TMI Blog2014 (8) TMI 606X X X X Extracts X X X X X X X X Extracts X X X X ..... (1)(i) for taxing income which arises from transfer of assets overseas and which do not derive bulk of their value from assets in India. In this view, the expression “substantially” occurring in Explanation 5 would necessarily have to be read as synonymous to “ principally”, “mainly” or at least “majority”. Explanation 5 having been stated to be clarificatory must be read restrictively and at best to cover situations where in substance the assets in India are transacted by transacting in shares of overseas holding companies and not to transactions where assets situated overseas are transacted which also derive some value on account of assets situated in India - there can be no recourse to Explanation 5 to enlarge the scope of Section 9(1) of the Act so as to cast the net of tax on gains or income that may arise from transfer of an asset situated outside India, which derives bulk of its value from assets outside India. Even if the transaction had been structured in the manner as suggested on behalf of the Revenue, the gains arising to the shareholders of Copal-Jersey from sale of their shares in Copal-Jersey to Moody UK would not be taxable under Section 9(1)(i) of the Act, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave been filed by the Revenue challenging a common ruling dated 31.07.2012 (hereinafter referred to as the impugned ruling ) passed by the Authority for Advance Ruling (hereinafter referred to as AAR ). 2. By the impugned ruling, the AAR held that the capital gains arising out of the sale of shares of an Indian Company - Copal Research India Private Limited, sold by a company incorporated in Mauritius (Copal Research Limited) to a Cyprus company (M/s Moody s Group Cyprus Ltd.) and sale of shares of a US company (Exevo Inc.) sold by the Mauritius Company (Copal Market Research Limited) to another US company (Moody's Analytics, Inc.) were not liable to tax, in India, in the hands of the seller companies. Consequently, the purchasing companies - M/s Moody s Group Cyprus Ltd. and Moody s Analytics, Inc.- had no obligation to withhold tax under Section 195 of the Income Tax Act, 1961 (hereinafter referred to as the Act ) from the consideration payable to the sellers the Mauritian companies. 3. The details of various companies involved in the present writ petition are:- i. Copal Research Limited ( CRL ) - a company incorporated on 17.03.2004 under the laws of Mauritius. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CRIL that were sold to Moody Cyprus 1,14,425 (constituting 92% of the entire shareholding of CRIL) were acquired by CRL on 10.08.2004, by way of subscription and the balance 9,999 shares (constituting 8% of the subscribed and issued share capital) were purchased on 21.05.2010. 6. The relevant facts with respect to Transaction-II are: CRL acquired 100% shares of CMRL on 01.04.2008. Thereafter, CMRL acquired 100% shares of Exevo-USA. Exevo-USA holds 100% of the shareholding (10,06,550 shares) of Exevo-India. Subsequently, CMRL entered into a Share Purchase Agreement dated 03.11.2011 (hereinafter referred to as the SPA-II ) with Moody-USA whereby CMRL sold all the shares of Exevo- USA to Moody-USA. The effect of the said transaction was that the control of the Indian Company (Exevo-India), which was a wholly owned subsidiary of Exevo-USA, was also indirectly transferred to Moody-USA (an American Company). The sale consideration under the said SPA-II comprised of two components being a fixed sum of USD 11,176,000 payable in lump-sum (referred to as initial consideration in the SPA-II) and deferred consideration in the form of an 'Earn-out' payable in one full and final ins ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reated as business profits, whether such profits would be taxable in India under the Act in the absence of any 'Business Connection' of CMRL in India? 4) If the answer to question no. 3 above is in the affirmative, whether the 'Earn-Out' consideration would be chargeable to tax in the assessment year relevant to the previous year in which transfer took place or the year in which Earn-Out consideration is received by CMRL? 5) If the 'Earn-Out' consideration is to be treated as other income, whether such income would be taxable under the Act by virtue of any income having accrued or arisen to CMRL in India through or from: i. Any property in India; or ii. Any asset or source in India? 6) If the answer to question no. 5, is in the affirmative, whether the `Earn-Out' consideration would be chargeable to tax in the assessment year relevant to the previous year in which transfer took place or the year in which Earn-Out is received by CMRL? 7) Whether on the stated facts, the Applicant, being a foreign company and in absence of a place of business in India, would be subject to tax under the provisions to Section 115JB of the Act? 8) Whether ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts and in law, Moody's Group Cyprus Ltd. another non-resident is required to withhold tax under section 195 of the Act on the income chargeable to tax in India in the hands of the applicant from the sale of shares? 