The recent decision of the Bombay High Court in the case of Aditya Birla Nuvo Ltd (ABNL) once again seeks to lift the corporate veil and tax gains in the hands of the ‘beneficial owners' of Indian investments that are held through Mauritius investment vehicles. The Vodafone decision having already captured the attention of international tax observers, the Bombay High Court has set another precedent by seeking to effectively distinguish the Supreme Court's decision in the case of the Azadi Bachao Andolan , where a valid tax residency certificate issued by the tax authorities in Mauritius was considered as sufficient proof of residency and ownership, to avail of the benefits of the India-Mauritius tax treaty (‘IM Treaty').
The IM Treaty essentially exempts from tax in India, any capital gains income arising from the transfer of shares of an Indian entity by a Mauritius tax resident.
Facts of the case
In 1995, a US Corporation (‘US Co') entered into a joint venture agreement (‘JVA') with an Indian Company (‘I Co1') to form a joint venture company (‘JVC') in India for offering wireless telecommunication services.
Under the JVA, the equity shares subscribed by the US Co could be issued in the name of a ‘permitted transferee', which was a 100 per cent subsidiary. Consequently, the shares of the JVC were allotted to a Mauritius company (‘Mauritius Co'), as a permitted transferee, but all the rights in respect of the equity shares, including voting rights, rights of management and the right of sale or alienation vested with the US Co. Equity shares of the JVC allotted in the name of the Mauritius Co was also approved by the RBI under the erstwhile FERA Regulations.
Subsequently, in the year 2000, through a shareholder's agreement (‘SHA') entered into between the US Co, I Co1 and another Indian conglomerate, an Indian Company of the latter group (‘I Co2') was merged into the JVC such that each party now held roughly one-third of the shareholding.
In 2005, through the operation of the right of first refusal provisions in the SHA, I Co1 and I Co2 agreed to buy out the US Co's share in the JVC. While I Co1 purchased the shares of the JVC from the Mauritius Co, I Co2 entered into an agreement to acquire the entire issued and paid-up share capital of the Mauritius Co from the US Co.
The question debated by the Bombay High Court was on the ‘legal' versus ‘beneficial' owner of the shares of the JVC. The question of ownership is of paramount importance as, if the owner of the shares is a Mauritius Co, there would be no capital gains tax in India due to the application of the IM treaty, while if the owner is held to be the US Co, it would be liable to capital gains tax in India.
Bombay High Court's Decision
The Bombay High Court disregarded the Tax Residency Certificate issued to the Mauritius Co as proof of beneficial ownership of the shares of the JVC and chose to look at the substance of the transaction to determine the real owner of the shares.
On account of the fact that the JVA and the SHA were entered into by the US Co with all rights in the shares vesting with the US Co, the Court was inclined to believe that US Co was the actual owner of the shares with the Mauritius Co only holding the shares as a ‘permitted transferee'.
Accordingly, the Bombay High Court held that the capital gains accruing on the transfer of the shares of the JVC was taxable in the hands of the US Co in India and taxes ought to be withheld in India on such transaction.
To withhold or not to withhold
The Bombay High Court's decision creates additional difficulties for the acquirer of the shares of an Indian company, given the devolution of withholding tax obligations on the acquirer.
The dilemma of companies such as Vodafone and, in this instance ABNL, to withhold or not to withhold taxes in India, is expounded in the case of cross-border transactions involving a Mauritius holding company for Indian investments.
While in this particular case, the root cause of the issue could be attributed to the restrictive or overriding covenants of the JVA, which led to the questioning of the economic substance and rationale of the Mauritius Co, there is an increasing trend of the revenue authorities looking beyond legal ownership to understand which entity ultimately operates and exercises control on the Indian company as the ‘beneficial' owner of the shares. The proposed introduction of General Anti-Avoidance Rules in the Direct Taxes Code will further empower the revenue authorities to look into the substance of the transaction.
Need for rethinking
These rulings underline the need for rethinking international holding structures for multinational companies investing in India, with specific reference to treaty jurisdiction. Investment through treaty jurisdictions where limitation of benefits and substance requirements are expressly stated, would gain preference as audit defence could be enhanced through compliance with monetary and other stated substance requirements.
(The authors are Senior Manager and Assistant Manager, Tax and Regulatory Services respectively, at PwC India.)
SMS your comments about Taxation page to 94449 07996