CA Anuja Garg

Introduction

International transactions have always been on the anvil of the tax department. The retrospective amendments in the Income-tax Act, 1961 (“the Act”) and introduction of GAAR despite existing specific anti-avoidance provisions, are evident of this fact.

The decision of the Calcutta High Court in the case of Maersk Line UK Ltd, which reiterates the fact that business transactions having commercial substance and bona fide business purpose are permissible as long as there is no misuse of the provisions, assumes importance since the same is the first (and probably the last) judicial pronouncement in respect of the dormant section 93 of the Actand more so, since the said section, being a specific anti-avoidance provision could lose its sheen once GAAR takes the reign.

Background

Section 93 of the Act corresponds to section 44D of the erstwhile Income-tax Act, 1922which was one of the earliest anti-avoidance legislations in India.

The said section was reintroduced in the 1961 Act with some cosmetic changes and presently reads as under:

“93. Avoidance of income-tax by transactions resulting in transfer of income to non-residents.

(1) Where there is a transfer of assets by virtue or in consequence whereof, either alone or in conjunction with associated operations, any income becomes payable to a non-resident, the following provisions shall apply—

(a)         where any person has, by means of any such transfer, either alone or in conjunction with associated operations, acquired any rights by virtue of which he has, within the meaning of this section, power to enjoy, whether forthwith or in the future, any income of a non-resident person which, if it were income of the first-mentioned person, would be chargeable to income-tax, that income shall, whether it would or would not have been chargeable to income-tax apart from the provisions of this section, be deemed to be income of the first-mentioned person for all the purposes of this Act;

(b)         where, whether before or after any such transfer, any such first-mentioned person receives or is entitled to receive any capital sum the payment whereof is in any way connected with the transfer or any associated operations, then any income which, by virtue or in consequence of the transfer, either alone or in conjunction with associated operations, has become the income of a non-resident shall, whether it would or would not have been chargeable to income-tax apart from the provisions of this section, be deemed to be the income of the first-mentioned person for all the purposes of this Act.

Explanation.—The provisions of this sub-section shall apply also in relation to transfers of assets and associated operations carried out before the commencement of this Act.

(2) Where any person has been charged to income-tax on any income deemed to be his under the provisions of this section and that income is subsequently received by him, whether as income or in any other form, it shall not again be deemed to form part of his income for the purposes of this Act.

(3) The provisions of this section shall not apply if the first-mentioned person in sub-section (1) shows to the satisfaction of the Assessing Officer that—

(a)   neither the transfer nor any associated operation had for its purpose or for one of its purposes the avoidance of liability to taxation; or

(b)   the transfer and all associated operations were bona fide commercial transactions and were not designed for the purpose of avoiding liability to taxation.

Explanation.—For the purposes of this section,—

(a)      references to assets representing any assets, income or accumulations of income include references to shares in or obligation of any company to which, or obligation of any other person to whom, those assets, that income or those accumulations are or have been transferred;

(b)      any body corporate incorporated outside India shall be treated as if it were a non-resident;

(c)       a person shall be deemed to have power to enjoy the income of a non-resident if—

(i)        the income is in fact so dealt with by any person as to be calculated at some point of time and, whether in the form of income or not, to enure for the benefit of the first-mentioned person in sub-section (1), or

(ii)      the receipt or accrual of the income operates to increase the value to such first-mentioned person of any assets held by him or for his benefit, or

(iii)    such first-mentioned person receives or is entitled to receive at any time any benefit provided or to be provided out of that income or out of moneys which are or will be available for the purpose by reason of the effect or successive effects of the associated operations on that income and assets which represent that income, or

(iv)     such first-mentioned person has power by means of the exercise of any power of appointment or power of revocation or otherwise to obtain for himself, whether with or without the consent of any other person, the beneficial enjoyment of the income, or

(v)       such first-mentioned person is able, in any manner whatsoever and whether directly or indirectly, to control the application of the income;

(d)      in determining whether a person has power to enjoy income, regard shall be had to the substantial result and effect of the transfer and any associated operations, and all benefits which may at any time accrue to such person as a result of the transfer and any associated operations shall be taken into account irrespective of the nature or form of the benefits.”

