Direct Tax Alert - DTAA benefit cannot be denied without invoking GAAR basis unsubstantiated cogent evidence and by disregarding valid TRC

BACKGROUND

Section 90(2) of the Income-Tax Act, 1961 (IT Act) provides that where a Double Taxation Avoidance Agreement (DTAA) have been entered into by the Central Government, the provisions of the IT Act shall apply to the extent they are more beneficial to that taxpayer.  Further, Section 90(2A) of the IT Act has an overriding effect over Section 90(2) of the IT Act. It provides that GAAR¹ provisions can be applied to a taxpayer even if such provisions are not beneficial to him. Thus, to deny beneficial treatment as per Section 90(2) of the IT Act, an arrangement entered by the taxpayer may be declared to be an impermissible avoidance arrangement² and the consequence in relation to tax arising from there may be determined subject to the provisions of Chapter X-A³ of the IT Act.

In this regard, recently the Delhi Tax tribunal⁴ had an occasion to examine whether a transaction could be declared as an impermissible avoidance arrangement without invoking GAAR provisions. We, at BDO in India, have summarised the ruling of the Delhi Tax Tribunal and provided our comments on the impact of this decision.

FACTS OF THE CASE

• The taxpayer, a tax resident of Mauritius, acts as an investment holding company and has a valid Tax Residency certificate (TRC). It held a Category 1 Global Business Licence issued by the Financial Services Commissioner, Mauritius.

• For the Fiscal Year (FY) 2019-20, the Taxpayer derived income from long-term and short-term capital gains from the sale of shares of two Indian Companies.
• In the return of income for the relevant FY, the taxpayer offered the short-term capital gain to tax. However, the long-term capital gain was not offered to tax since it held a valid TRC and thus was entitled to avail benefits⁵ under the India- Mauritius DTAA.
• The Tax Officer rejected the claim of the taxpayer and observed that the taxpayer has been set up through a scheme of arrangement to avoid taxes by adopting a colourable device hence the scheme has to be regarded as an Impermissible Avoidance Arrangement. Therefore, the tax officer held that the taxpayer will not be entitled to India-Mauritius DTAA benefits.
• Aggrieved, the taxpayer filed an appeal before the Dispute resolution panel (DRP) which affirmed the order passed by the tax officer. Further aggrieved, the taxpayer filed an appeal before the Delhi Tax Tribunal.

TRIBUNAL RULING

The Delhi Tax Tribunal made the following observations while ruling in favour of the taxpayer by allowing its claim to exempt long-term capital gains under India-Mauritius DTAA:

• TRC issued by the competent authority of a particular country determines the tax residency of a particular person/entity. The aforesaid position has not only been accepted by the Revenue in Circular No. 78, dated 13 April 2000, but also while upholding the validity of the aforesaid Circular, the Hon’ble Supreme Court in the case of Azadi Bachao Andolan⁶ has held that the person/entity holding a valid TRC would be entitled to the DTAA benefits. Subsequently, the aforesaid legal position has been followed in many decisions, including the recent decision of Blackstone Capital Partners (Singapore)⁷
• Though the tax authorities have made various allegations to conclude that the taxpayer is a conduit entity, however, such conclusion is not backed by any substantive and cogent material brought on record. In sum and substance, the tax officer has made mere allegations and has failed to substantiate that the taxpayer is a conduit company through clinching evidence.
• Though the tax officer has alleged that the taxpayer is a conduit company and has been set up as a part of an impermissible avoidance arrangement, he has not invoked GAAR provisions.  Further, the Tax Authorities have also not invoked the LOB clause⁸ as provided under Article 27A of India – Mauritius DTAA.
• Thus, facts on record indicate that the tax authorities were accepting the fact that the shares in the Indian companies had been acquired prior to 1 April 2017, hence the capital gain derived from the sale of such shares would be exempt from tax in India in terms of India-Mauritius DTAA.
• Therefore, the TRC issued by the competent authority in Mauritius would not only determine the residential status of the taxpayer but also its entitlement under the DTAA provisions.

BDO COMMENTS

This is a welcome ruling for the taxpayer. Firstly, because it re-emphasises the importance of TRC and other supporting documents relevant to establishing the economic substance of taxpayers for the purpose of availing DTAA benefits. Secondly, it enunciates that tax authorities cannot merely allege a taxpayer as a conduit company and have been set up under a scheme of impermissible avoidance arrangement without substantiating it through cogent evidence on record. There is a set procedure to invoke GAAR and the same should be followed by tax authorities.