The Delhi bench of Income Tax Appellate Tribunal (ITAT) has allowed exemption to Mauritius-based investment company, Sarva Capital, on the disposal of shares that arose from the conversion of cumulative convertible preference shares (CCPS) which took place after April 1, 2017. However, CCPS were issued before April 1, 2017.

A tax resident of Mauritius, Sarva Capital LLC derived capital gain by way of selling shares in Indian entities. The company filed a return and claimed exemption under various sections of Double Taxation Avoidance Agreement (DTAA). However, Income Tax Department declined treaty benefits alleging tax avoidance through the treaty shopping mechanism and TRC (Tax Residency Certificate) not sufficient to establish the tax residency, beside others.

However, the bench rejected I-T Department’s argument on TRC by saying “it is well settled that once the tax resident of Mauritius is holding a valid TRC, the Assessing Officer in India cannot go behind the TRC to question the residency of the entity.” It also termed the allegation of treaty shopping “thoroughly misconceived and not borne out from any material/evidence brought on record.”

Further, it said that the difference between the CCPS and equity shares is that a preference share goes with preferential rights when it comes to receiving dividends or repaying capital, whereas, dividend on equity shares is not fixed but depends on the profits earned by the company. Hence gain from shares converted from CCPS will also be exempted from tax, it said.

This issue is critical, as the protocol for amendment of the Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains between India and Mauritius was signed on May 10, 2016. With this Protocol, India gets taxation rights on capital gains arising from the alienation of shares acquired on or after April 1, 2017, in a company resident in India with effect from financial year 2017-18, while, simultaneously, protection to investments in shares acquired before April 1, 2017 has also been provided.

Commenting on the matter, Amit Maheshwari, Tax Partner with AKM Global, the treaty benefit being granted to CCPS in this ruling shall provide clarity on several such instruments issued prior to this date. “The tribunal held that the word ‘shares’ mentioned in the tax treaty is to be understood in a broader sense which will take within its ambit all shares, including preference shares and thus, CCPS acquired before Apr 1, 2017 would fall within the category of shares,” he said.