Major relief for FPIs from Mauritius, Singapore claiming DTAA treaty benefit

In a major relief for foreign portfolio investors (FPIs) coming via Mauritius or Singapore, the Bombay High Court has quashed an order by the Mumbai office of the Income-Tax Department that had denied any treaty benefits under the ‘grandfathering clause’ to investors, and withheld ₹800-crore of capital gains made from the selling of shares of an NBFC as tax deducted at source (TDS).

The High Court said that the theory of ‘colourable device’ is to be established by the Income-Tax Department at the time of assessment and if, prima facie , the transaction satisfies the Double Taxation Avoidance Agreement (DTAA) with Mauritius, then the TDS should not be withheld.

‘Grandfathering clause’

Under the ‘grandfathering clause’ in the amended tax treaty, the government allowed 7.5 per cent tax till 2019 only to those registered FPIs that could prove commercial substance in Singapore or Mauritius. The rest were to be charged at 15 per cent. But for investors’ gains from share-sale arising from an investment prior to March 2017, when the grandfathering clause was inserted, the profits cannot be taxed in India.

The Mauritius investor in this particular case claimed benefit under the Double Taxation Avoidance Agreement (DTAA) and sought to repatriate gains made from sale of an NBFC’s shares. The assessee made an application for ‘nil’ withholding tax certificate under Section 197, which was rejected by the Assessing Officer. Section 197 permits certain tax-payers to get relief from TDS at a lower or nil rate.

The AO reasoned that the entire transaction was not genuine merely on the fact that the investor had not transacted any other business by itself and held the deal a ‘colourable device,’ which is nothing but a transaction structured with the sole purpose of avoiding tax.

The High Court said the Tax Department in the present case did not provide sufficient prima facie material to demonstrate that the entire transaction was a sham and a colourable device. The Court was mainly of the view that such a matter should be dealt with during the assessment.

No concrete proof

But the High Court also acknowledged that “Despite the existence of DTAA, despite the availability of the TRC (tax residency certificate)… and despite the CBDT circular that such certificate, as long as in operation, would be a valid consideration for applying the DTAA, we do not find that as laid down by the Supreme Court through a series of judgments, has shut out the case of the revenue totally when it comes to a fraudulent or fictitious transaction.”

The High Court clarified that the mere fact that the assessee company has not transacted any other business by itself may not be conclusive, and the assessee’s inability to produce TRC of the companies that hold shares in the assessee company, the extent of administrative expenditure and the employment structure can be some of the factors which eventually would go to establish whether the transaction was a sham. But all these aspects can and need to be gone into during the assessment and not when claiming DTAA benefits.

A lawyer who deals with treaty cases said that “The ruling will mainly curtail the Tax Department’s bullying that goes on without any concrete proof to establish tax avoidance and impacts a large number of investors.”

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