Section 93 of the Act, therefore, applies in a situation wherein,either alone or in conjunction with associated operations –

–          pursuant to transfer of assets, consequently any income becomes payable to a non-resident, before or after such transfer, or

–          where any such first mentioned person receives or is entitled to receive any capital sum, the payment whereof is in any way connected with the transfer or any associated operations, then any income which by virtue or in consequence of the transfer, has become the income of a non-resident, whether it would or it would not have beenchargeable to income-tax apart from the provisions of the said section.

In other words, the section aims at protecting the interest of the Revenue in cases wherein payment of tax is sought to be evaded by transferring assets to non-residents while continuing to enjoy the income by resorting to dubious methods.

The section is applicable subject to fulfillment of the following conditions –

  • there is a transfer of assets;
  • by reason of that transfer, income traceable to the said assets becomespayable to a person who is a non-resident or resident but not ordinarily resident;
  • the resident, by means of the transfer alone or in conjunction with associated operations, acquires right toenjoy such income;
  • the income from the said assets, if it was the income of the resident, would bechargeable to income-tax.

The only exception to the applicability of section 93 is that if, to the satisfaction of the Assessing Officer, it is demonstrated that the transfer and all associated operations were bona fide commercial transactions not designed for the purposes of avoiding liability to taxation.

Recent decision of the Calcutta High Court in the case of DIT v. Maersk Line UK Limited: ITA No. 89/2013

The assessee, Maersk Line UK Limited, a company incorporated in the United Kingdom, is the partner of P&O Nedlloyed (“Nedlloyed”), a partnership firm established in the United Kingdom. Nedlloyed has two partners, the assessee and Nedlloyed BV (“the Dutch company”) a company incorporated under the laws of Netherlands.Nedlloyed carries on business of operation of ships all over the world including in India. The global profit and loss of the partnership is shared by its two partners, the assessee and the Dutch company in the ratio of 56:44 respectively.

P&O Nedlloyed India Private Limited (“NIPL”), a company incorporated inIndia under the Companies Act, 1956, and a wholly owned subsidiary of the assessee, is the authorized shipping agent of the partnership firm Nedlloyed in India and represents the partnership firm Nedlloyed in all transactions in India.

The assessee sold 10,71,420 equity shares of its wholly ownedsubsidiary, NIPL to Maersk India Private Limited for consideration ofRs.5,20,28,155/-.This sale was admittedly part of the overall reorganizationof the business of the assessee. The long term capital gain on sale of shares at a consideration of Rs.5,20,28,155/- worked out to Rs.2,58,76,351/-The assessee filed its income-tax return for the assessment year 2006-07 on 29th November, 2006, declaring totalincome of Rs.2,58,76,351/- on account of long term capital gain. In the return, the assessee also claimed credit for tax deductionat source (TDS).

During the previous year 2005-06, corresponding to assessment year 2006-07, NIPLdeclared dividendamounting to Rs.14,99,98,800/- to its non-resident shareholders, i.e. the assessee. Admittedly, NIPL India had earned profits and had cashsurplus and/or cash reserves for distribution of dividends, andaccordingly a resolution was adopted by the Board of Directors for distribution of dividend. While arriving at the revised net worth of NIPL, the valuers had made certain adjustments to the net worth of the equity shares up to 31st March, 2006 including,inter alia, deduction of Rs.17,10,36,000/- declared as dividend and paid to its shareholders from its net worth.

By the order of assessment dated 10th November, 2008 the Assessing Officer assessed the income of the assessee at Rs.17,12,57,331/- for the assessment year in question, inter alia, upon increasing the value of the shares sold by the assessee after disallowingthe deduction claimed on account of distribution of dividend and also credit claimed for deduction of TDS from Nedlloyed.

The assessing officer contended that Nedlloyed group had intentionally resorted to payment of dividend to avoid payment of tax on long term capital gains on sale of shares.