11. The AAR adopted the questions framed in AAR No.1186/2011 in AAR No.1189/2011, which were also answered in terms of the ruling in AAR 1186/2011. Similarly, the questions framed in AAR No.1188/2011 were adopted by the Authority in AAR No.1187/2011 and answered accordingly. The AAR passed a common order in all the four applications and by the impugned ruling held that the capital gains arising out of the said transaction were not liable to tax in India in the hands of the respondents. The AAR further ruled that the Earn-Out consideration would also be a part of the consideration receivable by the respondents. The AAR held that there was no obligation on Moody-USA and Moody- Cyprus to withhold tax under Section 195 of the Act. Aggrieved by the impugned ruling, the Revenue has filed the present writ petitions. 12. The learned counsel appearing for the Revenue has submitted that the transactions for sale of shares of Exevo-USA and CRIL must not be viewed in isol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CRIL held by CRL to Moody-Cyprus and shares of Exevo-USA to Moody-USA. Sellers in both these transactions, namely, CRL and CMRL were companies incorporated in Mauritius and the tax chargeable on gains arising from sale of shares in the hands of the Mauritius entities could be avoided by virtue of India-Mauritius Double Taxation Avoidance Agreement. It was submitted that in the given circumstances, the transactions in question, namely, sale of shares of CRIL and Exevo-US, were interspersed and as such were transactions structured prima facie for avoidance of tax. 14. The learned counsel for the assessee had objected to the contentions of the revenue and submitted that the same were neither raised before the AAR nor pleaded in the writ petition. He further submitted that the shares of CRIL and shares of Exevo-USA were sold to Moody Group as they insisted on acquiring 100% shareholding of these companies. However, with respect to shares of Copal-Jersey only 67% of its shares were sold to a separate entity of the Moody Group. That transaction, thus, ought to be considered as a transaction independent of Transaction-I and Transaction- II. 15. Before proceeding to consider the riv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d counsel for the respondents. He stated that the consideration paid by Moody-USA to CMRL was distributed by CMRL as dividend to CRL. CRL distributed the funds received as dividend and consideration for sale of shares of CRIL to Copal-Jersey, which in turn distributed the amounts received as dividends to its shareholders. 19. It follows from the above that the transactions of 03.11.2011 (i.e. SPA-I and SPA-II) resulted in Copal Group Shareholders receiving (i) dividend constituting 67% of the fixed consideration paid by Moody- Cyprus and Moody-USA for acquisition of the shares of CRIL and Exevo- US respectively; and (ii) sale consideration for the shares of Copal-Jersey. The banks and the financial institutions which held shares in Copal-Jersey also participated in the dividends that were distributed from the funds received from the sale proceeds of the sales of CRIL and Exevo-US. It would be obvious that this could not have been commercially achieved if the overall transaction had been structured in the manner as suggested by the Revenue i.e. by simplicitor sale of shares of Copal-Jersey. Thus, even if it is assumed that the transactions for sale of shares of CRIL and Exevo-US ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -Jersey would be exigible to tax assuming that the shares of Exevo-US and CRIL had not been transacted at the Mauritius level. 23. However, as the edifice of the arguments advanced by the Revenue is based on the substratal assumption that the gains arising from sale of shares of Copal-Jersey would be subject to tax, if shares of Exevo-US and CRIL had not been sold by CRL and CMRL, we consider it appropriate to consider the this contention. 24. In our view, the aforesaid contention of the Revenue also cannot be accepted for the reason that even if the sale of shares by the Copal Group Shareholders to Moody-UK has been structured in the manner as suggested by the Revenue, there would be no incidence of tax. According to the Revenue, the real transaction is sale of shares by shareholders of Copal- Jersey to Moody-UK. This would mean that shareholders holding 67% of the equity in Copal-Jersey namely the Copal Group Shareholders would transfer their shares to Moody-UK without there being any sale of shares by CRL and CMRL of their equity holdings in CRIL and Exevo-US respectively. 25. The consideration payable by Moody-UK to Copal Group Shareholders for their 67% shareholding w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be taxable in India. This would be true even if the entire value of the shares of an overseas company was derived from the value of assets situated in India. This issue arose in the case of Vodafone International Holdings BV v. Union of India and Anr.: (2012) 6 SCC 613 and the Supreme Court held that the transaction of sale and purchase of a share of an overseas company between two non-residents would fall outside the ambit of Section 9(1)(i) of the Act. Subsequently, Section 9(1) was amended by virtue of Finance Act, 2012 by introduction of Explanations 4 5 to Section 9(1)(i) of the Act, which read as under:- Explanation 4. For the removal of doubts, it is hereby clarified that the expression through shall mean and include and shall be deemed to have always meant and included by means of , in consequence of or by reason of . Explanation 5. For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value sub ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that may arise from transfer of an asset situated outside India, which derives bulk of its value from assets outside India. 