Reimbursement of Interest to Parent Company--No Tax withholding u/s 194A

IN THE INCOME TAX APPELLATE TRIBUNAL

BENCH 'C' MUMBAI

ONWARD E-SERVICES LTD Vs ASSTT COMMISSIONER OF INCOME TAX

Sections 40(a)(ia), 194A – Whether when the assessee reimburses interest payments to parent company for availing loans under its borrowing facility given by the bank, any TDS obligation arises u/s 194A  (2012-TIOL-276-ITAT-MUM)

A) The assessee company is engaged in the business of software development, trading of software and hardware and allied software and hardware services. The assessee had taken over a banking division of its parent company i.e. M/s. Onward Technologies Ltd. (OTL). In view of the taking over of the banking division the assessee had to share the interest cost burden of M/s OTL, based on the funds utilised as the parent company was enjoying borrowing facilities from the bank for its group companies. The assessee filed the return of income for the A.Y. 2005-06 declaring total income of Rs. ‘Nil’. It was noticed by the A.O. that the assessee had credited an amount of Rs.1,41,12,002/- in account of it’s parent company namely ‘M/s OTL’ towards the interest payment.

In the opinion of the A.O. the assessee should have deducted tax at source as per the provisions of sec.194A of the Act. The A.O. sought the explanation of the assessee why the whole interest payment of Rs.1,41,12,002/- made to M/s. ‘OTL’ should not be disallowed u/s.40(a)(ia) of the Act as no tax was deducted at source. The assessee filed the explanation before the A.O. stating that the assessee was wholly owned subsidiary of M/s. ‘OTL’. There were various facilities, which were commonly shared between the parent and the assessee company. Most of the facilities were normally in the name of parent company i.e. ‘OTL’, hence, at the first instance parent company incurred the expenses and it reimbursed the appropriate share of expenses from assessee depending on the uses of the company. It was stated that as a part of the arrangement, parent company (‘OTL’) enjoyed certain borrowings facilities from the bank. Out of borrowings from the bank, funds were transferred to the assessee-company and for use of the said funds the assessee’s parent company (‘OTL’) reimbursed its share of cost of funds utilised. The assessee also contended that the reimbursement of the cost was on actual basis both in terms of uses as well as cost thereof and no income was earned by the parent company (‘OTL’) out of reimbursement of the interest from the assessee. The assessee also demonstrated how the entries were passed in its books of account debiting the interest account and crediting the OTL’s account and in the final entries interest account was carried to the profit and loss account. The assessee also stated that in the case of the parent company i.e. OTL; amount of interest reimbursed from the assessee company was reduced from the interest paid to the bank and net amount of the interest paid was taken to the profit & loss account. The assessee also contended that as the interest payment by the assessee was only towards the reimbursement of the cost to the parent company and no income was earned by the parent company, hence, there was no obligation on the assessee to deduct the tax at source u/s.194A of the Act.

In the opinion of the AO the assessee should have deducted tax at source u/s.194A of the Act from amount paid/credited to M/S. OTL. He invoked the provisions of sec.40(a)(ia) of the Act and disallowed the entire interest payment of Rs.1,41,12,002/- and made the addition to the total income of the assessee. The CIT(A) upheld the additions made. In the opinion of the CIT (A) whatever was received by the parent company i.e. ‘OTL’ it was nothing but income on account of interest.

On appeal, the Tribunal held that,

A) ++ as per the language used by the Parliament in section 194A, what is contemplated is the ‘interest in the form of income’. In the present case the argument of the assessee is that it is only reimbursement of the interest payment in respect of the funds utilised by the assessee towards borrowing facility of it’s parent company. From the facts of the case, it can safely be concluded that the parent company was enjoying borrowing facilities from the bank through it’s parent company and the funds have been advanced to the assessee as the bank has not approved transferring the said borrowing facility to the assessee. As per the contention of the assessee to the extent of the funds utilised in respect of bank borrowing in the name of the parent company, the interest cost is reimbursed. In fact, the assessee is paying only the interest to the bank but it is through the parent company as admittedly parent company is not in lending business, as the transfer of the bank liability on the name of the assessee is awaited for the approval;

++ there are other aspects also to be considered. If it is an actual reimbursement of the interest by the parent company from the assessee in respect of the utilisation of the banking funds in respect of borrowing facilities enjoyed by the ‘M/S. OTL’, the parent company then it cannot be said to be the income of the parent company. In the assessment order, as per the explanation filed by the assessee, the ‘OTL’ has reduced the amount of interest received from the assessee company from it’s interest account and only the net amount of the interest is taken to the profit & loss account. Moreover, as per the provisions of sec.194A, otherwise also there is no liability on the assessee to deduct the tax at source if the interest is paid to any banking company to which Bank Regulations Act, 1949 applies. In present case assessee has paid interest to bank only but through it’s parent company;

++ the AO as well as CIT (A) have observed that the assessee has shown the loan amount in the name of the ‘OTL’ (parent company). In our opinion, if the credit limit has not been transferred in the name of the assessee but the credit facility is being enjoyed by the assessee through the parent company, then in such a situation the assessee cannot directly show the name of the bank but liability has to be shown on the name of the parent company. Further, in the AY 2006-07 the AO has not made any disallowance even though the assessment is completed u/s.143(3). The AO has also made the reference in respect of the disallowance of Rs.1,41,12,002/- made u/s.40(a)(ia) of the Act but no disallowance is made in this year. It is therefore, held that the assessee is under no statutory obligation to deduct the tax at source u/s.194A of the Act and, hence, there is no justification to invoke the provisions of sec.40(a)(ia) of the Act in making the disallowance;

 

ORDER

Per: R S Padvekar, JM:

These two appeals are filed by the assessee challenging the respective impugned orders of the Ld. CIT (A)-22, Mumbai for the A.Ys. 2005-06 & 2007-08. In both the appeals issues are common, hence, these appeals are disposed off by this consolidated order.

2. We first take the appeal for the A.Y. 2005-06 being ITA No.97/M/2010. The assessee has taken the following grounds:

“1. The Learned CIT (A) erred in confirming the disallowance of re-imbursement of interest of Rs.1,41,12,002/-, paid to the parent company Onward Technologies Ltd., u/s.40(a)(ia) of Income Tax Act, 1961.

“2. The Learned CIT (A) ought not to have confirmed the disallowances of re-imbursement of interest of Rs.1,41,12,002/-, paid to the parent company Onward Technologies Ltd., u/s.40(a)(ia) of Income Tax Act, 1961.

3. The facts which revealed from the record are as under. As observed by the A.O. the assessee company is engaged in the business of software development, trading of software and hardware and allied software and hardware services. It is stated that the assessee has taken over a banking division of its parent company i.e. M/s. Onward Technologies Ltd. (in short OTL). It is further stated that in view of the taking over of the banking division the assessee has to share the interest cost burden of M/S. OTL which is a parent company, based on the funds utilised as the parent company is enjoying borrowing facilities from the bank for its group companies. The assessee filed the return of income for the A.Y. 2005-06 declaring total income of Rs. ‘Nil’ and the said return was selected for scrutiny and assessment has been completed u/s.143(3) of the Act. It was noticed by the A.O. that the assessee had credited an amount of Rs.1,41,12,002/- in account of it’s parent company namely ‘M/S. OTL’ towards the interest payment.

