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1 PwC pwc.in

Tax Insights

29 August 2023

CCPS would be covered within the ambit of ‘shares’; CCPS acquired prior to 1 April 2017 and converted to equity shares post 1 April 2017 to be covered by Article 13(4) and not Articles 13(3A) or 13(3B) of India–Mauritius DTAA – Delhi bench of the Tribunal

In brief

The Delhi bench of the Income-tax Appellate Tribunal¹ (Tribunal) allowed an appeal in favour of a Mauritius taxpayer by allowing the benefits on long-term capital gains arising on transfer of shares of an Indian company under the India-Mauritius Double Taxation Avoidance Agreement (DTAA). The Tribunal, while deciding on the f acts of the case, inter-alia observed that the taxpayer had acquired the cumulative convertible preference shares (CCPS) prior to 1 April 2017, even though the same were converted to equity shares post 1 April 2017.

The Tribunal concluded that the term ‘shares’ in Article 13(3A) of the India-Mauritius DTAA is used in a broader sense and would also include preference shares. Hence, under the facts of the present case, the Tribunal was of the view that capital gains exemption under Article 13(4) of the DTAA would be available even when the CCPS were converted post 1 April 2017. The Tribunal f urther reaffirmed the principle that once the tax residency certificate (TRC) has been issued by Mauritian authorities, the tax officer (TO) cannot proceed without considering the TRC to determine the residency of the entity.

In detail

Facts

• The taxpayer is a tax resident of Mauritius holding a valid TRC entitling it to claim benefit under the India- Mauritius DTAA. The taxpayer is engaged in the business of investing in companies in India in various sectors such as education, healthcare, etc.

• During the year under consideration, the taxpayer had disposed its investment in the shares of two Indian companies X Limited and Y Limited and derived income under the head ‘long-term capital gains’.

X Limited

The taxpayer had acquired the equity shares of X Limited prior to 1 April 2017. The taxpayer claimed exemption on the sale of such equity shares in its original return of income.

1 ITA No. 2289/Del/2022

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Y Limited

The taxpayer had acquired shares in the form of CCPS prior to 1 April 2017, which were then converted into equity shares on 4 August 2017. While the exemption under Article 13(4) of the India-Mauritius DTAA was claimed for both sales in the original return of income, it subsequently offered the gains from the sale of shares of Y Limited to tax under Articles 13(3A) and 13(3B) of the India-Mauritius DTAA in the revised return.

• In the course of the assessment proceedings, the TO proceeded to examine the taxpayer’s claim of benefit in terms of Articles 13(3B) or 13(4) of the India-Mauritius DTAA and concluded that the taxpayer was not entitled to claim benefit under the India-Mauritius DTAA, holding inter-alia that the taxpayer was a conduit company, without any commercial rationale for the establishment of the taxpayer and that the TRC would not be sufficient to establish tax residency. The TO accordingly brought to tax the entire long-term capital gains under the provisions of domestic law. The Dispute Resolution Panel, in sum and substance, endorsed the views of the TO.

• The taxpayer, inter-alia, reiterated the facts before the Tribunal concerning its tax residency and highlighted the f act that the taxpayer was not a sham or conduit company, as evidenced by its substantive operational expenditure, TRC issued by the Mauritius revenue authorities, etc. The taxpayer f urther raised an additional ground for claim of exemption under Article 13(4) of the India-Mauritius DTAA on capital gains accruing on the sale of shares of Y Limited, which the Tribunal admitted.

Tribunal’s ruling

On issue of eligibility to claim tax benefits

• The Tribunal af f irmed the principle that the TO cannot proceed without considering the valid TRC to determine the residency of the taxpayer entity, relying inter-alia on the Central Board of Direct Taxes (CBDT) Circular 789 dated 13 April 2000, Supreme Court judgement in the case of Azadi Bachao Andolan² and recent jurisdictional High Court decisions³.

• The Tribunal also rejected the TO’s contention that the taxpayer, being a ‘fiscally transparent entity’, cannot claim benefits of the India-Mauritius DTAA. The Tribunal relied on the interpretation of the term ‘liable to taxation’ used in Article 4 of the India-Mauritius DTAA by the Supreme Court in its decision in the case of Azadi Bachao Andolan².

• The Tribunal also dismissed most of TO’s contentions pertaining to the taxpayer being a ‘conduit company’, especially with reference to Article 27A of India-Mauritius DTAA (i.e. limitation of benefits clause) without any commercial substance, set up as a scheme of arrangement of tax avoidance through treaty shopping etc. in the absence of any cogent evidence or concrete evidence brought on record by the TO.

Exemption on capital gains available under the India–Mauritius DTAA

• Regarding the long-term capital gains on the sale of X Limited’s shares, the Tribunal, inter-alia, was of the view that there cannot be dispute that the taxpayer is eligible for exemption claim under Article 13(4) of the India–Mauritius DTAA; without doubt, the shares were acquired prior to 1 April 2017.

• Regarding the long-term capital gains on the sale of equity shares of Y Limited as well, the Tribunal, inter- alia, concluded that the taxpayer would be eligible for exemption under Article 13(4) of the DTAA and not Articles 13(3A) or 13(3B) of the DTAA, based on the following elaborate reasoning.

- The taxpayer acquired the CCPS prior to 1 April 2017, which stood converted into equity shares as per the terms of issue, without any substantial change in the rights of the taxpayer.

- Conversion of CCPS into equity shares would only result in a qualitative change in the nature of rights of the shares, with no material difference in rights.

- Conversion of CCPS into equity shares did not, in fact, alter any of the voting or other rights with the taxpayer.

2 Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 (SC)

3 Blackstone Capital Partners (Singapore) VI FDI Three Pte Limited v. ACIT [2023] 146 taxmann.com 569 (Delhi); MIH India (Mauritius) Limited v. ACIT (ITA No. 1023/Del/2022)

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- Except for differences in preference in receiving dividend or repaying capital, there are no material dif ferences between the CCPS and equity shares.

- The term ‘shares’, as mentioned in Article 13(3A) of the India–Mauritius DTAA, is used in a broader sense and will take within its ambit all shares, including preference shares.

The takeaways

The Tribunal, while interpreting the term ‘shares’ in Article 13 of the India-Mauritius DTAA, has concluded that the term ‘shares’ must be interpreted in a broader sense and consequently, CCPS should be covered within its ambit. Accordingly, the Tribunal was of the view that even the CCPS acquired before 1 April 2017, converted into equity shares post 1 April 2017 and subsequently sold post 1 April 2017 as equity shares, should also be eligible for grandfathering under the DTAA. It would be interesting to watch how this interpretation would evolve and be evaluated by higher courts going forward. The Tribunal has also reaffirmed the principle that once the TRC has been issued by the Mauritian authorities, the TO cannot proceed without considering it and deny the DTAA benefit to the taxpayer.

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In this document, “PwC” refers to PricewaterhouseCoopers Private Limited (a limited liability company in India having Corporate Identity Number or CIN : U74140WB1983PTC036093), which is a member firm of PricewaterhouseCoopers International Limited (PwCIL), each member firm of which is a separate legal entity.

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