Whether gains on the sale of equity shares and Compulsorily Convertible Debentures are exempt from income tax in India by virtue of DTAA with Mauritius? And whether gains arising on the sale of CCDs are interest within the meaning of Section 2(28A) of the Income Tax Act, 1961 and taxable under Article 11 of India-Mauritius DTAA?

THE HIGH COURT OF DELHI AT NEW DELHI

 W.P.(C) 1648/2013 & CM NO.3105/2013

ZAHEER MAURITIUS

Petitioner

Versus

DIRECTOR OF INCOME TAX

(INTERNATIONAL TAXATION)-II

Respondent

Advocates who appeared in this case:

For the Petitioner: Mr Percy Pardiwala, Sr. Advocate Ms Rashmi

Chopra and Ms VritiAnand, Advocates.

For the Respondent: Mr SanjeevSabharwal, Sr. Standing

Counsel with Mr Ruchir Bhatia, Jr. Standing Counsel.

Before CORAM:

HON'BLE MR. JUSTICE S. RAVINDRA BHAT

HON'BLE MR. JUSTICE VIBHU BAKHRU

JUDGMENT

Judgment delivered on: 30.07.2014

VIBHU BAKHRU, J

1. The writ petitioner under Article 226/227 of the Constitution ofIndia, is a company incorporated under the laws of Mauritius, challenges aruling dated 21.03.2012 (hereinafter referred to as the ‘impugned ruling’) ofthe Authority for Advance Ruling, (herein after referred to as ‘AAR’) in A.A.R. No.1048 of 2011. By the impugned ruling, the AAR held that theentire gains on the sale of equity shares and Compulsorily Convertible Debentures (CCDs) held by the petitioner are not exempt from income taxin India by virtue of the Double Taxation Avoidance Convention(herein after referred to as ‘DTAA’) with Mauritius and that the gainsarising on the sale of CCDs are interest within the meaning of Section 2(28A) of the Income Tax Act, 1961 (herein after referred to as ‘the Act’) and Article 11 of the DTAC and are taxable as such.

2. Brief facts of the case are that Vatika Limited (hereinafter referred toas ‘Vatika’) is an Indian company and is inter alia engaged in the businessof developing and dealing in real estate. Vatika is the owner of a contiguoustract of land admeasuring 6.881 acres or 10,00,000 sq. ft situated in villageBadshahpur Tehsil, Gurgaon (hereinafter referred to as the ‘Land’), whichhas been reserved for being developed as a cyber park, to be used forsoftware development activities and IT enabled services as per theprovisions of Notification No. CCP (NCR)/GDP-III/2001/1555 dated 30.07.2001 as amended from time to time. SH Tech Park DevelopersPrivate Limited (hereinafter referred to as the ‘JV Company’) is an IndianCompany and was incorporated on 04.07.2007 as a 100% subsidiary of Vatika.

3. The petitioner is a company incorporated under the laws of Mauritiusand is a tax resident of Mauritius and is inter alia engaged in the businessof investment into Indian companies engaged in construction and development business in India. The petitioner entered into a Securities Subscription Agreement dated 11.08.2007 (hereinafter referred to as ‘SSA’)and a Shareholder’s Agreement dated 11.08.2007 (hereinafter referred to as‘SHA’) with Vatika and the JV Company. As per the SSA, the petitioner agreed to acquire 35% ownership interest in the JV Company by making atotal investment of `100 crores in five tranches. The petitioner agreed tosubscribe to 46,307 equity shares having a par value of `10/- each and88,25,85,590 zero percent CCDs having a par value of `1/- each in aplanned and phased manner. The SHA recorded the terms of therelationship between the petitioner, Vatika and the JV Company, their interse rights and obligations including matters relating to transfer of equityshares and the management and operation of the JV Company. The saidagreement also provided for a call option given to Vatika by the petitionerto acquire all the aforementioned securities during the call period andlikewise, a put option given by Vatika to the petitioner to sell to Vatika allthe aforementioned securities during the determined period.

