TMI Blog2014 (8) TMI 9X X X X Extracts X X X X X X X X Extracts X X X X ..... ng of Section 2(28A) of the Act and Article 11 of the Indo –Mauritius DTAA – Held that:- It cannot be read to mean that the petitioner was only entitled to a fixed return on the investments made by it in the equity and CCDs issued by the JV company - the CCDs held by the petitioner would mandatorily be convertible into equity shares and the petitioner would be entitled to the benefits that would accrue to an equity shareholder in respect of the equity shares issued by the JV Company on conversion of the CCDs - merely because an investment agreement provides for exit options to an investor, would not change the nature of the investment made - It also cannot be ignored that the options were granted to the investor as well as to Vatika - it is essentially a joint venture agreement and it is common in any joint venture agreement for the co-venturers to include covenants for buying each-others’ stakes - Although, the SHA enables the petitioner to exit the investment by receiving a reasonable return on it, and in that sense it is assured of a minimum return, it cannot be read to mean that the CCDs were fixed return instruments, since the petitioner also had the option to continue with it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sel with Mr Ruchir Bhatia, Jr. Standing Counsel. JUDGMENT Vibhu Bakhru, J 1. The writ petitioner under Article 226/227 of the Constitution of India, is a company incorporated under the laws of Mauritius, challenges a ruling dated 21.03.2012 (hereinafter referred to as the impugned ruling ) of the Authority for Advance Ruling, (hereinafter referred to as AAR ) in A.A.R. No.1048 of 2011. By the impugned ruling, the AAR held that the entire gains on the sale of equity shares and Compulsorily Convertible Debentures (CCDs) held by the petitioner are not exempt from income tax in India by virtue of the Double Taxation Avoidance Convention (hereinafter referred to as DTAA ) with Mauritius and that the gains arising on the sale of CCDs are interest within the meaning of Section 2(28A) of the Income Tax Act, 1961 (hereinafter 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 to as Vatika ) is an Indian company and is inter alia engaged in the business of developing and dealing in real estate. Vatika is the owner of a contiguous tract of land admeasuring 6.881 acres or 10 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... consideration of ₹ 80 crores. Subsequently, the petitioner transferred further equity shares and CCDs to Vatika. The AAR noted that the Balance Sheet of 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 197 of the Act before the Income Tax Officer requesting for a nil withholding tax certificate to receive the total consideration from Vatika for transfer of equity shares and CCDs without deduction of tax. The Income Tax Officer by order dated 12.09.2010, held that the entire gain on the transfer of equity shares 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 before the AAR for advance ruling on the question:- Whether on the facts stated in the application and in law gains arising to the Applicant, being a tax resident of Mauritius on sale of equity shares and Compulsorily Convertible ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6 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 in terms of the said agreements, the petitioner was entitled to receive a fixed rate of return and that the duration of the investment would determine the quantum of return receivable by the petitioner. It was, thus, submitted that the transaction in question must be viewed as a loan transaction and the returns on the investment were simply interest, liable to be taxed in India. 11. The controversy in the present case revolves around the issue of whether the gains resulting to the petitioner from sale of CCDs held in the JV company are taxable as interest in its hands. 12. The AAR examined various decisions including the decision of the Supreme Court in the case of CWT v. Spencer Co.: (1973) 88 ITR 429 and held that:- In view of the facts before us, and the law laid down by the Hon ble Supreme Court, we are of the view ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it subscribed to were capital assets in its hands. This has also not been disputed by the Revenue before us. Although the written comments filed on behalf of the Revenue before the AAR stated that the gains received by the petitioner were business income, apparently that contention was not pressed and the AAR also did not refer to this contention. The principal dispute between the petitioner and the Revenue is whether the gains arising in the hands of the petitioner from transfer of its investments in the JV Company is interest or capital gains . 