TMI Blog1996 (8) TMI 512X X X X Extracts X X X X X X X X Extracts X X X X ..... at the provisions of section 161 do not apply to the incomeof the applicant from the contributory trust because of the power vestedin the trustees to add to the list of the beneficiaries on the terms laiddown in the indenture of trust and the contribution agreement, then ifsuch power is deleted, would the assessment of the applicant in respectof its proportionate share of income of the trust be made in accordancewith section 161 ? Whether if it is held that the shares of the additional beneficiaries are indeter-minate whether the capital gains arising to the applicant will be chargedto tax at the rate of 20 per cent. as prescribed in section 112 of the Act ? Whether will there be any tax withholding by the investee companies at the time of distribution of income to the CT ? Whether, on the facts and circumstances of the case,the character of the applicant’s proportionate share in the income of thecontributory trust will be same as in the hands of the contributory trust? Whether the applicant’s share in the dividend earned by the contributorytrust will be chargeable to tax and if so at what rate? Whether the applicant’s share in the interest earned by the contributory ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urces and understanding of the region . The transactions now proposed (which give rise to the present applications) are restricted in its operations to the Indian sector . The American company in collaboration with an Indian financial service company now proposes to set up another fund. This fund will consist of two tranches (sections or branches), one a rupee tranche called a contributory trust holding funds in Indian currency and a Mauritian company (referred to as the foreign tranche ) holding funds in dollars. The rupee tranche is to be set up as a contributory trust (hereinafter referred to briefly as the CT ) constituted under an indenture of trust drawn up between the Indian financial service company and another Indian trust company. The trust company will be trustees of the CT and the trust funds will vest in it under the Indian law. The expression CT and trustees are, therefore, interchangeably used in the ensuing discussions. Parallel to the CT, the foreign tranche plans to hold funds to the tune of $100 million. The American company has committed to itself to contribute $15 million to this company for investment. Other contributors from several countries a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cessary documents to give effect to the above arrangements have been drawn up and placed before the Authority. These are: (i) Draft indenture of trust (T. D.) between the Indian financial service company and the trust company constituting the CT of which the said company is appointed trustees. [A draft trust deed originally filed with the application was allowed to be replaced by a revised draft trust deed at the time of arguments and it is this revised T. D. that is referred to below]. (ii) Draft contribution agreement (C. A.) between the contributors on the one hand and the trustees and the IM on the other. (iii) Draft investment management agreement between the trustees and the IM. (iv) Draft advisory agreement between the Indian financial service company and the management company. Arguments before the Authority were addressed on the basis of these draft agreements. However, since the transactions are still in the stage of proposed ones, counsel for the applicant was willing to consider suitable modifications in the agreement in respect of clauses which, as they stand, may create some difficulties for the applicants from the tax angle. These aspects are touched u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the contributors; and (v) the date of winding up of the I. M. Clause 3(a) of the T. D. obliges the trustees to appoint the I. M. to carry out its investment policies. The mode of distribution of the trust fund and income is set out in clause 5 of the trust deed which reads thus: Distribution of trust fund and income: 5. The trustee shall stand possessed of the trust fund and the income thereof shall accrue upon the trust for the benefit of the beneficiaries and the trustee shall make distributions to the beneficiaries/contributors as follows: (a) as regards the initial settlement as specified in the second schedule to distribute the same and any income accumulated thereon in equal proportions on termination of the trust amongst the beneficiaries as listed in the third schedule, (b) as regards all additional amounts to be distributed to the beneficiaries in proportion to the contributions made by them and in accordance with the fourth schedule-the contribution agreement. Clause 7 of the trust deed contains a provision to the following effect: Power of addition: 7. (a) The trustee shall have the power at any time or times during the trust per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trust deed, the instruments constituting the trust in their cases. The purposes of the trust are, as stated in the TD, to invest the trust funds and distributing the proceeds to the beneficiaries. This is, in a sense, nothing more than an arrangement by which certain parties agreed to contribute funds for a common purpose and divide the profits amongst themselves. No doubt, the same objective could be achieved by the constitution of a firm or a company but, equally, there seems to be no valid objection if the parties wish to do it in the form of a trust which, under the trust act, merely represents certain obligations annexed to the ownership of property in the form of the contributed funds. The purposes of the trust cannot be said to be forbidden by law or likely to defeat the provisions of any law or fraudulent or involving injury to any person or property or opposed to public policy: vide section 4 of the India Trusts Act (2 of 1882). It will appear later that, in entering into the present transactions, the parties took into account certain difficulties if the same transactions had been put through the format of a company and also took into account certain financial and tax imp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t part to income and to determine as between separate funds and separate parts or shares the allocation of income, gains, profits, losses and distributions and so that any decisions of the trustee under this regulation whether made in writing or implied from their acts shall so far as the law may permit be conclusive and binding on the beneficiaries and all persons actually or prospectively interested under this settlement. 