4. In the opinion of the A.O. the assessee should have deducted tax at source as per the provisions of sec.194A of the Act. The A.O. sought the explanation of the assessee why the whole interest payment of Rs.1,41,12,002/- made to M/s. ‘OTL’ should not be disallowed u/s.40(a)(ia) of the Income-tax Act as no tax is deducted at source. The assessee filed the explanation before the A.O. stating that the assessee is wholly owned subsidy of M/s. ‘OTL’. There are various facilities, which are commonly shared between parent and the assessee company. Most of the facilities are normally in the name of parent company i.e. ‘OTL’, hence, at the first instance parent company incurred the expenses and it reimburses the appropriate share of expenses from assessee depending on the uses of the company. It is stated that as a part of the arrangement, parent company (‘OTL’) enjoys certain borrowings facilities from the bank. Out of borrowings from the bank, funds are transferred to the assessee-company and for use of the said funds the assessee’s parent company (‘OTL’) reimburses its share of cost of funds utilised. The assessee also contended that the reimbursement of the cost is on actual basis both in terms of uses as well as cost thereof and no income is earned by the parent company (‘OTL’) out of reimbursement of the interest from the assessee. The assessee also demonstrated how the entries are passed in its books of account debiting the interest account and crediting the OTL’s account and in the final entries interest account is carried to the profit and loss account. The assessee also stated that in the case of the parent company i.e. OTL; amount of interest reimbursed from the assessee company is reduced from the interest paid to the bank and net amount of the interest paid is taken to the profit & loss account. The assessee also contended that as the interest payment by the assessee is only towards the reimbursement of the cost to the parent company and no income is earned by the parent company, hence, there is no obligation on the assessee to deduct the tax at source u/s.194A of the Act.

5. The A.O. was not impressed with the explanation of the assessee. In his opinion the assessee should have deducted tax at source u/s.194A of the Act from amount paid/credited to M/S. OTL. He invoked the provisions of sec.40(a)(ia) of the Act and disallowed the entire interest payment of Rs.1,41,12,002/- and made the addition to the total income of the assessee. The assessee carried the issue before the Ld. CIT (A) but without success. In the opinion of the Ld. CIT (A) whatever have been received by the parent company i.e. ‘OTL’ it is nothing but income on account of interest. The Ld. CIT (A) has also observed that the assessee itself has shown amount of loan in its balance sheet under head ‘unsecured loans’, which is payable to ‘OTL’. In the opinion of the Ld. CIT (A) payment by the assesseecompany to the ‘OTL’ is nothing but interest irrespective of nomenclature assigned by the assessee-company. The Ld. CIT (A) confirmed the addition made by the A.O. by invoking the provisions of sec.40(a)(ia) of the Act. Now, the assessee is in appeal before us.

6. We have heard the rival submissions of the parties and perused the records. The Ld. Counsel submits that the assessee company is incorporated on 19.06.2003 as a subsidy of the ‘OTL’, which is a parent company. He submits that there is no income element in the reimbursement by the assessee to the parent company as the reimbursement is made on actual basis. The Ld. Counsel took us through paper-book, more particularly, copy of the ‘Agreement to Assignment of Business’ Page nos.4 to 20 of compilation. The Ld. Counsel referred to details of the liabilities as per the Second Schedule to the said Agreement (Page No.20 of the compilation). He submits that a sum of Rs.5 crore, which is working capital in form of cash credit limit of the parent company, was also taken over by the assessee as per the terms of the Agreement dated 21.06.2003. He submits that in the balance sheet also the Bridge Loan of Rs.5 crore, which was on the name of the parent company i.e. ‘OTL’ has been shown in Schedule-II with a heading “unsecured loans”. The Ld. Counsel took us page no.23 of the Paper-book which is a part of the balance sheet in the form of the ‘notes’ to the accounts and submits that as per Note No.5; it is made clear that working capital enjoyed by the parent company to the extent of Rs.50.00 millions has been utilised by the assessee company and the approval is awaited from the bank to transfer said loan facility on name of assessee. The Ld. Counsel submits that as per sec.194A, interest payment should be in the nature of ‘income’ to the recipient and reimbursement cannot be treated as ‘income’. He also took us through sec.194C to make the distinction in language used by the Legislature and submits that in sec.194C language used is ‘any sum’. He, therefore, pleaded that there is no statutory obligation on the assessee to deduct any tax at source in respect of amount reimbursed to the parent company and as there is no statutory obligation, the provisions of sec.40(a)(ia) cannot invoked. The Ld. Counsel strongly relied on the decision in the case of ITO vs. Dr. Wilmar Schwer India P. Ltd. 3 SOT 71 (Del.), Jaipur Vidyut Vistar Nigam Ltd. Vs. ITO 123 TTJ (Jp) 888. Per contra, the Ld. D.R. relied on the order of the Ld. CIT (A).

7. Sec.194A reads as under:

(1) Any person not being an individual or a Hindu undivided family, who is responsible for paying to a resident any income by way of interest other than income by way of interest on securities, shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force:

Provided that an individual or a Hindu undivided family, whose total sales, gross receipts or turnover from the business or profession carried on by him exceed the monetary limits specified under clause (a) or clause (b) of section 44AB during the financial year immediately preceding the financial year in which such interest is credited or paid, shall be liable to deduct income-tax under this section.

Explanation-For the purposes of this section, where any income by way of interest as aforesaid is credited to any account, whether called “Interest payable account” or “Suspense account” or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly.

(2) Omitted by the Finance Act, 1992, w.e.f. 1-6-1992.

