Indian Tax Treaties: Capital Gains and Beneficial Ownership Test
The primary purpose of double taxation avoidance agreements ("DTAAs") is to eliminate double taxation by providing taxing rights or granting tax credit to one of the contracting states. Under India's DTAAs with certain countries (for e.g., Singapore, Mauritius and the Netherlands), capital gains on sale of shares is taxable only in the resident country of the transferor and no tax is payable in India. However, time-and-again, tax authorities in India have disputed the eligibility to claim benefit under the DTAAs on the basis that the transferor entity selling the shares is a shell/conduit entity and is not the "beneficial owner" of such shares. Further, in certain instances, the tax authorities have argued that the tax residency certificate ("TRC") is not sufficient evidence to claim the benefit under the DTAAs.
Interestingly, Article 13 relating to 'capital gains' in the DTAAs with Singapore, Mauritius and Netherlands, does not specifically provide for the test of beneficial ownership.
Recently, the Delhi High Court in Blackstone Capital Partners (Singapore) VI FDI Three Pte. Ltd. v. ACIT, held that the capital gains under the India-Singapore DTAA is taxable based on legal ownership and not beneficial ownership. Further, it held that the TRC is the only evidence required to claim DTAA benefit under the capital gains provisions and the tax authorities cannot go behind the TRC and test beneficial ownership.
However, the Supreme Court of India ("Supreme Court") has admitted the appeal filed by the tax authorities against the Delhi High Court's decision and has also stayed the operation of the Delhi High Court's judgement until further orders.
In this note, we analyze whether "beneficial ownership" of the shares is relevant to determine eligibility to claim tax benefits under India's DTAAs with other countries and whether a TRC is sufficient evidence to claim such benefits.
Meaning of beneficial ownership
The terms "beneficial ownership" and "beneficial owner" have neither been defined under the Income Tax Act, 1961, as amended ("Income Tax Act") nor under the DTAAs. Accordingly, reference is made to the meaning given in various dictionaries and commentaries.
Black's law dictionary defines "beneficial owner" as "a legal term where specific property rights ("use and title") in equity belong to a person even though legal title of the property belongs to another person".
Cambridge dictionary defines "beneficial owner" as "a person or organization that has the right to receive income, profits, etc. from a property or investment that they own".
The OECD Commentary on Model Tax Convention, 2017, does not define the term "beneficial ownership," although it does refer to the beneficial ownership of income as the right to use the income without any legal or contractual obligation to pass on the income to another person.
Based on the above, it can be inferred that one of the essential characteristics of beneficial ownership is the right to receive income and utilize such income at the recipient's own will without any obligation.
Relevant provisions of the DTAAs
Typically, the Article in the DTAAs on capital gains (Article 13 under the DTAAs with Singapore, Mauritius and the Netherlands) does not provide for a beneficial ownership test. However, we note that the requirement of beneficial ownership is specifically provided in the DTAAs under other Articles relating to dividends, interest and fees for technical services.
Also, Article 24A of the India-Singapore DTAA, provides that the benefit under Article 13 on capital gains is not available to conduit (shell) companies that have no real business. A company having an annual expenditure below a prescribed threshold under the DTAA is deemed to be a conduit/shell company.
Relevant circulars/press release
Circular No. 682, dated March 30, 1994 issued by Central Board of Direct Taxes ("CBDT") clarifies that a resident of Mauritius deriving capital gains from transfer of shares shall be taxable only in Mauritius as per the Mauritian law and there will not be any tax liability in India.
Circular No. 789, dated April 13, 2000 issued by CBDT clarifies that the TRC shall be considered as sufficient evidence for establishing the residential status of a Mauritian resident. Further, it reiterates that any capital gains on sale of shares by a Mauritian resident shall not be taxable in India.
Press release dated March 01, 2013 issued by Ministry of Finance, Government of India, further clarifies that the TRC produced by a resident of a contracting state will be accepted as evidence that he is a resident of that contracting state. It further stated that "the Income Tax Authorities in India will not go behind the TRC and question his resident status".
Relevant judicial pronouncements
In UOI v. Azadi Bachao Andolan,1 the Supreme Court upheld the constitutional validity of Circular No. 682 and Circular No. 789.
