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2025 (6) TMI 1932 - AT - Income TaxCapital gain income on account of sale of equity oriented mutual funds in India - capital gains were claimed as exempt under Article 13(4) of the India-Mauritius DTAA - AO held that when the assessee sells the equity-oriented Mutual Funds it becomes the beneficiary of capital gains arising from the alienation of the underlying asset of investment i.e. shares/ equity accordingly held that since the assessee has underlying assets of transactions as Equity therefore 65% of the total capital gains is covered under Article 13(3A) of the India Mauritius DTAA as the underlying asset in the transaction is shares and is taxable HELD THAT - In Mutual Fund schemes dividends are distributed when the fund has booked profits on the sale of securities in its portfolio. Mutual Fund dividend and stock dividends are two different things. While stock dividends represent the profits earned by a company mutual fund dividends are not an indicator of the profitability of a mutual fund scheme. High mutual fund dividends do not mean that the fund is doing very well or otherwise. When a mutual fund scheme declares a dividend the NAV (Net Asset Value) of the concerned scheme falls by a corresponding amount. The most vital aspect of investment in shares and investment in mutual funds is that while in selling of shares the possibility of rigging the share prices leading to heavy capital gain and siphoning out the gains to tax heavens cannot be ruled out. There can be no rigging of the price or artificial appreciation of the capital gains. Thus there is no doubt left that under the Indian Laws the shares and mutual fund both are different forms of securities and investment in both of them have significant differences in terms of the rights of investors regulation nature of return and taxability under the domestic laws. Equity Mutual Funds are merely a class of mutual funds. They may be treated along with equity shares for giving exemption or rate of taxation by virtue of section 10(38) or 112 of the Act but for the DTAA the gain on sale of Equity Mutual Funds cannot be said be out of alienation of shares . Deeming provisions for purposive interpretation cannot be extended absurdly to include in the definition of shares even a right entitlement to allotment of the shares of a company. Then in ITO Vs. Satish Beharilal Raheja 2013 (8) TMI 1113 - ITAT MUMBAI while dealing with Article 13(6) of the India Swiss DTAA the coordinate bench has following the decision of Apollo Tyres Ltd 2002 (5) TMI 5 - SUPREME COURT held that the units of mutual fund cannot be treated as shares of a company. Thus as concluded is that as for the purpose of taxing an income earned from selling a security the DTAA should be strictly interpreted and if any security is not specifically mentioned then by any fiction or way of purposive interpretation a distinct nature of security cannot be considered akin to one giving rise of taxable income.Appeal of the appeal of assessee is allowed.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered in the judgment are:
2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Taxability of capital gains on sale of equity-oriented mutual fund units under India-Mauritius DTAA Relevant legal framework and precedents: Article 13 of the India-Mauritius DTAA governs taxation of capital gains. Article 13(3A) provides that gains from alienation of shares acquired on or after 1 April 2017 in a company resident in a contracting state may be taxed in that state (source country). Article 13(4) provides that gains from alienation of any property other than those specified in earlier paragraphs (including shares) shall be taxable only in the resident state. Precedents include Supreme Court rulings emphasizing strict interpretation of tax statutes and various tribunal decisions holding that mutual fund units are distinct from shares for DTAA purposes. Court's interpretation and reasoning: The Assessing Officer (AO) initially held that since the underlying assets of the mutual funds were equity shares, the capital gains should be taxable under Article 13(3A). The Dispute Resolution Panel (DRP) affirmed this view, relying on the doctrine of purposive construction, reasoning that units of equity-oriented mutual funds are akin to shares because:
The DRP relied on the purposive construction rule, citing Supreme Court precedent that statutes should be interpreted in a manner harmonious with their object. It concluded that the entire capital gains from sale of equity-oriented mutual fund units are taxable in India under Article 13(3A). Key evidence and findings: The AO and DRP relied on mutual fund asset allocation data showing minimum 65% equity investment, Income Tax Act provisions treating mutual fund units similarly to shares for tax purposes, and the legislative intent behind the DTAA amendments. Application of law to facts: The AO and DRP applied Article 13(3A) to the capital gains arising from sale of equity-oriented mutual fund units, treating them as gains from alienation of shares, and thus taxable in India. Treatment of competing arguments: The assessee argued that mutual fund units are