29. It is also relevant to refer to the draft report submitted by the expert committee appointed by the Prime Minister in 2012 to report on the retrospective amendment relating to indirect transfer of assets (Shome Committee). The said Committee had, in its draft report, considered the import of the expression substantially as used in Explanation 5 to Section 9(1)(i) of the Act. The Committee considered the submissions of stakeholders that the expression substantially did not have any fixed meaning and was vague. After analysis, the Committee noted that it was necessary to pin down a definition of the said expression and for that purpose, there were no reason to depart from the Direct Tax Code Bill, 2010 (DTC) that had been put in the public domain. Under the DTC, gains from the sale of assets situated overseas, which derived more than 50% of their value from assets situated in India, were liable to be taxed in India. The Shome Committee in its draft report recommended as under:- The word substantially used in Explanation 5 should be defined as a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of the capital stock of a company, or of an interest in a partnership, trust or estate, the property of which consists directly or indirectly principally of immovable property situated in a Contracting State may be taxed in that State. In particular: (1) Nothing contained in this paragraph shall apply to a company, partnership, trust or estate, other than a company, partnership, trust or estate engaged in the business of management of immovable properties, the property of which consists directly or indirectly principally of immovable property used by such company, partnership, trust or estate in its business activities. (2) For the purposes of this paragraph, principally in relation to ownership of immovable property means the value of such immovable property exceeding 50 per cent of the aggregate value of all assets owned by the company, partnership, trust or estate. 32. The OECD Model Tax Convention on Income and on Capital provides a means of settling on a uniform basis the most common problems that arise in the field of international juridical double taxation. Article 13 of the said Convention deals with the taxes on capital gains. Article 13(1) provides that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce their revenues are generated from within the Copal Group. It is, therefore, urged that since Rishi Khosla is a resident of the United Kingdom, the situs of CRL and CMRL ought to be taken as United Kingdom - from where the affairs of the Copal Group, including CRL and CMRL are alleged to be conducted - and not Mauritius. The learned counsel for the Revenue had submitted that Rishi Khosla had also varied the terms of the transactions. According to him, the same indicated that management of the companies was synonymous with Rishi Khosla. 37. The learned counsel for the respondents contested these contentions urged by the petitioner. It was stated that the companies were managed by their respective Board of Directors. It is also disputed that CRL and CMRL were not operative companies. It is stated that both CRL and CMRL held category-I Global Business Licenses (GBL) w.e.f. 18.03.2004 and 03.04.2008 respectively. CRL received substantial revenues from provision of services relating to business of financial research and CMRL also received revenues from provision of services relating to business of market research. The financial statements of both the said companies indicated that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a role larger than that of a normal agent but circumstances did not warrant an inference that the control and management of the companies vested with him and not with the respective Board of Directors. The relevant findings of the AAR are as under:- 11. Assuming that learned counsel for the Revenue is right in his submission the decision in Vodafone has modified the ratio of the decision in Azadi Bachao Andolan on the conclusiveness of a tax residency certificate, it cannot be said that it has been shown that the effective management of the companies is not from where their Board of Directors function. Normally, the management of a company vests in its Board of Directors as authorized by the General Body. The role of Rishi Khosla highlighted by the Revenue is in respect of the sale transactions undertaken and in pushing them through. It does not appear to be a role in connection with the running of the businesses of the companies concerned. It is not shown that the management of the companies in Mauritius in general, is not with a Board of Directors of those companies sitting in Mauritius and that the management and control is from United Kingdom of which Rishi Khosla is a resi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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