15. Under normal circumstances, it is undeniable that gains arising from transfer of a debenture, which is a capital asset in the hands of the transferor, in favour of a third party, would be capital gains and not interest. In other words, if a debenture (which is a capital asset) is transferred by a holder to a third party, the gains that arise i.e. difference between the costs of purchase and the sale consideration would be capital gains in the hands of a transferor. The dispute in the present case arises only because it has been held that the transaction between the petitioner and the Vatika is a sham transaction and is essential ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any part thereof. Essentially, the real estate project on the land in question now vested with the JV Company. 18. The terms of participation of the petitioner in the JV Company and, consequently, in the project were recorded in two separate agreements entered into on 11.08.2007 namely the SSA and the SHA. Under the SSA, it was contemplated that in the first instance (i.e. the First Closing Date) authorised share capital of the JV Company would be increased and Vatika would subscribe to 76,000 equity shares for an aggregate consideration of ₹ 7,60,000/-. The petitioner would also make its first tranche of investment in the JV company and be allotted 7350 equity shares of ₹ 10 each and 209,926,500 CCDs of ₹ 1 each. The petitioner would also subscribe to the shares and Compulsorily Convertible Debentures in 3 additional tranches. In aggregate, the petitioner would invest ₹ 100 crores and be allotted 46,307 equity shares, and 88,25,85,590 zero percent CCDs having a face value of ₹ 1. 19. The terms and conditions of the issue of CCDs were specified in schedule III to the SHA. The CCDs were compulsorily convertible into equity shares after expiry of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Date; (III) the Equity Payment; and (IV) an amount equal to 8% per annum of the Investor Investment Amount (less any Bought Back Subscription Amount) calculated from the second anniversary of the First Closing Date till the Completion Date, less the Vatika Return, if any; (ii) if the Call Option is exercised after the expiry of the third anniversary of the First Closing Date, shall be the sum of (I) the Investor Subscription Amount (less any Bought Back Subscription Amount); (II) the amount equal to the Accrued Return till the Completion Date; and (III) the Equity Payment, less the Vatika Return, if any. xxxx xxxx xxxx xxxx xxxx 10.2 Investor Put Option (a) In consideration of the mutual covenants of Vatika and the Investor contained herein, Vatika hereby grants to the Investor an option (the Put Option ), exercisable at any time on or subsequent to the fifth anniversary of the First Closing Date or in the event of a Material Default by the Company or Vatika which default has not been remedied or cured within thirty (30) days of notice of such default by the Investor, to sell to Vatika, all the Investor Securities ( Put Option Securities ) and upon exercise of the Put ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... By the very definition, call put options were only options that were available to the contracting parties. In the event none of the options were exercised, the CCDs held by the petitioner would mandatorily be convertible into equity shares and the petitioner would be entitled to the benefits that would accrue to an equity shareholder in respect of the equity shares issued by the JV Company on conversion of the CCDs. In our view, merely because an investment agreement provides for exit options to an investor, would not change the nature of the investment made. It also cannot be ignored that the options were granted to the investor as well as to Vatika. A plain reading of the SHA indicates that it is essentially a joint venture agreement and it is common in any joint venture agreement for the co-venturers to include covenants for buying each-others stakes. Although, the SHA enables the petitioner to exit the investment by receiving a reasonable return on it, and in that sense it is assured of a minimum return, the same cannot be read to mean that the CCDs were fixed return instruments, since the petitioner also had the option to continue with its investment as an equity sharehold ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unless a majority of the Directors present at such Board Meeting, which shall include at least one (1) Investor Director, vote in favour of such resolution. xxxx xxxx xxxx xxxx xxxx 4.6 Affirmative Vote Items 4.6.1 Subject only to any additional requirements imposed by the Act and Articles 4.6.2 and 11.1(b) below, during the term of this Agreement, neither the Company nor any Shareholder, Director, officer, committee, committee member, employee, agent or any of their respective delegates shall, without the affirmative written consent or approval of each of the Investor and Vatika whether in any Board Meeting, meeting of a committee of Directors, General Meeting, through any resolutions by circulation or otherwise, with respect to the Company, take any decisions or actions in relation to any of the matters set forth in the Schedule-II (the Affirmative Vote Items ). xxxx xxxx xxxx xxxx xxxx 4.7 General Meeting 4.7.1 An AGM shall be held each calendar year within three (3) months following the end of the previous