17. Decisions, etc., of the trustee.. . . . (d) The following powers of the trustee shall only be exercised by a majority of the directors of the trustee present and voting at a meeting of its board of directors: (i) application of the net profit of the trust otherwise than by way of distribution to the beneficiaries; and (ii) delegation of any powers and authorities of the trustee. The First Schedule to the T. D. sets out the Regulations that govern the trustee. Attention has been drawn to paragraph 2 and paragraph 8 which read thus: 2. The trust fund shall be managed by the investment manager in accordance with the investment objectives, policies and restrictions set forth in the private placement memorandum dated November, 19 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the investment manager. Each contributor s capital contribution shall be in an amount pro rata to the contributor s capital commitments to the trust. The investment manager shall give the contributor a takedown notice (draw down) in accordance with this agreement (notice clause) within 21 calendar days in advance of the date on which the capital contribution shall be required to be made. (b) On the draw down date, for any draw down of the contribution amount, if all conditions specified in article IV (conditions of contributions) are met, each of the contributors will pay their draw down in rupees, payable at par, to the trust s bank account as specified in the investment manager s notice of contribution. (c) Notwithstanding the above, the investment manager may choose to establish the contribution fund with minimum commitments of ₹ 750 million for the initial closing (the closing) with staged closings for subsequent commitments. Such staged closings will occur not later than 12 months after the closing. 2.05 Upon receipt of draw down amount from any of the contributors, the trustee, shall: (a) issue, to the respective contributor, units with a total nominal value ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n its capital account adjusted under paragraph 2.06(c) and payable only out of, and to the extent of, that portion of the proceeds of investments made prior to the date of the takedown notice, with respect to which such defaulting contributor defaulted, which corresponds to such defaulting contributor s contributed capital percentage as of such date; and (f) appropriate adjustments shall be made to the contributed capital percentages of the non-defaulting contributors. Each of the contributors hereby consents to the application to it of the remedies provided in this paragraph 2.06 in recognition of the risk and speculative damages its default would cause to the other contributors, and further agrees that the available such remedies shall not preclude any other remedies which may be available in law, in equity, by statute or otherwise. The initial closing is to be on the date of the trust deed [clause 1(k) of the deed] and will be followed by subsequent closings within 12 months from this date [paragraph 4.04]. Investments made subsequent to this date but before any subsequent closing are governed by paragraph 2.09 which reads: 2.09 Investments prio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons from such investments, net of operating expenses including distribution of fees and share of profit to the investment manager and capital expenditures as the investment manager shall reasonably determine will be distributed as follows: (a) First, to the contributor until 100 per cent. of capital contribution has been deemed to have been returned plus a 9 per cent. annual rate of return compounded semi-annually on all such capital contributions from the time of draw down ( the priority return ). (b) Thereafter, 80 per cent. to the contributor and 20 per cent. to the investment manager, provided that distributions will be made in accordance with sub-paragraphs (a) above until the earlier of: (i) the first anniversary of the first closing, (ii) the date on which the fund is deemed to be fully invested by the investment manager, or (iii) the date on which the investment manager gives written notice of the dissolution of the contribution fund to the contributor. . . . 6.04 Income and expenses from other sources: All items of income gain, loss or expenses not directly attributable to a particular portfolio investment (e.g., interest or temporary investments, and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pay to the trust, any contributor or any creditor of the trust all or any fraction of any negative amount of such contributor s capital account. 