(3) The provisions of sub-section (1) shall not apply-

(i) where the amount of such income or, as the case may be, the aggregate of the amounts of such income credited or paid or likely to be credited or paid during the financial year by the person referred to in sub-section (1) to the account of, or to, the payee, does not exceed-

(a) ten thousand rupees, where the payer is a banking company to which the Banking Regulation Act, 1949 (10 of 1949) applies (including any bank or banking institution, referred to in section 51 of that Act);

(b) ten thousand rupees, where the payer is a co-operative society engaged in carrying on the business of banking;

(c) ten thousand rupees, on any deposit with post office under any scheme framed by the Central Government and notified by it in this behalf; and

(d) five thousand rupees in any other case:

Provided that in respect of the income credited or paid in respect of-

(a) time deposits with a banking company to which the Banking Regulation Act, 1949 (10 of 1949) applies (including any bank or banking institution referred to in section 51 of that Act; or

(b) time deposits with a co-operative society engaged in carrying on the business of banking;

(c) deposits with a public company which is formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes and which is eligible for deduction under clause (viii) of subsection (1) of section 36,

the aforesaid amount shall be computed with reference to the income credited or paid by a branch of the banking company or the co-operative society or the public company, as the case may be;

(ii)

(iii) to such income credited or paid to-

(a) any banking company to which the Banking Regulation Act, 1949 (10 of 1949), applies, or any co-operative society engaged in carrying on the business of banking (including a co-operative land mortgage bank), or

(b) any financial corporation established by or under a Central, State or Provincial Act, or

(c) the Life Insurance Corporation of India established under the Life Insurance Corporation Act, 1956 (31 of 1956), or

(d) the Unit Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963), or

(e) any company or co-operative society carrying on the business of insurance, or

(f) such other institution, association or body or class of institutions, associations or bodies] which the Central Government may, for reasons to be recorded in writing, notify in this behalf in the Official Gazette;

(iv)

(v)

(vi)….(x)

Explanation 2.-

(4) The person responsible for making the payment referred to in sub-section (1) may, at the time of making any deduction, increase or reduce the amount to be deducted under this section for the purpose of adjusting any excess or deficiency arising out of any previous deduction or failure to deduct during the financial year.]Explanation.-[Omitted by the Finance Act, 1992, w.e.f. 1-6- 1992.”

8. As per the language used by the Parliament what is contemplated is the ‘interest in the form of income’. In the present case the argument of the assessee is that it is only reimbursement of the interest payment in respect of the funds utilised by the assessee towards borrowing facility of it’s parent company. We find that as per the facts on record the assessee company was originally incorporated on 19.06.2003 with the name of ‘Onsoft Technologies Ltd.’ but the said name was subsequently changed to ‘Onward eServices Ltd.’. Nowhere it is controverted that he assessee-company is a subsidy of ‘OTL’. The assessee company entered into Agreement with the parent company dated 21.06.2003 and took over the business of providing ‘Software Driven Solutions’ vide Agreement of Assignment of Business. As per the terms of the said Agreement, the assessee also took over the different liabilities of the parent company along with assigned of its business, which included sundry creditors, advances from customers, provisions for salary and funds base working capital cash credit limit of Rs.5 cores. (Page no.20 of the paper book). In the Audit report for year ending 30th June, 2003, factum of acquisition of running business of ‘Banking Software Solutions Division’ of ‘OTL’ (Parent company) is mentioned (page no.21 of the compilation). In the balance sheet Schedule –II under the head ‘unsecured loans’ the ‘Bridge Loan’ from the parent company ‘OTL’ towards banking borrowing to the extent of Rs.5 crore is shown (page no.22 of the compilation). As per Note No.5 (page No.23 of the compilation) it is made clear that the working capital limit of Rs.5 crore currently enjoyed by the parent company for which approval is awaited from the bank. In the interim period M/S. OTL has advanced a ‘Bridge Loan’ of similar amount. From the above evidence, it can safely be concluded that the parent company was enjoying borrowing facilities from the bank through it’s parent company and the funds have been advanced to the assessee as the bank has not approved transferring the said borrowing facility to the assessee. As per the contention of the assessee to the extent of the funds utilised in respect of bank borrowing in the name of the parent company, the interest cost is reimbursed. In fact, the assessee is paying only the interest to the bank but it is through the parent company as admittedly parent company is not in lending business, as the transfer of the bank liability on the name of the assessee is awaited for the approval.

9. There are other aspects also to be considered. If it is an actual reimbursement of the interest by the parent company from the assessee in respect of the utilisation of the banking funds in respect of borrowing facilities enjoyed by the ‘M/S. OTL’, the parent company then it cannot be said to be the income of the parent company. In the assessment order, as per the explanation filed by the assessee, the ‘OTL’ has reduced the amount of interest received from the assessee company from it’s interest account and only the net amount of the interest is taken to the profit & loss account. Moreover, as per the provisions of sec.194A, otherwise also there is no liability on the assessee to deduct the tax at source if the interest is paid to any banking company to which Bank Regulations Act, 1949 applies. In present case assessee has paid interest to bank only but through it’s parent company.

10. The AO as well as Ld. CIT (A) has observed that the assessee has shown the loan amount in the name of the ‘OTL’ (parent company). In our opinion, if the credit limit has not been not transferred in the name of the assessee but the credit facility is being enjoyed by the assessee through the parent company, then in such a situation the assessee cannot directly show the name of the bank but liability has to be shown on the name of the parent company. We further find that in the assessment year 2006-07 the AO has not made any disallowance even though the assessment is completed u/s.143(3). The AO has also made the reference in respect of the disallowance of Rs.1,41,12,002/- made u/s.40(a)(ia) of the Act but no disallowance is made in this year. We, therefore, hold that in the light of the above discussion, the assessee is under no statutory obligation to deduct the tax at source u/s.194A of the Act and, hence, there is no justification to invoke the provisions of sec.40(a)(ia) of the Act in making the disallowance. We, therefore, allow the grounds taken by the assessee and delete the addition made by the A.O.

11. Now, we take-up assessee’s appeal for the A.Y. 2007-08 being ITA No.2974/M/2010.

12. The first issue is in respect of disallowance of interest expenses of Rs.91,36,748/- u/s.40(a)(ia) of the Act. In this year also the assessee has credited interest amount of Rs.91,36,748/- to the accounts of its parent company namely i.e. M/s. ‘OTL’ and the same has been claimed as ‘deduction’ in the profit & loss account. In the opinion of the A.O. the assessee should have deducted the tax at source as per the provisions of sec.194A of the Act. The facts are identical as in the A.Y. 2005-06. In this year also the AO made disallowance of Rs.91,36,748/- by invoking the provisions of sec.40(a)(ia) of the Act. The Ld. CIT (A) confirmed the disallowance.

13. We have already decided the identical issue in this order in the appeal for the A.Y. 2005-06. Following our reasoning in the A.Y. 2005-06, in this year also i.e. A.Y. 2007-08, we hold that the assessee was not under statutory obligation to deduct the tax at source u/s.194A of the Act and hence, the disallowance made by the AO u/s.40a(ia) of the Act is not justified. We, accordingly, delete the addition of Rs.91,36,748/- made u/s.40(a)(ia) of the Act and accordingly relevant grounds ground are allowed.

Regards,

Praveen Boda

Reimbursement towards services attracts tax withholding requirements

 Reimbursement towards services in the nature of assistance, professional and administrative consultation and training @ attracts tax withholding requirements

In a recent AAR ruing in case of Mersen India Private Limited, it was held that--under Article 13 of the India-France DTAC, there is no stipulation that managerial services should 'make available' any, knowledge experience, skills, and know-how before the consideration paid for it can be taxed. In other words, mere rendering of managerial services to the applicant would invite the liability to be taxed in India for the consideration received for that service. Advice on business strategy, on general management, on marketing and commercial matters, on financial control and accounting matters, and on purchase and sales, environment and safety and the giving of training to optimize sales techniques to the employees of the applicant, are all capable of being put to use by the applicant on its own and hence can be said to be 'made available' to applicant and taxable in terms of Article 13.4 of India-France DTAC read with para 4 of Article 12 of India-US DTAC.