In Vodafone International Holdings B.V. v. UOI and Anr,2 the Supreme Court confirmed the view of Azadi Bachao Andolan and held that TRC is sufficient evidence to show residence of the contracting state.
In Blackstone Capital Partners (Singapore) VI FDI Three Pte Ltd. (supra), the assessee, a Singapore resident, did not pay capital gains tax on sale of shares in India, claiming benefit under Article 13 of the India-Singapore DTAA. However, the assessing officer denied the benefit under the India-Singapore DTAA on the basis that the assessee was not the "beneficial owner" of shares as the source of funds and management of affairs was from the U.S. holding company. On appeal, the Delhi High Court held that:
- The concept of "beneficial ownership" under the India-Singapore DTAA is not applicable to capital gains. This concept features in the India-Singapore DTAA only in the context of dividends, interest and royalty.
- The assessee was not a conduit/shell company as it exceeded the threshold of operational expenditure specified under the India-Singapore DTAA clause relating to the limitation of relief.
- The tax authorities cannot go behind the TRC issued by other jurisdictions as it is sufficient evidence to claim treaty eligibility, residential status, legal ownership and accordingly, there is no capital gains tax in India.
A similar view has been given by certain other High Courts and Income Tax Appellate Tribunals.3
It is worth mentioning that a contrary view has been given by the Bombay High Court in Aditya Birla Nuvo Ltd. v. DDIT4 and the Authority of Advance Ruling in AB Mauritius In Re.5 However, these cases are distinguishable on facts as the taxpayers did not contend that "beneficial ownership" is not a precondition for claiming benefit under Article 13 of the India-Mauritius DTAA.
Wait and watch!
In the absence of a specific requirement on "beneficial ownership" under Article 13 of India's DTAAs with Singapore/Mauritius/the Netherlands and based on the CBDT circulars and the previous decisions of the Indian courts on sufficiency of TRC, it would appear that a person claiming capital gains tax benefits under India's DTAAs with Singapore/Mauritius or Netherlands does not need to satisfy any test on "beneficial ownership" of the shares. However, the Supreme Court's decision to admit the special leave petition6 and stay the operation of the order of the Delhi High Court in Blackstone Capital Partners (Singapore) VI FDI Three Pte Ltd. (Supra) has now introduced uncertainty. The Supreme Court's verdict on this matter is highly anticipated and hopefully, puts this matter to rest.
Footnotes
1 Supreme Court's judgement in UOI v. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC), dated October 10, 2003
2 Supreme Court's judgement in Vodafone International Holdings B.V. v. UOI and Anr, (2012) 6 SCC 613 (SC), dated January 20, 2012
3 Punjab & Haryana High Court's judgement in Serco BPO (P.) Ltd v. AAR, (2015) 379 ITR 256 (P&H), dated August 26, 2015
Delhi Tribunal's judgement in Veg 'N' Table v. DCIT, ITA No. 2251 of 2022, dated October 31, 2023; as available at:https://itat.gov.in/files/uploads/categoryImage/1698929870-ita%20no.%202251%20of%202022,%20Veg%20N%20Table%20vs.%20dcit.pdf
Delhi Tribunal's judgement in Reverse Age Health Services Pte. Ltd. v. DCIT, ITA No. 1867 of 2022, dated February 17, 2023; as available at: https://itat.gov.in/files/uploads/categoryImage/1676612993-1867%20Del%202022.pdf
Mumbai Tribunal's judgement in Blackstone FP Capital Partners v. DCIT, ITA Nos. 981 and 1725 of 2021, dated May 17, 2022; as available at: https://itat.gov.in/files/uploads/categoryImage/1652865106-Blackstone%20Finalized%20version.pdf
4 Bombay High Court's judgement in Aditya Birla Nuvo Ltd. v. DDIT, (2012) 342 ITR 308 (Bom), dated July 14, 2011
5 Authority of Advance Ruling's judgement in AB Mauritius In Re, (2018) 402 ITR 311 (AAR), dated November 8, 2017
6 Supreme Court's order in ACIT v. Blackstone Capital Partners (Singapore) VI FDI Three Pte. Ltd. (Supra)
This insight/article is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.
