Case Law Details
DCIT (International Taxation) Vs K.E. Faizal (ITAT Cochin)
Introduction: The case of DCIT (International Taxation) vs K.E. Faizal, adjudicated by the ITAT Cochin, revolves around the taxation of short-term capital gains (STCG) derived from the sale of units of equity-oriented mutual funds by a non-resident Indian (NRI) during the assessment year 2012-2013. The dispute primarily hinges on the interpretation of the India-UAE Double Taxation Avoidance Agreement (DTAA) regarding the taxability of such gains in India.
Detailed Analysis: The crux of the matter lies in determining whether the units of equity-oriented mutual funds can be considered as “shares” for the purpose of taxation under the provisions of Article 13 of the India-UAE Tax Treaty. The Tax Tribunal examined the relevant clauses of the treaty and scrutinized the definition of “shares” under Indian laws to ascertain the applicability of Article 13(4) or Article 13(5) to the case.
Article 13(4) of the Tax Treaty pertains to the taxation of gains from the alienation of shares in Indian companies, while Article 13(5) stipulates that gains from the sale of any property other than shares shall be taxable only in the contracting state of the alienator’s residence. The crucial question before the tribunal was whether units of mutual funds fall under the category of “shares” as defined by the treaty.
The tribunal relied on legal precedents and definitions provided under Indian laws, particularly the Companies Act, 2013, to discern the nature of mutual fund units. It concluded that mutual fund units do not qualify as “shares” under the Companies Act, as mutual funds are established as trusts, not companies. Additionally, the definition of “securities” under Indian regulations distinguishes between “shares” and “units of mutual funds,” further supporting the argument that they are distinct entities.
Drawing parallels with similar cases and judicial interpretations, including the Mumbai Bench of the Tribunal’s ruling in a comparable matter, the ITAT Cochin held that gains arising from the transfer of units of mutual funds should not be taxed in India under Article 13(4) of the Tax Treaty. Instead, they fall under the purview of Article 13(5), implying that such gains are taxable only in the contracting state of the alienator’s residency, i.e., UAE in this instance.
Conclusion: The ruling in the DCIT vs K.E. Faizal case underscores the significance of precise legal interpretation and the application of tax treaties in cross-border transactions. By clarifying the tax treatment of mutual fund gains for NRIs under the India-UAE DTAA, the ITAT Cochin’s decision provides clarity and guidance to taxpayers and reinforces the principles of international tax law. This case serves as a precedent for similar disputes and highlights the importance of understanding the nuances of tax treaties in minimizing tax liabilities for non-resident investors.
FULL TEXT OF THE ORDER OF ITAT COCHIN
This appeal at the instance of the Revenue is directed against CIT(A)’s order dated 11.06.2018. The relevant assessment year is 2012-2013.
2. The grounds raised read as follows:-
“1. The order of the learned Commissioner of Income Tax (Appeals)-II, Kochi is contrary to the law and facts of the case.
2. The learned Commissioner of Income Tax (Appeals)-II Kochi erred in holding that the units of equity oriented Mutual Funds and equity shares cannot be held to be the same.
3. The learned Commissioner of Income Tax (Appeals)-II Kochi ought to have considered the fact that the underlying instrument of any equity oriented Mutual Fund is nothing but a share and hence the gains arising from the sale of the underlying instrument, being the equity share results in Capital Gains.
4. The learned Commissioner of Income Tax (Appeals)-II Kochi erred in holding that as per the provisions of the India-UAE Double Taxation Avoidance Agreement the gain can be taxed only in the country of residence which is UAE.
5. The learned Commissioner of Income Tax (Appeals)-II Kochi ought to have considered the fact that the Equity Share being the underlying instrument, the gains from the alienation of Units of an Equity oriented Mutual Fund is thus taxable under Article 13(4) of the India-UAE Treaty in India i.e. the contracting State in which the company, whose share / units have been transferred, is a resident.
6. The learned Commissioner of Income Tax (Appeals)-II Kochi erred in relying on the decision of the Mumbai Bench of ITAT without considering the fact that the decision of the Mumbai Bench of ITAT is not binding on the Income-tax authorities of Kerala Charge.
7. For these and other grounds that may be adduced at the time of hearing, it is prayed that the order of the learned Commissioner of Income Tax (Appeals)-II Kochi may be cancelled and that of the AO may be restored.”
