Tax Insights
from India Tax & Regulatory Services
www.pwc.in
Tribunal considers factual matrix;
holds Cyprus entity beneficial owner of interest for purposes of the tax treaty
September 10, 2019
In brief
Recently,1 the Mumbai bench of the Income-tax Appellate Tribunal (Tribunal), while dealing with the concept of “beneficial ownership” in the context of interest income earned by the taxpayer from an Indian entity held that:
The taxpayer has “dominion and control” over the interest income earned from the Indian entity.
The taxpayer was not constrained by any contractual, legal or economic arrangement with any other third party and was free to utilise the interest income on its sole and absolute discretion.
The fact that the investment was funded through shareholder loan and capital does not affect the
“beneficial ownership/ status” of the taxpayer.
The taxpayer is the beneficial owner of the interest income and will be taxed as per Article 11 of the Double Taxation Avoidance Agreement (tax treaty) between India and Cyprus at 10%.
In detail
Facts
The taxpayer is a limited liability company and a tax resident of Cyprus,
engaged in business of an investment holding company. It is a wholly owned subsidiary of a company based out of Mauritius (Mauritius Co).
Also, Mauritius Co. held 99.5% in an Indian company (I Co.).
The taxpayer held compulsory convertible debentures (CCDs) in I Co.
1 ITA No. 6958/ Mum/ 2017
It earned interest on CCDs during the relevant assessment year (AY). The taxpayer filed its tax return for the relevant AY
showing income from interest on CCDs in I C0.
Such interest income was offered to tax at the rate of 10% in accordance with Article 11 of the India- Cyprus tax treaty.
The Tax Officer (TO) denied the benefit of the tax treaty on the basis that the taxpayer was not the beneficial owner of interest
income and taxed the said income at rates in force.
The Dispute Resolution Panel (DRP) affirmed the finding of the TO and held that the taxpayer was a mere conduit for the passage of funds.
With regard to the taxpayer’s reliance on the Central Board of Direct Taxes (CBDT) circular no.
789, the DRP held that the circular was not applicable to the Cyprus entity.
Tax Insights
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Issue before Tribunal Whether the taxpayer is the
“beneficial owner” of the interest income and is eligible for the beneficial rate of tax at 10% under Article 11 of the India-Cyprus tax treaty?
Taxpayer’s contentions
The term “beneficial owner”
is not defined in the Income- tax Act, 1961 (Act) or tax treaty. Internationally, the term denotes the entity that is the legal owner of the
property and has dominion and control over the property.
The Revenue had completely failed to prove that the taxpayer did not exercise full dominion and control over the interest income.
The taxpayer was the sole owner of the interest income and was under no
contractual, legal, or economic obligation to pass on the interest income it received to its immediate shareholder, or to its ultimate parent, or to any other entity.
The fact that the investment was funded using shareholder loan and equity does not ipso facto, mean that corporate status may be disregarded.
The taxpayer stated that the TRC issued by the tax authorities of Cyprus in its name would be a sufficient basis for residential status and “beneficial ownership”, as required under CBDT circular no. 789.
Revenue’s contentions
Investment made by the
2 Para 10.2 of OECD Commentary (2017) on Article 11 (Interest) of the ‘Model Tax Convention’: Where the recipient of
taxpayer in the I Co. is a back-to-back loan transaction out of the funds received from its immediate parent
company, i.e., the Mauritius Co.
The taxpayer was a mere
“name plate” company, carrying out no business activities in Cyprus and a conduit for the passage of funds between the two entities. Hence, it cannot be regarded as a beneficial owner of the interest income.
The CCDs were issued at a hefty premium of 70% over and above the fair market value of each share of I Co.
The Revenue relied on the DRP’s observation that the taxpayer did not possess the CCDs in its own right and its power of disposal is not unhindered. In addition, the financial statements did not indicate the taxpayer was doing any business other than merely routing the funds.
Tribunal’s ruling
The taxpayer applied for CCDs using a portion of the share capital and the interest free shareholder loan and was still left with a reasonable cash balance.
The taxpayer invested in CCDs and received interest for its own exclusive benefit and not on behalf of any other entity.
Reference was made to the provisions of the OECD commentary (2017) to support the meaning of
“beneficial owner.”2
interest does have the right to use and enjoy the interest unconstrained by a contractual or legal obligation to pass on
Also, the TO could not establish that the taxpayer was constrained by a
contractual, legal or economic arrangement with any third party with respect to the interest income received.
The taxpayer maintained the foreign exchange risk on CCDs (as they were denominated in INR), and counter-party risk on interest payment arising on the CCDs.
The transactions between the parties cannot be considered as a back-to-back transaction lacking economic substance.
The taxpayer is eligible for tax treaty benefits, and the interest income from CCDs have been rightly offered to tax at the rate of 10% in the return of income.
The takeaways
This ruling provides some clarity on how ‘beneficial ownership’ could be determined in case of investment holding companies.
The ruling would also strengthen claims for lower withholding tax certificates for Cyprus companies which were hereto being denied by the tax authorities on the basis that they were not
‘beneficial owners’ of these investments.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
the payment received to another person, the recipient is the ‘beneficial owner’ of that interest.”
Tax Insights
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