In short, reimbursement towards with services in the nature of assistance, professional and administrative consultation and training @ attracts tax withholding requirements.

[2012] 20 taxmann.com 475 (AAR - New Delhi) AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), NEW DELHI

Mersen India (P.) Ltd., In re JUSTICE P.K. BALASUBRAMANYAN, CHAIRMAN

A.A.R. NO.1074 OF 2010

RULING

________________________________________

1. The applicant is a company incorporated under the companies Act 1956. It is a 100% subsidiary of a French company. The French company in turn has another 100% subsidiary incorporated in France. The said subsidiary is now known as Mersen Corporate Services. The applicant originally entered into what is called a "Services agreement" on 1.1.2008, which was to be in force for a period of one year. On the expiry of one year, another agreement was entered into which was also to be for one year. With effect from 1.1.2010, the applicant has entered into a fresh agreement with the French company. Though the agreement stipulates the term of one year, unlike the earlier agreements, it provides for an automatic renewal of its terms for one year at a stretch. The applicant has also produced the agreement dated 30.12.2009 which is to come into effect on 1.1.2010, which is the agreement currently governing the relationship between the parties. The applicant and its parent company in France, are both in the business of manufacturing electrical components. The applicant is doing its business in Bangalore and Chennai for over a decade.

2. Under the services agreement, Mersen has undertaken to provide the applicant with services in the nature of assistance, professional and administrative consultation and training. The applicant has to pay the expenses incurred by Mersen for the services rendered to the applicant plus 5% of that amount. The invoice was to be in Euro and the money had to be remitted to a bank in Paris in France. The payment had to be made free of and without withholding taxes and duties and other charges and if such withholding was necessary, the same had to be borne by the applicant and there could be no deduction of the same from the amount to be paid to Mersen. The applicant had also entered into another agreement with Mersen wherein Mersen had undertaken transactions in the nature of E-Sourcing, Mail messaging, ERP maintenance etc. The applicant was not seeking an advance ruling in respect of that transaction. The applicant was seeking a ruling on the transaction evidenced by the services agreement.

3. After hearing the applicant and the Revenue which raised no objection to the allowing of the application under section 245R(2) of the Income-tax Act, this Authority allowed the application for giving a ruling on the following questions:

(1) Whether, pursuant to the "Services Agreement" entered into by the Applicant with Mersen, France, the payment made by the Applicant to Mersen, France, towards advisory services is 'fees for technical services' as per Article 13 (4) of the India-French DTAA read with the protocol to the said DTAA?

(2) If the answer to query 1 is in the affirmative, what is the rate at which the Applicant is required to deduct tax at source from such payment under Section 195(1) of the Income tax Act, 1961 (hereinafter referred to as the IT Act)?

(3) If the answer to query 1 is in the negative, is the above payment in the nature of business profits dealt with by Article 7 of the Indo-French DTAA?

(4) If the answer to query 3 is in the affirmative, is the above payment not taxable in India as Mersen, France does not have a permanent establishment in India as per Article 5 of the India-French DTAA?

(5) If the answer to query 4 is in the affirmative, is the Applicant required to deduct tax at source under section 195(1) in respect of the aforesaid payment to Mersen, France?

4. Though in the application, as part of its contentions, a contention is raised that what is payable under the services agreement to the French company was not fees for technical services within the meaning of section 9(1)(vii) of the Income-tax Act, at the hearing, learned counsel for the applicant did not dispute the position that the payment would be fees for technical services within the meaning of the Act. It was also agreed that going by the Double Taxation Avoidance Convention between India and France the amount would qualify as fees for technical services under paragraph 4 of Article 13 of the Convention. What was mainly contended for was that in terms of clause 7 of the protocol annexed to the DTAC, the applicant was enabled to claim the benefit of the limiting of the scope for taxation of technical services and if one restricted it to the convention between India and the United States, for satisfying the definition of included services in that Convention, it had also to be shown that the know-how was made available to the applicant before the payment for it could qualify as fees for included services under that Convention. It was also pointed out that managerial services were not included in the concept of "included services" under the India-US Convention and hence, the payments could be understood only as the business income of the French company and the payments to it could not be taxed in India in the absence of that company having a permanent establishment in this country.

5. On behalf of the Revenue it was contended that going by the definition contained in the Income-tax Act and the DTAC between India and France, payments made under the services agreement, would be fees for technical services and taxable as such. The exemption contained in section 9(1)(vii) of the Act did not apply and the transaction was liable to tax in India. In terms of the DTAC, what was inter alia being provided was consultancy services and the same fell within the concept of included services as now put forward. As regards the protocol, it is submitted that it will make no difference to the situation and the payments were taxable in India.

6. As per explanation 2 to section 9(1)(vii) of the Income-tax Act, fees for technical services means any consideration for the rendering of any managerial, technical or consultancy services. Under paragraph 4 of Article 13 of the Convention between India and France also, fees for technical services means payment of any kind as consideration for services of a managerial, technical or consultancy nature. Learned counsel is right in his submission that the position under the Convention and under the Act are the same regarding the nature of the payment. He has, therefore, rightly pitched his arguments on the modification brought about by the protocol to the DTAC wherein it is provided as follows:

"7. In respect of articles 11 (Dividends), 12 (Interest) and 13 (Royalties, fees for technical services and payments for the use of equipment), if under any Convention Agreement or Protocol signed after 1.9.1989, between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, fees for technical services or payment for the use of equipment to a rate lower or a scope more restricted than the rate of (?) scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items of income shall also apply under this Convention, with effect from the date on which the present Convention or the relevant Indian Convention, Agreement or Protocol enters into force, which ever enters into force later."

7. It is curious to see that the convention between India and France was signed on 29.9.1992. The protocol was also signed on the same day with a preamble that the same was to form an integral part of the Convention. But a look at clause 7 of the protocol indicates that if any other Convention, agreement or protocol had been signed by India after 1.9.1989 (a date preceding the signing of the DTAC between India and France) with a third state, which is a member of the OECD, in which India limits its taxation at source on fees for technical services (relevant for our purpose) to a rate lower or scope more restricted than the rate of (?) scope provided for in this Convention, the same rate or scope as provided for in that Convention, was also to apply under the DTAC.