Financial Year. The Board shall provide the Company's previous Financial Year's Financial Statements to all Shareholders at least one (1) month bef ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uditors of the Company. The Company shall also appoint a reputed accounting firm acceptable to the Investor as the internal auditor of the Company. xxxx xxxx xxxx xxxx xxxx 8. RELATED PARTY TRANSACTIONS 8.1 Vatika and the Company covenant that any related party transactions entered into by the Company shall be after full and adequate disclosure of all material aspects of such transactions and with the consent of the Investor which consent shall not be unreasonably withheld and in any event on an arm's-length basis and in compliance with all requirements of the Act and subject to procurement of any approvals that maybe required from any Governmental Authority. 8.2 Vatika and the Company shall ensure that all transactions with tenants, service providers, customers, vendors, contractors or the like, that are common between the Company and Vatika or its Affiliates, shall be on an arm's length basis. xxxx xxxx xxxx xxxx xxxx 9.7 Bank Accounts The Company shall, and Vatika shall cause the Company to open and maintain a bank account or bank accounts in its own name with such bank or banks as may be determined by the Board. Such account or accounts shall be ope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uld be made by the JV Company to Vatika under the Construction Contract without the authority of an independent Asset Manager which was defined as Westcourt Properties Private Limited. All the clauses clearly indicate that the affairs of the JV Company were to be managed independent of Vatika. In view of the above, we find the conclusion that when the corporate veil of the JV Company is lifted, Vatika and the JV Company were essentially one and the same entity to be wholly erroneous and not warranted. In our view, the terms of the SHA cannot be read to justify this conclusion. 29. Lastly, we must examine the finding that the present agreement has been structured only for the purposes of avoiding tax. Foreign Direct Investment (FDI) is permitted in the real estate sector, provided that certain mandatory conditions are met. According to Press Note 2 of 2005 issued by the Department of Industrial Policy Promotion, 100% FDI under the automatic route was allowed for investments in townships, housing, built up infrastructure and construction-development projects subject to the guidelines specified therein. The guidelines specified under the Press Note are quoted below:- a. Minim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not to be readily inferred that the entire structure of the transaction was designed solely for the purposes of avoiding tax. 32. It would also be relevant to note that if the gains are considered as payment of interest by Vatika, as is contended by the Revenue, the same would also mean that the quantum of interest is a deductable expenditure in the hands of Vatika. Viewed from this perspective, it would be erroneous to conclude that the whole transaction had been structured to ensure avoidance of tax on income. 33. The Supreme Court in the case of Vodafone International Holdings BV v. Union of India and Anr.: (2012) 6 SCC 613 had held that Court must look at the entire transaction as a whole and not adopt a dissecting approach. The Supreme Court further held that the court cannot start with the question of whether the transaction is a tax saving device, but should instead apply the look at test to ascertain its true legal nature. The relevant extract from the said judgment of the Supreme Court is quoted below:- 79. When it comes to taxation of a holding structure, at the threshold, the burden is on the Revenue to allege and establish abuse, in the sense of tax avoidanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entify the scheme and its dominant purpose. The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device. The stronger the evidence of a device, the stronger the corporate business purpose must exist to overcome the evidence of a device. 34. In the present case, there is sufficient commercial reason for the petitioner to have routed its investment in the real estate project through equity and CCDs. The pre-mature exit options as recorded in the SHA and the minimum return assumed by Vatika on its investment are clearly commercial agreements between the parties. These by itself do not change the legal nature of the transaction entered into between the parties. The terms of the arrangements between Vatika and the petitioner reveal that the JV was a genuine commercial venture, in which both partners had management rights. The call and put options were defined commercial options capable of being elected by the parties. In our opinion, there is, thus, no reason to ignore the legal nature of the instrument of a Compulsorily Convertible Debenture or to lift the corporate veil to treat the JV ..... X X X X Extracts X X X X X X X X Extracts X X X X
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