By Geeta Jani | Dhishat B. Mehta
Chartered Accountants
21 [2019] 112
taxmann.com 119 (Mum.)(Trib.) JCIT vs. Merrill
Lynch Capital Market Espana SA SV ITA No. 6109 (Mum.)
of 2018 A.Y.: 2013-14 Date of order: 11th
October, 2019
Articles 7, 14 and
23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or
14 (though not taxable under those Articles), Article 23 is not applicable
Article 14 of
India-Spain DTAA – Merely because companies are engaged in real estate
development, it could not be concluded that their assets ‘principally’ consist
of immovable properties; therefore, capital gain earned on sale of shares of
such companies not taxable under Article 14
FACTS I
The assessee was a
company incorporated in, and tax resident of, Spain. It was registered as a
Foreign Institutional Investor (FII) in India. During the relevant year, the
assessee had undertaken certain transactions to hedge its exposure in foreign
exchange on Indian investments and earned gains therefrom.
During the course
of assessment proceedings, the A.O. noticed that the assessee had earned gain
from hedging which it had claimed was exempt under Article 14 of the
India-Spain DTAA. The A.O. observed that being an investor, the assessee could
not carry on any business activity. Accordingly, the A.O. held that the receipt
was in the nature of other income, which was taxable in India in terms of
Article 23(3) of the India-Spain DTAA.
In appeal, the
CIT(A) followed the orders of his predecessors in the assessee’s own case.
Further, the CIT(A) also relied on the decision in Citicorp Banking
Corpn., Bahrain vs. ACIT (IT Appeal No. 6625/{Mum.} of [2009]). Accordingly,
the CIT(A) observed that hedging contracts had nexus with the investment in
India because forex transactions were to hedge investment in securities. Hence,
gains from hedging were capital gains. As investment income of the FII was not
taxable in India in terms of Article 14(6) of the India-Spain DTAA, gains from
hedging were also not taxable in India.
HELD I
- Article 23 comes into play
only if an item of income is ‘not expressly dealt with’ in the preceding
articles (i.e. Articles 6 to 22) of the DTAA. The Revenue has not contended
that as the gains are not covered by Article 7 (Business Income) or Article 14
(Capital Gain), they should be taxable under Article 23 (Other Income) which
gives residuary taxation rights to source jurisdiction.
- Income cannot be brought
within the ambit of Article 23 only because it cannot be taxed as the
conditions for taxability in source jurisdiction were not fulfilled. However,
income which is otherwise not covered under Articles 6 to 22 (such as alimony,
income from chance, lottery or gambling, rent paid by resident of a contracting
state for the use of an immovable property in a third state, and damages which
do not pertain to loss of income covered by Articles 6 to 22, etc.) only will be
covered by Article 23.
- Income from gains from
hedging was covered by Article 7 or Article 14. It was taxable if conditions
were satisfied. Hence, Article 23 would not have any application.
- If hedging contracts were
entered into in the course of business, notwithstanding regulatory
permissibility, such contracts could either be revenue or capital in nature.
- If gains were capital in
nature, they will be capital gains and would be subject to Article 14 of the
India-Spain DTAA. A perusal of Article 14(1) to 14(5) shows that none of the
clauses could be invoked. Accordingly, in terms of Article 14(6), the gains
were not taxable in source jurisdiction.
- If gains were revenue in
nature, they will be business profits and would be subject to Article 7. They could
be taxed in source jurisdiction only if the assessee has a PE in India. Article
7 of the India-Spain DTAA merely mentions ‘profits of an enterprise’. The A.O.
has mentioned that ‘as an investor, the assessee cannot carry out any business
activity’ and, therefore, it cannot be said to be a business activity. However,
Article 7 does not even remotely suggest compliance with regulatory conditions
for qualifying under the DTAA. Whether with regulatory approval or without
regulatory approval, and whether legal or illegal, business profits are taxable
nevertheless.
- Even if these were not
hedging contracts but the assessee was dealing in forward exchange contracts simplicter,
by itself it could not make gains taxable under Article 7 if the assessee did
not have a PE in India, or under Article 14 if the gains were not covered in
Article 14(1) to 14(5). Merely because gains though covered under Article 7 or
14 but not taxable, would not be covered by Article 23. Hence, gains from
hedging could not be taxed as non-business income.
- Accordingly, the assessee
was not liable to tax on gains under the India-Spain DTAA.
FACTS II
The assessee had invested in shares of certain companies engaged in
development of real estate. Shares of these companies were listed on the stock
exchange (and the taxpayer held them as portfolio investment such that the
holding in each company was less than 7%). During the relevant year, the
assessee earned capital gains on sale of these shares. In India, such gain
could be taxed in terms of the India-Spain DTAA only if the property of such
company, directly or indirectly, consisted of immoveable properties in India
and the shares of such company derived their value principally from such
immovable properties.
The A.O. observed that these companies were in the real estate sector,
including development of residential and commercial properties, and further,
the value of the shares of the companies was derived from the value of
immovable properties held by them.
Accordingly, the A.O. concluded that capital gain on the sale of their
shares was taxable in India under Article 14(4) of the India-Spain DTAA.
In appeal, the
CIT(A) observed that the assessee had minuscule shareholding which could not
have given any right, either in stock-in-trade of those companies, or to occupy
immovable properties of those companies. The CIT(A) further observed that
Article 14(4) was meant to cover cases of indirect transfer of immovable
properties through transfer of shares of companies holding properties. It would
not cover cases where commercial investments were made in shares of companies
engaged in the real estate sector. Hence, the CIT(A) held that gains on the
sale of shares were not taxable in India in terms of Article 14(6) of the
India-Spain DTAA.
HELD II
- The assessee had sold no
more than 2% shares in any of the six realty companies. It did not hold any
controlling interest or even significant interest in these companies which
could provide any right to occupy properties. All the companies were engaged in
the business of real estate development and not in holding of real estate per
se.
- Under Article 14(1), gains
from immovable property may be taxed in source state. The purpose of Article
14(4) is to cover gains from shares of a company holding immovable property
which would not have been covered in Article 14(1).
- The India-Spain DTAA does
not specifically define the expression ‘principally’. From clarifications in
model convention commentaries, in the absence of anything to suggest a
different intention, the threshold test should be 50% of total assets. Only
such companies where holding of immovable property directly or indirectly
comprises at least 50% of aggregate assets are covered.
- Merely because a company is
engaged in real estate development it would not imply that over 50% of its
aggregate assets consist of immovable properties. Apparently, the A.O. has
presumed that just because these companies are dealing in real estate
development the assets of these companies ‘principally’ consist of immovable
properties.
- Accordingly, the CIT(A) had
correctly held that cases where commercial investments were made in shares of
companies engaged in the real estate sector were not covered. Hence, gains on
sale of shares were not taxable in India in terms of Article 14(6) of the
India-Spain DTAA.