3. Brief facts of the case are as follows:
The assessee, an individual, is non-resident for the relevant assessment year, viz., A.Y. 2012-2013. The assessee had sold units of equity oriented mutual funds during the relevant assessment year and derived short term capital gains (STCG) on the same amounting to Rs.1,34,99,407. For the assessment year 2012-2013, the return of income was filed on 31.07.2012 by claiming the short term capital gain amounting to Rs.1,34,99,407 as exempt to tax in India by virtue of Article 13(5) of India-UAE Treaty. The assessment was completed u/s 143(3) of the I.T.Act vide order dated 30.03.2015. The Assessing Officer held that the underlying instrument of any equity oriented mutual funds is nothing but a `share’, and therefore, as per Article 13(4) of the Treaty, STCG would be taxable in India. Accordingly, he added a sum of Rs.1,34,99,407.
4. Aggrieved by the above said addition under the short term capital gains, the assessee preferred an appeal to the first appellate authority. The assessee raised various contentions before the first appellate authority and the same was reproduced at pages 6 to 10 of the impugned order (portion of para 4.3 of the CIT(A) order). The CIT(A) decided the issue in favour of the assessee by holding that the short term capital gains derived by the assessee on account of sale of units of equity oriented mutual funds are not taxable in India. The CIT(A) was of the view that the equity oriented mutual funds are not `shares’ and therefore the case was governed by para 5 of Articled 13 of the India-UAE Treaty. In taking the above view, the CIT(A) also relied on the order of the Mumbai Bench of the Tribunal in the case of ITO (IT) v. Satish Beharilal Raheja [(2013) 37 taxmann.com 296 (Mumbai-Trib.)].
5. The Revenue being aggrieved by the order of the CIT(A) has filed this appeal before the Tribunal. The learned Departmental Representative strongly relied on the grounds raised. The learned AR, on the other hand, has filed a paper book comprising of 49 pages enclosing the income tax return, the statement showing capital gains / loss incurred during the relevant assessment year, submissions made before the Income-tax authorities etc. The learned AR reiterated the submissions made before the Income-tax authorities.
6. We have heard the rival submissions and perused the material on record. The assessee admittedly is a non-resident Indian for the relevant assessment year. The tax residency certificate issued to the assessee stating he has a valid residency in UAE is on record (pages 27 to 29 of the paper book filed by the assessee). The Assessing Officer also admits that the assessee is a NRI during the relevant assessment year. For the relevant assessment year the assessee sold equity linked mutual funds and derived STCG. As per section 5(2) r.w.s. 9(1)(i) of the I.T.Act, transfer of a capital asset situated in India shall be deemed to accrue or arise in India. The income from transfer of units of an equity-oriented mutual funds situated in India is deemed to accrue or arrive in India and therefore is taxable in India even in the case of a non-resident. However, taxation in the case of non-resident is subject to the provisions of the relevant Treaty between India and the State of residency of the assessee. In the instant case, the provisions of India-UAE Treaty would be applicable. Section 90(2) of the I.T.Act states that the provisions of the Treaty shall apply to the extent they are more beneficial to the assessee as compared to the corresponding provisions of the Act. The Assessing Officer also does not state that the assessee is not entitled to the beneficial provisions of the DTAA entered between India and UAE. The Assessing Officer negated the assessee’s contention by holding Article 13(4) of the Treaty would apply and not Article 13(5) of the Treaty. To understand the issue in controversy, it is necessary to reproduce Article 13 of the India-UAE Tax Treaty and the same reads as follow:-
“ARTICLE 13 : CAPITAL GAINS
1. Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in paragraph (2) of Article 6 and situated in the other Contracting State may be taxed in that other State.
2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such fixed base may be taxed in that other State.
3. Gains from the alienation of shares of the capital stock of a company the property of which consists directly or indirectly principally of immovable property situated in a Contracting State may be taxed in that State.
4. Gains from the alienation of shares other than those mentioned in paragraph 3 in a company which is a resident of a Contracting State may be taxed in that State.
5. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3 and 4 above shall be taxable only in the Contracting State of which the alienator is a resident.”
