The Hindu Business Line : Double tax avoidance treaties

The India-Mauritius Double Tax Avoidance Agreement is in news with the Finance Minister planning a revisit as and when it is expedient to do so having regard to economic, political and diplomatic considerations. For FIIs, setting up companies in Mauritius was useful to secure exemption from capital gains tax and concessional tax treatment on dividends. However, now with both exempt from Indian tax, the significance of the Treaty has been whittled down considerably. H. P. Ranina looks at the DTAAs.

THE Finance Minister recently stated in Parliament that he may revisit the India-Mauritius Double Tax Avoidance Agreement as and when it is expedient to do so having regard to economic, political and diplomatic considerations.

The beneficial provisions of the India-Mauritius Treaty have been the compelling force for foreign institutional investors (FIIs) setting up companies in Mauritius to secure exemption from capital gains tax and concessional tax treatment on dividends.

However, with the tax treatment of capital gains and dividends having undergone a sea-change in recent times with both being exempt from Indian tax, the significance of the Treaty has whittled considerably.

With the Securities Transaction Tax being effectively implemented without any hitches or glitches and with foreign institutional investors bringing in huge inflows running into billions of dollars, the taxability of profits arising on buying and selling of securities should elate the tax department.

With long-term capital gains tax being brought down to zero rate in respect of securities traded on stock exchanges and short-term capital gains tax rate brought down to 10 per cent, the only other issue pertains to profits arising from buying and selling securities.

In this context, what becomes important is the distinction between capital gains and trading profits.

The important principles that need to be emphasised are:

where a company purchases and sells shares, it must be shown that they were held as stock-in-trade, the power to purchase and sell shares in the memorandum of association being not decisive of the nature of transaction;

the substantive character of transactions, the manner of maintaining books of account, the magnitude of purchases and sales and the ratio between purchases and sales to the volume of holding would furnish a good guide to determine the nature of the transactions;

ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend, etc., then the profits accruing by transfer of such investments will yield capital gain and not revenue receipt.

These principles were considered in a ruling of the Authority for Advance Rulings (AAR) in Fidelity Advisor Series VIII, The facts in this case were that the applicant was registered as an investment company under the Investment Company Act, 1940 of the US. It invested in equity shares and also sought to provide long-term capital appreciation to its investors.

For the assessment year 2003-04 for which the previous year ended on March 31, 2003, the statement of purchases and sales of shares in various companies disclosed enormous transactions.

Except in respect of shares of Bharat Petroleum, Tata Iron and Steel Ltd., Bharat Heavy Electrical Ltd. and Bajaj Auto, the shares were sold after a year from the date of the purchases.

Having regard to the objects of the company, its investment of the amounts in India, the registration with SEBI, obtaining FII licence and the enormity and frequency of purchases and sales, the AAR concluded that the applicant held the shares and securities as business assets and the profits from the purchases and sales were in the nature of business income.

In view of this finding, the business profits of the applicant could be taxed in India under Article 7 of the Treaty but only if the applicant has a permanent establishment in India.

The AAR observed that the applicant did not have any branch or office in India, nor did it have any place of business in India that would lead to an inference that the applicant has a permanent establishment in India.

The applicant did not have any dependent agent or any employee in India that could be considered as the applicant's permanent establishment in India.

The only connection the applicant had in India was an independent domestic custodian appointed by the global custodian. The appointment of a global custodian and domestic custodian is in compliance with the requirement of Regulation 16(1) of SEBI.

The AAR ruled that the agent was of independent status. Hence, though business profits have been earned, they are not attributable to any permanent establishment in India and, therefore, cannot be made liable to tax under the Double Taxation Avoidance Agreement (DTAA).

Once an independent agent has been appointed, the FII or the non-resident cannot be said to have a permanent establishment.

Therefore, though business may be undertaken in India, in the absence of such business activities being related to a permanent establishment, no profits can be taxed in India.

Similar view has been taken earlier by the AAR in the case of Al Nisr Publishing. The facts in this case were that the applicant was a firm resident in Dubai in the United Arab Emirates engaged in the business of publishing, printing and distributing newspapers. It publishes a daily English newspaper called Gulf News.

The applicant sold advertising space to clients in different countries for publication in the Gulf News and associated publications.

In order to solicit orders for advertisement, the applicant entered into agency agreements with advertisement representatives in several countries. For India, such agreement was entered into by the appellant with BCL, which was appointed an exclusive agent for the solicitation of advertisements.

Under paragraph 2(e) of the agreement, BCL agreed that it would not enter into any contract or accept any order on behalf of the company or act on behalf of the applicant or bind or attempt to bind it in any way.

The applicant sought an advance ruling on the questions whether any business profits or income accrued or arose in India in the hands of the applicant out of advertising revenue received or receivable from its agent in India, and whether such advertising revenues remitted out of India by the agent of the applicant were subject to deduction of tax at source under Section 195 or any other provision of the Act.

The AAR ruled that Paragraph 4 of Article 5 of the DTAA between India and the UAE, creating a permanent establishment in India, is applicable only to a case where the person who acts as agent for the non-resident is not of independent status within the meaning of Paragraph 5.

BCL was an agent for receiving advertisements and collecting advertisement revenues on behalf of the applicant in India.

However, the agency was not exclusive. The BCL memorandum of association permitted it to carry on business as advertising agents and, in exercise of this power, and in the course of such business, BCL entered into contracts with several foreign newspapers to act as their representative for collection of advertisements in India.

The case thus clearly fell under the terms of Paragraph 5 of Article 5 of the DTAA because BCL was an agent of independent status within the meaning of this paragraph.

Therefore, there was no permanent establishment in India. Hence, the advertising revenues earned in India by Al Nisr Publishing were not taxable in its hands in view of Article 7 read with Article 5 of the DTAA.

In view of the aforesaid rulings, foreign institutional investors involved in trading activities of buying and selling securities will have a great advantage of not being liable to tax in India in respect of profits derived from their business activities, so long as they take the precaution to undertake their transactions in India through independent agents such as custodians, depositories and brokers who act for other investors as well.

This is irrespective of the location of the foreign company, whether it is in Mauritius or any other country because all DTAAs provide that no business profits can be taxed in India if the business is carried on through an independent agent which does not result in a permanent establishment.

Therefore, in such cases, the business profits would not be taxable in India whether the FIIs have set up companies in Mauritius or elsewhere.

(The author is a Mumbai-based advocate. He can be contacted at ranina@bom2.vsnl.net.in)

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