AAR Ruling: Capital gains arising upon the transfer of shares of a wholly owned Indian subsidiary by a non resident parent company to a non resident would not be liable to tax as per the India-Netherlands DTAA [KSPG Netherlands Holding B.V.– AAR No. 818 of 2009].
KSPG Netherlands Holding B.V. (applicant), is a company incorporated in Netherlands on November 6, 2008 with its registered office in Amsterdam. PG India is the private limited company incorporated under the Companies Act, 1956 on October 26, 2006, which was held by Pierburg GmbH until November 2008. During November 2008, Pierburg GmbH sold its entire shareholding in PG India to the applicant. The applicant, thereafter, made substantial investments in PG India.
Questions before the Authority for Advance Ruling (AAR):
- Whether the applicant would be liable to tax in India on the dividends received by it from PG India as per the provision of the Income Tax Act, 1961 (Act)?
- Whether the applicant would be liable to tax in India on the capital gains that may accrue from the transfer of shares in PG India to another non-resident as per the provisions in the India-Netherlands Double Taxation Avoidance Agreement (DTAA)?
- Whether the transferor would be liable to tax in India on the capital gains that may accrue from the buy-back of shares by PG India?
Provisions of DTAA
Para 5 of Article 13 dealing with capital gains on transfer of shares reads as under:
“5. Gains from the alienation of any property other than that referred to in paragraphs 1,2,3 and 4, shall be taxable only in the State of which the alienator is a resident.
However, gains from the alienation of shares issued by a company resident in the other State which shares form part of at least a 10 per cent interest in the capital stock of that company may be taxed in the other State if the alienation takes place to a resident of that other State. However, such gains shall remain taxable only in the State of which the alienator is a resident if such gains are realised in the course of a corporate organisation, reorganisation, amalgamation, division or similar transaction, and the buyer or seller owns at least 10 per cent of the capital of the other.”
AAR Observation and Ruling:
- By virtue of Section 9(1)(iv) of the Act, a dividend paid by an Indian company outside India is deemed to be taxed in India. However, in view of section 10(34) of the Act, the income by way of dividend s referred to in section 115-O of the Act (payment of dividend distribution tax on dividend by PG India) is exempt from the total income of the previous year.
- As regards the capital gains is concerned the AAR observed that as per para 5 of Article 13 of the DTAA, the transfer of shares of an Indian company by the Netherlands company to a resident of India and such share holding in the Indian company forms more than 10 per cent of the share capital of such Indian company, may also be liable to tax in India. However, in the instant case, there would be a transfer of shares of an Indian company by the Netherlands company to another non-resident and hence, it would be liable to tax only in Netherlands.
- The Revenue contended that the interpolation of the Netherlands company i.e. applicant is a part of the scheme for the avoidance of capital gains tax liability and therefore, Pierburg GmbH should be considered as beneficial owner. Hence, as per the India-Germany DTAA, such capital gains would be liable to tax in India. The AAR found it difficult to apprehend this contention of the Revenue. The AAR observed that assuming that the concept of beneficial ownership which finds specific mention in Articles 10 to 12 of the Treaty (relating to dividends, interest, royalty and FTS), can be transposed into Article 13, the same did not find any factual or legal basis to hold Pierburg GmbH as the real beneficial owner of the shares and the capital gains that would accrue on such transfer. The glaring fact which is to be taken note of in this context is that the applicant, which was incorporated towards the end of 2008 made significant investments in PG India.
- The AAR further observed that the applicant had initially acquired the shares of the Indian Company from Pierburg GmbH at a price determined as per the evaluation guidelines prescribed under the Foreign Exchange Management Act, 2000. The substantial investments, that were made subsequently with a view to broaden the capital base of the Indian company. Therefore, the implied suggestion of the Revenue that the applicant is a sham entity or a conduit company deliberately set up to avoid the tax liability relating to capital gains is wholly misconceived. It is not possible to assume that the applicant would merely act as a conduit to syphon off the gains to the ultimate holding company by means of a colour able device contrary to its corporate status and the stake in the Indian company.
- Based on the above arguments, AAR held that the capital gains, which would be earned by the applicant by transferring the shares of PG India to a non- resident outside India, would not be liable to tax, even if the quantum of such transfer is more than 10 per cent of the total shareholding.
- As regards the capital gains on buy back of shares by PG India is concerned, the AAR observed that this transaction of buy-back of shares would be an altogether different transaction from the transfer of shares embraced within Question No.2. Therefore, the AAR refrained from giving any ruling on the question raised by the applicant in this regard and directed to the applicant to make a separate application for this transaction at the appropriate time.
Comments: This Ruling is in line with the interpretation of Article 13(5) of the DTAA and that all business transactions which have a bearing on the tax liability are not always to be seen as tools of tax avoidance.