8. Learned counsel for the applicant submitted that the DTAC between India and the United States was entered into on 12.9.1989, a date later than 1.9.1989 referred to in clause 7 of the protocol and that the applicant was relying on the relevant clause of that Convention, which had a more restricted scope for taxation of such fees. He submitted that in Article 12 of the Convention between India and the US, what was taxable was fees for included services. He pointed out that paragraph 4 of Article 12 of that Convention, provides that fees for "included services" means payment of any kind in consideration for the rendering of any technical or consultancy services, if such services are ancillary and subsidiary to the application or enjoyment of the right, property or information for which the payment described as royalty is received or make available technical knowledge, experience, skill, know how or consists of the development and transfer of a technical plant or technical design. His submission was that even though the DTAC between India and the French Republic did not insist on the making available of the technical knowledge etc., by virtue of the protocol, this concept had also to be taken note of while deciding the question whether the payment made is fees for technical services. Similarly, the Convention between India and the US has not taken in managerial services as part of included services the payment in consideration of which would be fees for technical services and consequently, notwithstanding the relevant paragraph in the India-France DTAC, payment made for managerial services, cannot be taxed as fees for technical services.

9. I find it some what strange that in spite of having entered into a DTAC with United States on 12.9.1989, preceding the signing of the Convention with France, the language or scope of the Convention between India and United States was not adopted for the India-France Convention. If the intention was to adopt the Convention as contained in the India-US DTAC, there would have been no difficulty in adopting the relevant clause in the India-France Convention as well. From the fact that in the India–France Convention, the bargaining countries struck to the definition as it is found in the Convention and parallel to the one found in the Indian Income-tax Act, surely, the intention must be taken to be not to adopt the concept as in the India-US DTAC. When this logical interference follows, in steps the protocol, providing for adopting the scope of taxation from any other treaty entered into after 1.9.1989, a date almost 3 years prior in point of time to the signing of the DTAC between India and France. I find it strange that if the intention was to have an identical regime of taxation, and nothing stood in the way of enacting an Article in the India–France DTAC along the same lines as the one found in the India–US DTAC, why that intention was not given effect to. If one were to draw the interference that the intention was not to adopt the parallel provision found in the India-US Convention, in steps the protocol with its abjuration that the other Convention must be given effect to. It is not clear why this confusing process has been adopted. It has also created considerable difficulty in understanding what exactly was the intention behind wording Article 13 in the Convention between India and France in the manner in which it is done. No doubt, as indicated by the Supreme Court in Azadi Bachao Andolan (263 ITR 706), the approach of a diplomat has to be adopted in interpreting a Convention between nations. Even such an approach does not appear to be capable of removing the confusion created by the circuitous process adopted, while entering into the Convention and signing the protocol with France.

10. Clause 7 of the protocol reads:

"…………………… India limits its taxation at source on dividends, interest, royalties, fees for technical services or payments for use of equipment to a rate lower or a scope more restricted than the rate of scope provided for in this convention on the said items of income the same rate or scope as provided…."(Emphasis supplied)

Can one take what is contained in the emphasized portion, a printer's devil? Or, is it deliberate to show that only provision for lower rate is intended to be applicable? The copy of the protocol provided by the applicant and the publications available in this Authority all show this expression. Counsel for the applicant submits that this is only a printing error, and the expression is really 'rate or scope', and reading it so, will be consistent with the use of the expression in the other parts of the clause. The representative for the revenue submitted that only provision for a lower rate of taxation is roped in and the scope of the provision in the DTAC for taxation cannot be whittled down by using this clause.

11. One supposes that reading the clause as a whole, it would be appropriate to read the expression 'rate of scope' as 'rate or scope' in the context. One also supposes that it is open to this Authority or a court to 'iron out the creases' if warranted, to give a meaning to the provision. On making that approach, I am inclined to accept the submissions of Counsel for the applicant that both rate of taxation and scope of taxation are brought within the purview of clause 7 of the protocol.

12. Going by the submissions of Counsel for the applicant, what has to be considered is whether the payments made by the applicant to the French Company is 'fees for technical services' In Article 12 of the India-US DTAC which provides for taxation of 'Fees for Included Services' paragraph 4 explains that 'fees for included services' means payment of any kind to any person in consideration for the rendering of any technical or consultancy services, if such services make available technical knowledge, experience, skill, know-how, or processes or consist of the development and transfer of a technical plan or technical design. So, notwithstanding the absence of a 'make available' stipulation in the Indo-French Convention, the applicant can rope in the concept of 'make available.' But this can be done only for technical and consultancy services which alone are embraced by the India-US Convention and from the 'Make Available' stipulation, Managerial Services are left out. It is the case of the applicant that consideration for managerial services paid to the French service provider, will only be business income and can be taxed in India only if it has a Permanent Establishment in India.

13. The applicant, receiving services from the French Company, can claim the application of the DTAC between India and France, or the provisions of the Income-tax Act which ever is more beneficial to it. The applicant has claimed the benefit of the DTAC. Now, under the DTAC, managerial services are taxable as 'Fees for Technical Services' under paragraph 4 of Article 13 which says that fees for technical services means payments in consideration for 'services of a managerial, technical or consultancy nature'. So, managerial services are taxable under the DTAC as FTS and under paragraph 2 of Article 13 read with paragraph 7 thereof, the same can be taxed in India as provided therein. By the strength of the protocol it has also claimed the benefit of the India-US Convention. In respect of technical and consultancy services, it is entitled to insist on the 'make available' requirement. This leaves out managerial services to be taxed under the DTAC between India and France. Managerial services are specifically dealt with under Article 13 of that DTAC. So, it is not possible to resort to Article 7 or Article 23 to look for a Permanent Establishment in this country before it being taxed.

14. Under Article 13, there is no stipulation that managerial services should be made available before the consideration paid for it can be taxed. In other words, mere rendering of managerial services to the applicant would invite the liability to be taxed in India for the consideration received for that service.

15. I will now briefly consider the services that are being provided or are to be provided under the services agreement. They include:

(1) Advice and assistance on business strategy and on general management.

(2) Advice and assistance on marketing and commercial matters.

(3) Advice and assistance on international relationship matters.

(4) Advice and assistance on financial matters

(5) Advice and assistance on finance control and accounting matters.

(6) Advice and assistance on tax and legal matters.

(7) Advice and assistance on insurance matters.

(8) Advice and assistance on purchases and sales, environment and safety matters.

(9) Advice and assistance on human resources matters.

16. In addition, the French company is to provide the applicant with services other than those mentioned when requested, if the French company had sufficient expertise and knowledge to render such services. The applicant is also entitled to seek specific services from the French company which it had agreed to provide. Various elements under which all these heads are recited in the services agreement, make it clear that the services to be rendered under any particular head, are not limited to what are enumerated in the agreement but that what are enumerated are to be included. In other words, the services agreement provides to the applicant advice and assistance on management, on marketing, on international relationship, on finance, on financial control and accounting, on taxation and law, on insurance, on purchases and sales, environment and safety and on human resources issues. I have noticed that the applicant is in the business of manufacturing electrical components. A reference to the areas covered by advice and assistance to be made available by the French Company to the applicant, would show that the advice and assistance pervades the entire business of the applicant. One thing to be noticed is that under some of the heads training is also imparted. A reference to the various clauses under each head would also show the pervasiveness of the area of advice and assistance by the French Company. It appears to me that the services rendered take in technical, managerial and consultancy services. The clauses contain provisions for services which relate to over all management and direction, marketing and managing the accounts and financial operations of the applicant. I am, therefore, satisfied that managerial services, within the meaning of paragraph 13 of India-France DTAC, are provided by the French Company to the applicant for a consideration equivalent to the cost incurred by the French Company plus 5% thereof as mark up.

