The Authority for Advance Ruling (AAR) has said that E*Trade Mauritius Ltd (ET Mauritius) is not liable to pay capital gains tax in India as per the Double Taxation Avoidance Agreement—(DTAA) between the two countries.

ET Mauritius, a subsidiary of US-based Converging Arrows Inc which in turn is a subsidiary of E*Trade Financial Corp (ET USA), is a tax resident of Mauritius. It transferred shares it held in India-based IL&FS Investsmart Ltd (now called HSBC InvestDirect after the takeover by the foreign bank) to HSBC Violet Investment (Mauritius) Ltd. When ET Mauritius approached Indian tax authorities for a 'nil' rate withholding tax certificate under Section 197 of the Income-Tax (I-T) Act, the authorities issued a certificate directing HSBC to deduct tax on the amounts paid to ET Mauritius.

ET Mauritius filed a writ petition in the Bombay High Court challenging the certificate issued by the I-T authorities. Without going into the merits of the case, the High Court disposed of the petition and directed ET Mauritius to file a revision application under Section 264 of the I-T Act before the Director of Income-Tax (DIT) for International Taxation and also directed HSBC to deposit a sum of Rs245 million which would be withheld from the consideration paid to ET Mauritius, pending disposal of the revision petition by the DIT.  

However, DIT, confirming the view taken by the tax authorities that the transaction prima facie gave rise to capital gains chargeable to tax in India, disposed the revision petition filed by ET Mauritius. 

The company then approached AAR to determine whether, by virtue of being a resident of Mauritius, it is eligible to the benefits of the India-Mauritius treaty and hence not subject to tax in India on the capital gains realised.

Before the AAR, the DIT contended that though the legal ownership of shares of IL&FS vests with ET Mauritius, the real and beneficial owner is ET USA and hence, ET Mauritius is merely a facade to avoid capital gains in India. DIT said that it has taken a prima facie view that the capital gains arising from the transaction are taxable in the hands of ET USA.

ET Mauritius relied on the Circular No 789 dated 13 April 2000 issued by the Central Board of Direct Taxes (CBDT) and the decision of the Supreme Court in the case of Azadi Bachao Andolan and argued that the Tax Residency certificate issued by the Mauritian tax authorities should constitute sufficient evidence for accepting the status of residence for applying the provisions of the India-Mauritius tax treaty. 

The AAR in an order issued on 22^nd March upheld the benefits available under the India-Mauritius tax treaty. It said, “As all the legal formalities for purchase of shares and their subsequent transfer had been completed by ET Mauritius and the consideration had been received by ET Mauritius, it is difficult to assume that capital gain has arisen to ET USA and not ET Mauritius."

The AAR also upheld the fact that ET USA provided the funds and played a role in negotiating the sale transaction did not lead to legal inference that the shares were, in reality, owned by ET USA.

"The fact that a subsidiary has its own corporate personality and is a separate legal entity needs to be considered. Even though the holding company exercises acts of control over its subsidiary, that did not, in the absence of compelling reasons, dilute the separate legal identity of the subsidiary," the AAR said.

Relying on the decision of the Supreme Court in the case of Azadi Bachao Andolan, the AAR held that there is no legal prohibition against 'treaty shopping' and tax avoidance is not objectionable if it is within the framework of law and not prohibited by law.

"The AAR ruling affirms that the Indian tax authorities are not in a position to levy capital gains tax on the transfer of shares in an Indian company by a Mauritian tax resident in view of the provisions of the India-Mauritius tax treaty, the Circular issued by CBDT and the law laid down by the Supreme Court in Azadi Bachao Andolan case," said Maulik Doshi of Sudit K Parekh & Co.

A ruling by the AAR is binding only on that applicant, in respect of the transaction in relation to which the ruling is sought and on the tax authority. However, it does have persuasive value and the courts in India, the tax authorities and the appellate authorities do recognise the principles and ratios laid down by the AAR while deciding similar cases. Other taxpayers who would like to achieve certainty on their transactions could consider approaching the AAR for a ruling after evaluating the facts of their respective cases.

"As far as the case of ET Mauritius is concerned, the only option available for the tax department now is to file a special leave petition before the Supreme Court against the said AAR ruling," Mr Doshi added. — Moneylife Digital Team