4. Vatika and the JV Company executed a Development Rights Agreement dated 06.11.2007 (hereinafter referred to as ‘DRA’) in terms of which Vatika transferred the exclusive development rights, entitlementsand interest in the Land to the JV Company for development of the Land,with the right to retain the sale proceeds thereof exclusively.

5. On 08.04.2010, Vatika partly exercised the call option and purchased22,924 equity shares and 43,69,24,490 CCDs from the petitioner for a totalconsideration of `80 crores. Subsequently, the petitioner transferred furtherequity shares and CCDs to Vatika. The AAR noted that the Balance Sheetof Vatika for the year 2010-11 indicates that Vatika had acquired the entire CCDs subscribed to by the petitioner during the Financial Year – 2010-11, and the petitioner was left with only 23,383 equity shares of the JV Company.

6. On 12.05.2010, the petitioner filed an application under Section 197of the Act before the Income Tax Officer requesting for a ‘nil’ withholdingtax certificate to receive the total consideration from Vatika for transfer ofequity shares and CCDs without deduction of tax. The Income Tax Officerby order dated 12.09.2010, held that the entire gain on the transfer of equityshares and CCDs would be treated as interest and tax at the rate of 20%(plus surcharge and cess) should be withheld on the same.

7. Thereafter, on 16.02.2011, the Petitioner filed an application beforethe AAR for advance ruling on the question:-

“Whether on the facts stated in the application and in law gainsarising to the Applicant, being a tax resident of Mauritius onsale of equity shares and Compulsorily Convertible Debentures(CCDs) held by the Applicant in SH Tech Park DevelopersPrivate Limited, an Indian Company are exempt from capitalgains tax in India under Article 13(4) of Double TaxationAvoidance Agreement between India and Mauritius(‘DTAA’)?”

8. By the impugned ruling dated 21.03.2012, the AAR held as follows:“We, accordingly, answer the question that the entire gainsarising to the applicant on the sale of equity shares and CCDsare not exempt from capital gain tax in India under DTAC withMauritius. The gains arising on the sale of CCDs being interestwithin the meaning of Section 2(28A) of the Act and Article 11of the DTAC and are taxable as such.”

9. The learned counsel appearing for the petitioner submitted that theAAR had erred in passing the impugned ruling and holding that the amountof gains received/receivable by the petitioner resulting from transfer of theinvestments held by the petitioner in the JV company, was interest underSection 2(28A) of the Act. It was submitted that the AAR erred in notappreciating that there was no debtor and borrower relation between Vatikaand the petitioner. The CCDs were held as a capital assets by the petitionerand the transfer of the said investment was a transfer of a capital asset andany gains arising therefrom were liable to be treated as capital gains. Consequently, such gains could not be subjected to income tax in India interms of the DTAA between India and Mauritius. The petitioner further contended that the AAR erred in concluding that the transaction enteredinto between the petitioner, Vatika and the JV company was essentially aloan transaction, disguised as an investment in shares and CCDs. It was contended that the AAR erred in holding that the corporate veil ought to belifted and in proceeding on the basis that Vatika and the JV Company were,essentially, a single entity. Based on this conclusion, the AAR had held that the debt owed by the JV company was in reality Vatika’s debt and the amount received by the petitioner in excess of the investment made by the petitioner would amount to ‘interest’ paid/payable by Vatika for borrowing funds from the petitioner.

10. The learned counsel appearing for the respondent supported the decision of the AAR and submitted that the ruling was a reasoned one andwas neither arbitrary nor perverse and thus could not be challenged under Article 226 of the Constitution of India. It was contended on behalf of the Revenue that the transaction entered into between Vatika and the petitioner was essentially in the nature of an External Commercial Borrowing (ECB)and that was clear from the structure of the SSA and the SHA entered into by the petitioner, Vatika and the JV company. It was contended that interms of the said agreements, the petitioner was entitled to receive a fixedrate of return and that the duration of the investment would determine thequantum of return receivable by the petitioner. It was, thus, submitted that the transaction in question must be viewed as a loan transaction and thereturns on the investment were simply interest, liable to be taxed in India.

To read the full judgement, please find the attached file.

Attached File:

http://lobis.nic.in/dhc/VIB/judgement/30-07-2014/VIB30072014CW16482013.pdf