17. It is also clear from a reading of the obligations undertaken by the French Company under the agreement, that it is rendering consultancy services. The services rendered on marketing, on strategy and the training provided to optimize sales techniques all would come within the purview of consultancy services. Though on reading some of the items of advice and assistance, it may even be possible to say that technical services are also rendered, the predominant purpose of the services agreement appears to be to provide managerial and consultancy services.

18. I have already held that for taxing the payment made for managerial services under the India-France DTAC, it is not necessary to make available such services within the meaning of that expression as generally understood with reference to fees for technical services. On the terms of the agreement it is even possible to say that the services are made available so as to satisfy even that test. Suffice it to say, that payments made for managerial services are liable to be taxed in terms of paragraph 4 of Article 13 of the DTAC between India and France.

19. As regards consultancy services, the question is whether such services are made available in the context of the DTAC between India and France read with the DTAC between India and US relied on by the applicant. It is seen that the advice and assistance rendered by the French Company to the applicant are not transient in nature and are capable of being used by the applicant on its own. It is true that some of the consultancy services rendered may not have that quality of permanency and may be a one time assistance, but advice on business strategy, on general management, on marketing and commercial matters, on financial control and accounting matters, and on purchase and sales, environment and safety and the giving of training to optimize sales techniques to the employees of the applicant, are all capable of being put to use by the applicant on its own. The services are enduring and they help in promoting the business of the applicant. The employees of the applicant are in a position to, actually they are expected to use the knowledge gained, in the business of the applicant. Thus, knowledge and know-how are made available to the applicant. Hence, on an understanding of the over all effect of the services agreement, it has to be held that the consultancy services are made available to the applicant.

20. Thus on a true construction of the services agreement between the applicant and the French company, I hold that the French company is rendering managerial and consultancy services to the applicant. The managerial services are taxable under paragraph 4 of Article 13 of the DTAC. They are taxable even if one were to invoke the concept of 'make available' for making the payments for such services taxable. The consultancy services provided are taxable in terms of Article 13.4 of the DTAC between India and France read with paragraph 4 of Article 12 of the India-US DTAC.

21. In the light of what is stated above, I rule on question no. 1 that the payments made by the applicant to Mersen France towards advisory services is fees for technical services in terms of paragraph 4 of Article 13 of the India-French DTAC read with the protocol to the said DTAC.

22. On question number 2, I rule that in terms of paragraph 2 of Article 13, the tax charged is not to exceed 10% of the gross amount of the fees. The deduction under section 195(1) of the I.T. Act has to be on that basis.

23. On question no. 3, I rule that the payments in terms of the services agreement are not in the nature of business profits dealt with in Article 7 of the India-French DTAC.

24. On question no.4, I rule that the question of existence of a permanent establishment does not arise in view of the finding that the payments are liable to be taxed as fees for technical services.

25. On question no. 5, I rule that the applicant is required to deduct tax at source under section 195(1) of the Income Tax Act, 1961.

AAR says OTIS’ share buyback deal with Mauritius holding co meant to evade tax

AAR says OTIS’ share buyback deal with Mauritius holding co meant to evade tax

Indian tax authorities have drawn the first blood in the war against sophisticated financial structures used to escape tax. The Authority for Advance Ruling (AAR), a quasi-judicial body that largely decides tax issues relating to foreign companies and cross-border deals, has upheld a tax demand on OTIS Elevators, an Indian firm, and denied capital gains tax benefit provided under the India-Mauritius tax treaty to its holding company OTIS Mauritius.

The transaction between the Indian company and OTIS Mauritius, according to AAR, was designed to avoid tax in India. The tax body gave its ruling on March 22, shortly after the Budget opened up a gamut of complex tax issues with the announcement of the General Anti-Avoidance Rule (GAAR).

The ruling follows the principle of ‘substance over form’, which means concerned parties structuring a transaction purely to avoid tax will come under the tax net. This is central to the spirit of GAAR, which is awaiting Parliament’s approval.

In the case before AAR, OTIS Elevator bought stocks from OTIS Mauritius in a share buyback programme

[2012] 20 taxmann.com 52 (AAR - New Delhi)

AUTHORITY FOR ADVANCE RULINGS (INCOME TAX), New Delhi

A Mauritus, In re

A.A.R. No. P of 2010 March 22, 2012

RULING

--------------------------------------------------------------------------------

Justice P.K. Balasubramanyan, Chairman - The applicant is a company incorporated in India in the year 1953 under the Companies Act of 1913. It is a closely held Public Limited Company. 48.87 % of its share are held by 'A'(USA), 25.06% by 'A'(Mauritius), 27.37% by company 'A' (S), Singapore and 1.76% by the general public. On 15.6.2010, the Board of Directors of the applicant has passed a resolution proposing a scheme of buy-back of its shares from existing shareholders in accordance with Section 77A of the Indian Companies Act.

2. 'A' (Mauritius) which holds 25.06% of shares in the applicant and incorporated on 6.4.2001 in Mauritius, proposes to accept the offer of buy-back. It acquired the shares in the applicant during the period 2001 to 2005 for Rs. 280 per share on the first occasion and Rs. 320 per share on the subsequent occasions. It is in that context that the applicant approached this Authority for Advance Ruling as to whether the capital gains that may arise, is chargeable to tax in India in the context of the Double Taxation Avoidance Convention between India and Mauritius and whether it will have the obligation to withhold tax in terms of Sec 195 of the Indian Income-tax Act.

3. In its comments accompanying the letter dated 31.1.2011, the revenue raised the contention that there was a previous buy-back in the year 2008 and on a return of income filed by 'A' (M) which sold back some of its shares, the question was pending before the assessing officer and hence the entertaining of the application was barred by clause (i) of the proviso to section 245R(2) of the Act. In the letter dated 28.3.2011 it was contended that the whole of the transaction was designed to avoid payment of tax in India. This Authority did not specifically overrule the contention based on clause (i) of the proviso presumably because the transaction of 2008 though similar in nature, was a different transaction and hence that clause was not attracted. As regards the objection based on clause (iii) of the proviso, this Authority overruled the objection then raised based on the ultimate control said to be vesting in the American Company, but with a rider that it can look whether question of avoidance at a later stage, of the circumstances warranted it. Thus this Authority allowed the Application under Sec 245R(2) of the Act to give a ruling on the following questions:-

(1) Whether on the stated facts and in law, the capital gains arising to 'A' (M), a tax resident of Mauritius, pursuant to the tendering of shares of 'A' (the applicant) under the buy-back scheme of the applicant would be Exempt from taxation in India, having regard to the provisions of paragraph 4 of Article 13 of the India-Mauritius Tax Treaty?

