (FCo). While FCo held 99.99% of shares in the
Taxpayer, a nominee held the balance shares on behalf of FCo.

During the relevant year, the Taxpayer undertook buyback of
its shares from FCo at price which was substantially higher than the face value
of the shares. FCo treated the income from such buyback as capital gains. In
terms of Article 13(4) of India-Mauritius DTAA, FCo claimed that capital gains
were not chargeable to tax in India.

The AO noted that FCo held 99.99% of shares of the Taxpayer.
Hence, the entire reserves and surplus were distributable only to FCo. The AO
concluded that FCo and the Taxpayer adopted buyback route to distribute
reserves and surplus to FCo as distribution of dividend would have entailed
dividend distribution tax. Accordingly, the AO held buyback as a colorable
device and reclassified the difference between the face value of the shares and
the amount distributed to FCo as deemed dividend u/s. 2(22)(d) of the Act.

The Taxpayer contended that:

– “buyback” is specifically excluded from the
definition of “dividend” under the Act;

–  prior to amendment of section 115QA with
effect from 1^st June 2013 distribution by way of buyback was not
subject to tax;

–  Circular No. 3 of 2016 dated 26 February 2016
(2016 Circular) has clarified that buyback consideration between the period 1^st
April 2000 and 1^st June 2013 would be treated as capital gains
and not as deemed dividend; and

–   even if the transaction was undertaken with
the objective of avoiding taxes, the same cannot be disregarded, unless the Act
vests such power in the tax authority¹.

The DRP
upheld the draft order of the AO. 

Held

– Section 2(22)(iv) specifically excludes
buyback consideration from the ambit of “dividend”. Further, tax on buyback is
applicable only from 1^st June 2013. The 2016 Circular also clarifies
that buyback consideration between 1^st April 2000 and 1^st June
2013 should be taxed as capital gains.

–  To the extent of buyback undertaken at fair
market price (FMP), consideration would be treated as capital gains u/s. 46A.
Hence, in terms of India-Mauritius DTAA, it would not have been chargeable to
tax in India. However, a buyback undertaken at artificially inflated and
unrealistic price which does not represent FMP, would be considered as
colourable device particularly where the shareholder holds 99.99% of the share
capital.