The fact that distribution of dividend by NIPL prior to its sale by the assessee, even after the payment of dividend distribution taxes, had resulted in tax advantage of Rs.94 lakhs was not disputed.The fundamental question that arose was whether the declaration of dividend byNIPL, just before sale of its shares to Maersk India, could betreated as a colourable device and part of impermissible taxavoidance scheme.

The High Court, dismissed the Revenue’s appeal on the following grounds –

  • There was no legal bar to the distribution of dividends, which was done in accordance with the provisions of the Companies Act, 1956. The Revenue has not been able to demonstrate any illegality in the distribution of dividend, in view of admitted cash reserves and surplus for such distribution.
  • On acceptance of dividend distribution tax, the legality of distribution of dividend could not be questioned. Further, if there was no legal infirmity in distribution of dividend, the mere fact that such distribution of dividend ended up in saving taxes on sale of shares would not invalidate the distribution of dividend.
  • That the share valuation was done in due compliance of RBI guidelines and did not suffer from any infirmity, was demonstrated by concurrent finding of facts.

Judicial Precedents in respect of section 44D of the erstwhile 1922 Act

Kadar Mohideen v CIT: 38 ITR 647 (Madras HC)

The decision of the Madras High Court, in the case of Kadar Mohideen, was the first precedent on section 44D of the erstwhile 1922 Act, wherein the assessee, a resident in India, was carrying on business of manufacture of ball threads in Ceylon and was assessed to income-tax on the income from the said business. In the books of the business there were credits in the names of his wife, minor sons and his nephew. A private company was formed in Ceylon and the business was transferred to it. The company in turn allotted shares to the assessee, his wife, minor sons and nephew. Subsequently, the assessee filed his return of income by including the dividend income from the company in respect of the shares standing in the names of his wife and his minor sons. In the assessment year 1947-48, which related to the year of account in which the company was formed, the Income-tax Officer held that the entire profits of the company should be included in the assessment under section 44D of the Income-tax Act, as the assessee had failed to prove that the transfer of assets to the foreign company was not made with a view to avoid a liability to taxation. In view of the fact, that the majority of the shares in the company were owned by the assessee, the other shares being in the name of his near relations, the officer held that the assessee had the power to enjoy the income of the company. He, therefore, included the entire profits of the company in the assessable income of the assessee.

The High Court held that the entire income of the company (not only the dividend declared by the company) could be assessed in hands of the assessee only if the assets transferred by him to the company constituted the entire share capital of the company and the assessee had the power to enjoy the income from the transferred assets. In this case, the consideration for shares allotted to the wife of the assessee represented her own money deposited with the business and if two persons transferred their respective assets to a non-resident company, which together constituted the share capital of the company, each of them had to be taxed in respect of the assets transferred by him, one person could not be taxed in respect of the entire income of the company nor could both of them be treated as a single assessee. In such a case each person has to be taxed in respect of the dividends received by him from the company. In view of the fact that the entire assets which were transferred to the limited company did not belong to the assessee, it follows that the assessee would be entitled only to the dividends from that foreign company, and not the entire profits. The assessee had disclosed the income from the dividends received by his wife and minor sons in his return and thus, it could not, therefore, be said that the transfer of assets was made for the purpose of avoiding income-tax.

CIT v. Mohammed Ibrahim Sahib: 45 ITR 166 (Madras High Court)

The legal principle of section 44D of the erstwhile 1922 Act was further explained in the case of Mohammed Ibrahim Sahibby the Madras High Court. In this case, the assessee was carrying on a business at Colombo for more than twenty years. He decided to leave Ceylon and settle down in India. All the assets of the business including goodwill were transferred to a private limited company, of which he became a major shareholder, the other shareholders being his sons.

It was contended by the Department that the transaction came within the purview of section 44D.

The assessee, however, affirmed that the transfer was made with a view to preserve the business to the family and not for the purpose of avoidance of tax.

The High Court held that in every case where there is a transfer of an income producing asset to a non-resident company, there will be avoidance of tax and the assessee who transfers such assets would certainly know or be presumed to know that the effect of the transfer would be that the tax liability would be avoided. The real question to be decided in a case like this is whether the actual avoidance of tax was the result of a design on the part of the assessee and not merely an incident or effect of the transaction entered into for other reasons.