(2) If the answer to question No.1 is affirmative then whether, on the stated facts and n law the applicant is required to withhold tax on the remittance of the buy-back proceeds to 'A'(M)?

4. It is argued on behalf of the applicant that a buy-back is a legally recognized transaction and that the buy-back proposed is strictly in terms of section 77 of the Companies Act. In view of section 46A of the Income-tax Act, and the amendment of the definition of Dividend under that Act, there cannot be any doubt that what would be generated would be capital gains. Under paragraph 4 of the DTAC between India and Mauritius such gains are taxable only in Mauritius. It is, therefore, submitted that the questions may be ruled in favour of the applicant.

It is argued on behalf of the Revenue that the hearing of the application is barred by clause (i) of the proviso to Section 245R(2) of the Act. It is submitted that there was an identical buy-back in the year 2008 and on an application being made by the applicant under section 195(2) of the Act it was directed that tax had to be withheld. The applicant had withheld the tax and remitted it. Subsequently, 'A' (M) had filed a return of income claiming Nil liability and the question whether the income was taxable in India was pending before the Assessing Officer when the applicant filed the above application under section 245Q of the Act. The identical question was hence pending adjudication before an income-tax authority when this Authority was approached by the applicant. Senior counsel for the applicant met this by pointing out that the objection had already been overruled either expressly or impliedly when this Authority allowed the application under section 245R(2) of the Act and that in any event the earlier was a different transaction and hence there was no bar as has been held by this Authority on a number of occasions.

5. We find some force in the contention of counsel for the Revenue that the question pending before the Authority was an identical one. We have in this case already overruled the objection either expressly or impliedly when we allowed the application under section 245R(2) of the Act. Moreover, this Authority has been taking the view that if the transaction is different the bar is not attracted. We do not think it necessary in this case to reconsider the question. Hence, we overrule the objection.

6. Learned Counsel for the Revenue then argued that this was a transaction designed to avoid payment of tax in India. He submitted that after the introduction of Section 115-O of the Act with effect from 1.4.2003, the applicant had not declared or paid any dividend to its shareholders. It had allowed the reserves to grow substantially and was now transferring it to 'A' (M) to take over under the DTAC between the two countries and avoid payment of any tax on the sum transferred out of the country. He pointed out that if dividends had been declared and paid as was done prior to 1.4.2003 the applicant would have been forced to pay dividend distribution tax and the ruse adopted was with a view to avoid that tax payment. He submitted that this Authority had not closed the doors on this question while allowing the application under section 245R(2) of the Act and the question may now be considered.

7. Learned counsel sought to meet this contention by submitting that this Authority had already overruled this contention while allowing the application under section 245R(2) of the Act and it is not open to the Revenue to raise this contention all over again. He submitted that buy-back of shares was sanctioned by law and there was no justification in going behind the transaction or to question the motive for the transaction or to question its bona fides. He also submitted that it was for the Board of Directors of the Company to decide on whether dividend was to be paid or not and the decision taken by the Board in that behalf was a bona fide and valid decision. Taking advantage of legal and permissible means to arrange one's affairs cannot be characterized as a scheme for avoidance of tax.

8. We may observe some of the other relevant aspects. Though a buy-back was offered in the year 2008 and now, neither 'A' (USA), nor 'A' (S) accepted the offer. According to the Revenue, this was because the gain on buy-back would have been taxable at the hands of those entities under the India -USA DTAC and conditionally under the India-Singapore DTAC. The India-Mauritius DTAC did not make the gain taxable in India and it was not taxed in Mauritius. The acceptance of the offer by 'A' (M) alone on both occasions, was therefore significant. The public held only 1.76% of the shares and even if some of them had accepted the offer, there was no significant change in the holdings.

9. 'A' (Mauritius) is a wholly owned subsidiary of 'A' (Hong Kong). It was established to undertake offshore business activities as a corporate investment vehicle. 'A' (H) makes adequate funds available to it as and when investment directions for offshore business activities are taken. Until 14-3-2004, the immediate holding company of 'A' (M) was 'A' (UK) Limited, a company incorporated in Hong Kong. From 15-3-2004, the immediate holding company is 'X' International Corporation-Asia Private Limited, a company incorporated in Singapore. The ultimate holding company is 'X' Corporation, a company incorporated in the State of Delaware, USA. It is in this context that the Revenue contended that since the control and management of 'A' (M) was with 'X' Corporation USA, the treaty that should govern the present transaction, is the India-USA DTAC. According to it, the place of management of 'A' (M) lies in USA only.

10. Dividend was being distributed by the applicant to its shareholders until 1.4.2003. With effect from 1.4.2003, Section 115-O of the Act in its present from was introduced. This obliged the applicant to pay a tax on distributed profits. The applicant, if it had paid dividends, would have incurred this liability to pay tax. The applicant did not pay any dividend after 1.4.2003. It allowed its reserves to accumulate. The reserve has grown from Rs.(1) crores as in March, 2003 to Rs.(3) crores in March, 2008 and to Rs.(4) crores in March, 2010. In the year 2008, the applicant offered a buy-back of shares. Neither the shareholder US 'A' nor the shareholder 'A' (S) accepted the offer. In fact, their shareholding remained and remains constant from the year 1998 till the year 2009-2010. The offer of buy-back was accepted only by 'A' (M). It is the case of the Revenue that it is only under the India-Mauritius DTAC that capital gains is totally not taxable in India, and that is the reason why the offer is being accepted only by 'A' (M) among the major shareholders. The general public held only 1.76% of the shares and it is not clear whether anyone among them has chosen to accept the offer. The contention of the Revenue is that what would have been payable as tax on distribution of profits in India, is now evaded and the fund transferred out of the country under the guise of a buy-back of shares. This amounts to clear avoidance of tax in India. A scheme has been devised for such avoidance.

11. It is argued on behalf of the Revenue, that what is devised is a colouable transaction and the authorities under the Act and the courts are free not to accept them. It was submitted that even going by the decision in Azadi Bachao Andolan, the Mc Dowell principle will apply and hence the present proposed transaction may be ignored and it may be held that the payment is taxable as dividend under the Income-tax Act read with the India-Mauritius DTAC. This Authority is reminded of the development of the law from Ramsay to Vodafone in this context.

12. On behalf of the applicant it is reiterated that the application having been allowed under section 245R(2) of the Act, inspite of an objection of similar nature being raised, it was no more open to the Revenue to raise this objection. Even otherwise, the applicant is entitled to arrange its affairs in such a manner that it lightens the burden, by choosing a legal means available to it and that arrangement cannot be characterized as scheme for avoidance of tax. In any event, in view of the amended definition of dividend under the Act, the receipt cannot be taxed as dividend. It is only capital gains attracting Section 46A of the Act and paragraph 4 of Article 12 of the India-Mauritius DTAC.