distinct from shares under Indian law and DTAA, citing Securities Contract (Regulation) Act, 1956, Companies Act, 2013, and various tribunal decisions. It contended that Article 13(3A) applies only to shares, not mutual fund units, and that gains on mutual fund units fall under Article 13(4) and are taxable only in the resident state (Mauritius). The assessee also invoked Supreme Court rulings that tax statutes and treaties must be interpreted strictly and as per the plain meaning of terms. The Court observed that the DRP's purposive construction ignored the settled principle that treaties, including DTAAs, are to be interpreted primarily by the ordinary meaning of their terms unless ambiguous. The Court noted that 'shares' is not defined in the DTAA, and the meaning must be derived from Indian domestic law as a whole, not selectively from Income Tax Act provisions. The Court emphasized that mutual fund units and shares are distinct securities under Indian law: shares represent ownership in a company under the Companies Act, whereas mutual funds are trusts regulated by SEBI and the Securities Contract (Regulation) Act separately defines shares and mutual fund units as different securities. Conclusions: The Court concluded that for the purposes of the India-Mauritius DTAA, units of equity-oriented mutual funds cannot be treated as 'shares' and thus gains arising from their alienation do not fall under Article 13(3A). Instead, such gains fall under the residuary clause Article 13(4) and are taxable only in the resident state (Mauritius), exempt in India. Issue 2: Applicability of grandfathering clause for units acquired prior to 1 April 2017 Relevant legal framework: Article 13(3A) applies only to shares acquired on or after 1 April 2017. Gains from shares acquired before that date continue to be exempt in India under Article 13(4) (grandfathering clause). Court's reasoning: The AO and DRP acknowledged the grandfathering clause but differed on whether it applied to mutual fund units. The assessee submitted detailed purchase and sale records showing units acquired prior to 1 April 2017, claiming exemption for gains on these units. The DRP directed the AO to verify the claim and grant exemption if substantiated, without making further enquiries from the assessee as per section 144C(8) of the Income Tax Act. Application of law to facts: The Court upheld the principle that gains on units acquired prior to 1 April 2017 should not be taxable in India under Article 13(3A), and accordingly, the AO was directed to allow exemption subject to verification. Issue 3: Proportionate taxation based on minimum equity allocation AO and DRP view: The AO initially taxed only 65% of the total capital gains, corresponding to the minimum equity allocation in the mutual funds, on the premise that only the equity portion is taxable under Article 13(3A). The DRP disagreed, holding that if mutual fund units are to be treated as shares, the entire capital gain is taxable, not just the proportionate equity component. Court's conclusion: The Court agreed with the DRP that once units are treated as shares for DTAA purposes, the entire capital gain on sale of such units is taxable in India under Article 13(3A), rejecting the AO's partial taxation approach. Issue 4: Levy of interest under section 234B of the Income Tax Act The assessee challenged the levy of interest under section 234B. The Court did not elaborate extensively on this issue but noted it as a ground of appeal. Given the main appeal was allowed on merits, the interest levy would be consequentially impacted. 3. SIGNIFICANT HOLDINGS "The Court concluded that for the purpose of the India-Mauritius DTAA, units of equity-oriented mutual funds cannot be treated as 'shares' within the meaning of Article 13(3A). The gains arising from alienation of such units fall under Article 13(4), which confers taxing rights exclusively to the resident state. Hence, capital gains arising from sale of equity-oriented mutual fund units by a Mauritius resident are exempt from tax in India." "The Court emphasized that the definition of 'shares' for DTAA purposes must be derived from the Indian domestic law as a whole, including the Companies Act, Securities Contract (Regulation) Act, and SEBI regulations, which distinctly classify shares and mutual fund units as separate securities." "The Court rejected the application of purposive construction by the DRP to expand the term 'shares' to include mutual fund units, holding that treaties must be interpreted according to the ordinary meaning of their terms unless ambiguity exists." "The Court upheld the grandfathering clause for units acquired prior to 1 April 2017, directing the AO to exempt gains on such units from taxation in India." "The Court agreed with the DRP that if mutual fund units were to be treated as shares (which they are not), the entire capital gain would be taxable and not just a proportionate amount based on equity allocation." "Accordingly, the appeal was allowed, setting aside the addition of capital gains income made by the AO and DRP, and holding that such gains are not taxable in India under the India-Mauritius DTAA."
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