In the present case, the transfer of the assessee’s assets to the non-resident company was not with the object of avoiding Indian income-tax but with a view to facilitate the continuance of the business which he was carrying on.

The High Court observed that the mere fact that the transfer results in the avoidance of the tax liability could not mean that there was an intention to avoid such liability. The word “purpose” signifies an intention or design to achieve a particular result, namely, the avoidance of liability to taxation. Where the purpose is shown to be other than the avoidance of liability to taxation, the exemption given by the section would apply.

Contrary view of the Supreme Court in the case of Chidambaram Chettiar (through legal heirs) v. CIT: 60 ITR 28.

The facts in the case of Chidambaram Chettiarare similar. In this case, a Hindu undivided family carried on an extensive money lending business in British India, Burma and elsewhere. There was a partition in the family, and the members constituted themselves into a firm to carry on the business. Subsequently the firm started a money-lending business in Kuala Lumpur with capital transferred from its business in Burma. A company was incorporated in Pudukottai, a native State, with the purpose of taking over the Kuala Lumpur business. Subsequently the assets of the business of the firm in Kuala Lumpur were transferred to the company in consideration of shares of the company issued to the partners of the firm. Five years later, the company distributed bonus shares out of its profits.

The Revenue sought to assess the partners of the firm separately in respect of the profits of the company incorporated in Pudukottai derived from the business in Kuala Lumpur under section 44D.

It was contended by the taxpayer to begin with that since the transfer of assets to the non-resident company was made by the partnership firm in India, the partners of the firm could not be brought under the purview of the provision.

The contention was negatived by the Court relying on the decision of House of Lords in the case of Congreve &Anr. v. IRC: 16 ITR Supp. 107, wherein it was argued that for an income to fall under the purview of the above provision, it must have been such income as would have been taxable in India in the year of transfer. In the said year it was foreign income not remitted to India and as such was not taxable in India. The Court disregarded this contention on the ground that the taxability should be adjudged in the year of assessment of income only and not in the year of transfer, because what is relevant is the enjoyment of a foreign income by a resident in the year of assessment and not the transfer of assets by the transferor.

The apex Court held –

“…the sub-section is not concerned with the transferor but only with the result brought about by means of the transfer of the assets in conjunction with associated operations. The sub-section was designedly couched in the widest phraseology to prevent evasion of tax in the manner prescribed thereunder. If it was not so, a person can transfer his assets to another in a year they have not yielded any income at all, reserving indirectly the right to enjoy the income therefrom in future or he may transfer his assets when they are not yielding any income, but which may, under a scheme of future development, yield enormous profits. On the other hand, a bona fide transferor is amply protected by sub-s. (3) of s. 44D of the Act.”

The Court also held that since the partners of the firm along with their close relatives owned all the shares of the company, it has to be construed that they had the power to enjoy the income of the company arising from the transferred assets.

Conclusion

The deeming provision regarding power of enjoyment of income has been phrased in the widest possible way and its application has to be analyzed in the facts of each case. The provision will not be applicable if the main purpose of the transfer of assets was commercial expediency, incidentally resulting in savings of tax.

Post assessment year 2016-17, tax-avoidance,however, would be examined on the touchstone of GAAR. The list of illustrations given by the Shome Committee on the applicability of GAAR clarifies that GAAR would not be invokes in cases wherein tax benefit is linked to declaration or non-declaration of dividend since declaring dividend is a strategic policy decision which cannot be questioned. The ratio decidendi in the case of Maersk Line UK is in line with the rationale drawn by the Shome Committee. It would be, in such circumstances, interesting to note as to whether, post-implementation of GAAR, the factual matrix underlined in section 93 would become redundant and resume silence the way it hadsince the inception of Income-tax Act, 1961 or whether the same would still retain its place in a modified form.

(Author is working as Senior Executive – Corporate Tax with Wipro Limited at Bangalore)

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