13. It is true that while allowing the application under section 245R(2) of the Act for giving a ruling, this Authority did not accept the plea of avoidance then put forward. At the same time, this Authority did not shut the door fully on the question. This Authority stated:

"Just because the ultimate holding company of the transferor is 'X' Corporation, USA, it would not ipso facto label the transaction to be prime facie designed for avoidance of tax. At the same time, we may clarify that the hands of this Authority are not tied to take up the issue, if later on, the transaction is proved to be designed for avoidance of tax."

The objection now raised by the Revenue, is not the same as that raised earlier. Moreover, the order makes it clear that if later on adequate material is available to hold that the transaction is designed for avoidance of tax, it could be considered. On the terms of the order, it cannot be said that the consideration of the objection now raised by the Revenue is barred.

14. That apart, a plea that a transaction is colorable or that it is devised as a scheme for avoidance of tax, is a plea that has to be considered while giving a ruling under Section 245R(4) of the Act. According to us, it is a fundamental objection, which if upheld, would disentitle the applicant to a ruling or the ruling he has sought on a set of facts put forward. There is always a duty in this Authority to see whether there has come into existence a devise or scheme for avoidance of tax, before pronouncing on the taxability or otherwise of that transaction. This follows from the long line of judicial precedents which it is unnecessary to reiterate.

15. In this case, there is no dispute that no dividend had been paid to any of the shareholders after 1.4.2003 on which date Section 115-O of the Act was introduced in its present form. The accumulation in the reserves was allowed to be increased considerably. It may be noted that the major shares are held by the 'A' group and only 1.76% of shares are outstanding with the general public. The payment of dividend in the normal course by a company making profits, would have meant that the applicant would have been obliged to pay tax on distribution of profits to its shareholders. Instead of distributing the dividend on the basis of profits that accrued, the applicant allowed the reserves to grow. The proposed buy-back, if followed up, would mean that considerable sums would be repatriated to 'A' (M) in Mauritius without the tax on the distributed profits being paid, by resort to paragraph 4 of Article 13 of the DTAC between India and Mauritius. In this context, it is significant to note that neither 'A' USA nor 'A' (S) accepted the offer of buy-back, obviously because in the case of one it would have been taxable in India as capital gains and in the case of the other, its taxability would have depended on certain conditions being fulfilled, whereas under the India-Mauritius DTAC, capital gains is totally out of the Indian tax net. There was no proper explanation on the part of the applicant as to why no dividends were declared subsequent to the year 2003 when the company was regularly making profits and when dividends were being distributed before the introduction of Section 115-O of the Act in its present form. We are, therefore, satisfied that the proposal projected before us of buy-back is a scheme devised for avoidance of tax. In fact, it is a colorable device for avoiding tax on distributed profits as contemplated in Section 115-O of the Act.

16. It is true that if the receipt in the hands of 'A' (M) is treated as capital gains, it would be Section 46A of the Act that will be attracted and by the force of paragraph 4 of Article 13 of the concerned DTAC, the receipt would not be taxable in India. But in view of our finding that the transaction of buy-back proposed to be resorted to, is a colorable transaction, the question is whether the amount would not be taxable as dividend in terms of Section 2(22) of the Act as amended with effect from 1.4.2003. When the proposed transaction is found to be colorable, it is not a transaction in the eye of law and once it is ignored as such, the arrangement can only be treated as a distribution of profits by a company to its shareholders which does not attract Section115-O of the Act. Dividend in terms of the definition includes any distribution by a company of accumulated profits to its shareholders. The exemption is only in respect of a germin buy-back of shares. On our finding that the proposed buy-back is colourable, the distribution in question will satisfy the definition of dividend under the Act and consequently taxable as such. Under Article 10, paragraph 2 of the DTAC, dividend paid by a company which is a resident of India, to a resident of Mauritius, may also be taxed in India, according to the laws of India but subject to the limitation contained therein,. It may also be noticed that the payment in question, would also satisfy the definition of dividend in paragraph 4 of Article 10 of the DTAC between India and Mauritius. We are of the view that the proposed payment would be taxable in India in terms of paragraph 2 of Article 10 of the DTAC between India and Mauritius.

17. In the light of the reasoning and conclusion as above, we rule on question no. 1 that the amount that would be payable by the applicant to 'A' (M) would be taxable in India in terms of Article 10 of the DTAC between India and Mauritius. On question no. 2, we rule that the applicant is required to withhold tax on the proposed remittance of the proceeds to 'A' (M).

Buy-back of shares by wholly-owned subsidiary taxable as capital gains

In Re RST (AAR)

S. 47(iv) relief not available if holding co and nominees hold 100% of subsidiary

In the case of RST,  it was held that buy-back of shares by a wholly-owned subsidiary (WOS) of a foreign company would be chargeable to tax as capital gains. This is in view of the specific provisions contained in the Income-tax Act, 1961 (the Act). The applicant’s plea seeking exemption from charge to tax was rejected in view of the specific provisions contained in the Act treating a buy-back to be chargeable to tax as capital gains.


The ruling is a first of its kind on buy-back of shares by a WOS and may be of relevance for all WOSs contemplating buy-back of shares.

The applicant, a German company, held 99.99% of the shareholding of an Indian company. The rest of the shares were held by other companies as nominees of the applicant. The Indian company proposed a buy back of shares u/s 77A of the Companies Act which would have resulted in transfer of shares of the Indian company from the applicant to the Indian company at a price to be determined. The applicant claimed that as it and its nominees held 100% of the shares of the Indian company, the exemption conferred by s. 47(iv) on transfers between holding company and 100% subsidiary applied and s. 46A would not apply. HELD by the AAR:

(i) S. 47(iv) exempts a transfer of a capital asset by a company to its subsidiary if “the parent company or its nominees hold the whole of the share capital of the subsidiary company”. The word used is “or” and not “and”. The assessee held only 99.99% of the shareholding. The shares held by the nominees cannot be considered as held by the assessee. If, under Indian law (s. 49 (3) of the Companies Act), a company cannot by itself hold 100% of the shares in a subsidiary, it would only mean that Parliament did not intend to confer the benefit of s. 47(iv) on such a parent company. Though this approach confines the relief to a particular species of parent companies, it does not mean that the provision is unworkable. If the nominees are treated as holding the shares benami for the parent company, it would offend the Benami Transactions (Prohibition) Act, 1988 and also violate s. 49(3) of the Companies Act. The nominees can also not be regarded as a trustee in view of s. 153 of the Companies Act. The result is that the applicant does not hold 100% of the share capital of the subsidiary and so s. 47(iv) is not attracted;

(ii) S. 46A, which provides that in the case of a buyback, the difference between the consideration and the cost of acquisition shall be deemed to be capital gains is a special provision and prevails s. 45. S. 47 overrides s. 45 but not s. 46A. There is no reason to enquire whether s. 46A is a charging section or not. The result is that even if the exemption in s. 47(iv) is held applicable, it does not override s. 46A and the applicant is subject to capital gains.