(Emphasis supplied]
6.1 As per Article 13(5) of the Tax Treaty, income arising to a resident of UAE from transfer of property other than shares in an Indian company, are liable to tax only in UAE. On the other hand, Article 13(4) of the Tax Treaty provides that income arising to a resident of UAE from transfer of shares in an Indian company other than those specifically covered within the ambit of provisions of other paragraph of Article 13 may be taxed in India. Article 13(4) of the Tax Treaty covers within its purview capital gains arising from transfer of `shares’ and not any of the property. Therefore, Article 13(4) of the Tax Treaty cannot be applied in the instant case unless the units of mutual funds transferred by the assessee qualify as shares for the purpose of Tax Treaty.
6.2 The term “share” is not defined under the tax treaty. As per Article 3(2) of the tax treaty, any term not defined under the tax treaty shall, unless the context otherwise requires, have the meaning which it has under the laws of the country whose tax is being applied. Therefore, the term “share” would carry the meaning ascribed to it under Act, and if no meaning is provided under the Act, then the meaning that the term carries under other allied Indian laws would need to be applied. The Act does not define the term “share”. However, section 2(84) of the Indian Companies Act, 2013 defines the term “share” to mean “a share in the share capital of a company and includes stock”. Further, the term “company” has been defined to mean a “company incorporated under the Companies Act, 2013 or under any previous company law”. Under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1995, mutual funds, in India can be established only in the form of “trusts”, and not “companies”. Therefore, the units issued by Indian mutual funds will not qualify as “shares” for the purpose of Companies Act, 2013. Further, under the Securities Contract (Regulation) Act, 1956, a security is defined to include inter alia –
(a) shares, scrips, stocks, bonds, debentures, debenture stock or other body corporate; and
(b) units or any other such instrument issued to the investors under any mutual fund scheme.
6.3 From the above definition of “securities”, it is clear that “shares” and “units of a mutual fund” are two separate types of securities. Applying the above meaning to the provisions of the tax treaty, the gains arising from transfer of units of mutual funds should not get covered within the ambit of Article 13(4) of the tax treaty, and should consequently be covered under Article 13(5) of the tax treaty. Therefore, the assessee, who is a resident of UAE for the purposes of the tax treaty, STCG arising from sale of units of equity oriented mutual funds and debt oriented mutual funds should not be liable to tax in India in accordance with the provisions of Article 13(5) of the tax treaty.
6.4 Reliance is also placed on the decision of the Mumbai Bench of the Tribunal in the case of Income-tax Officer v. Satish Beharilal Raheja [(2013) 37 taxmann.com 296], wherein on similar facts and in the context of the Treaty between India and Switzerland, the Tribunal held as under:
“In our view in the absence of any specific provision under the Act to deem the unit as shares, it could not be considered as shares of companies and therefore, the provisions of Article 13(5)(b) (of the Indo-Swiss Treaty) cannot be applied in case of units. We agree with the findings of the Commissioner (Appeals) that provisions of Article 13(6) (of the Indo-Swiss Treaty) are applicable in case of units as per which capital gains cannot be taxed in India. “
6.5 The Mumbai Tribunal came to above conclusion by relying on the judgment of the Hon’ble Supreme Court (“SC”) in the case of Apollo Tyres Ltd v CIT [2002J 122 Taxman 562 (SC), wherein the Hon’ble Apex Court held as under:
“Even though the said section (Section 32(3) of the UTI Act, creates a fiction to make UTI as a deemed company and distribution of the income received by the unitholder as deemed dividend, by virtue of these deeming provisions it cannot be said that it a/so makes the unit of UTI a deemed share. A deeming provision of this nature, as found in Section 32(3) (of the UTI Act) should be applied for the purposes for which the said deeming provision is specifically enacted, which in the instant case was confined only to deeming the UTI as a company, and the income from the units as a dividend. If as a matter of fact, the Legislature had contemplated making the unit as also a deemed share, then it would have stated so. In the absence of any such specific deeming in regards to units as shares, it would be erroneous to extend the provisions of Section 32(3) of units of UTI for the purpose of holding that the unit is a share.”
6.6 In view of the aforesaid reasoning and the judicial pronouncement cited supra, we are of the view that the CIT(A) is justified in deleting the addition of Rs.1,34,99,407 as short term capital gain. It is ordered accordingly.
7. In the result, the appeal filed by the Revenue is dismissed.
Order pronounced on this 08th day of July, 2019.
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