3. Investment management agreement (I. M. A.): The management of the trust funds is to be entrusted by the CT to the IM under an agreement entered into with it. The IM is a limited life company incorporated in Mauritius. It is a 100 per cent. subsidiary of an American asset management company but it is proposed to restrict its shareholding to 73 per cent. by transferring 22 per cent. to the Indian financial service company and five per cent. to the Asian Development Bank Ltd. (ADB). Its board of directors will also have representatives of the two companies and ADB. The IM is to be responsible for the day-today management of the trust fund in accordance with the provisions of this Agreement and any directions and instructions of the trustees [2.01]. Paragraph 3.03 states that the investment manager shall be responsible for the day-to-day management of the trust fund, which shall be subject to any directions, instructions and guidelines provided by the trustees . Paragraphs 5.01, 6.04 and 7.01 refer to the areas in which the trust ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... estment managerial support and/ or guidance to the portfolio investment and the entrepreneurs and if necessary to assist in the administration of the trust fund. Article XIII dealing with delegation of duties envisages an investment committee (paragraph 13.01), an advisory board (paragraph 13.02) and advisory contracts with the Indian financial service company and the American company (paragraph 13.03) but makes it clear (paragraph 13.04) that, regardless of all delegation, the manager shall remain responsible for all decisions and be liable for any delegate s act or omission that it would otherwise have been liable for. Paragraph 14.01 stipulates for the payment to the IM of a fee of 2.5 per cent. of the aggregate capital commitments of the contributors reduced by returns of capital directly attributable to specific investments upon which distributed gains (or losses) of the trust have been realised. At the end of the commitment period, the investment management fee shall be based on the aggregate unreturned capital. To the extent that the balance of capital commitments or unreturned capital of the trust fund plus the capital commitment or unreturned capital of the the fund ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 161 of the Income-tax Act, 1961 (the Act) ? 2. Based on the facts and circumstances of the case, whether the contributory trust would be regarded as a see through or transparent entity vis-a-vis the applicant; i.e., to say the applicant will be taxed in respect of its proportionate share of income under section 161 of the Act ? 3. Based on the facts and circumstances of the case, if it is held that the provisions of section 161 do not apply to the income of the applicant from the contributory trust because of the power vested in the trustees to add to the list of the beneficiaries on the terms laid down in the indenture of trust and the contribution agreement, then if such power is deleted, would the assessment of the applicant in respect of its proportionate share of income of the trust be made in accordance with section 161 ? 4. Based on the facts and circumstances of the case, even if it is held that the shares of the additional beneficiaries are indeterminate whether the capital gains arising to the applicant will be charged to tax at the rate of 20 per cent. as prescribed in section 112 of the Act ? 5. Based on the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of management fees and carried interest to the applicant ? The AR submitted that the phrasing of the first question above in the negative is not correct and that this question may be reframed thus: 1. Based on the facts and circumstances of the case, and in view of the provisions of the India-Mauritius double tax avoidance agreement, can it be construed that the applicant has a permanent establishment (P.E.) in India ? There can be no objection to this and it is the question, as thus modified, along with the other three questions that will be considered by the Authority. Though numerous and seemingly involved in their language, the points raised by the applicants lie within a narrow compass. In the case of the IC, the basic question to be decided is whether the assessments of the CT and the IC will be governed by section 161 or section 164 of the Act and what rates of tax would be applicable to the IC s receipts from the CT. In the case of the IM, the very short question that has to be answered is whether it can be said to have a permanent establishment in India within the meaning of the Agreement for the Avoidance of Double Taxation between India and Maur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 164. Charge of tax where share of beneficiaries unknown. (1)Subject to the provisions of sub-sections (2) and (3), where any income in respect of which the persons mentioned in clauses (iii) and (iv) of sub-section (1) of section 160 are liable as representative assessees or any partthere of is not specifically receivable on behalf or for the benefit of anyone person or where the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable are indeterminate or unknown (such income, such part of the income and such persons being hereafter in this section referred to as relevant income , part of relevant income and beneficiaries , respectively), tax shall becharged on the relevant income or part of relevant income at the maxi-mum marginal rate: Provided that in a case where - (i) none of the beneficiaries has any other income chargeable under this Act exceeding the maximum amount not chargeable to tax in the case of an association of persons or is a beneficiary under any other trust; or (ii) the relevant income or part of relevant income is receivable under a trust declared by any person by will and such trust is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e person on whose behalf or for whose benefit such income or such partthereof is receivable during the previous year is expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and is identifiable as such on the date of such order, instrument or deed; (ii) the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is received shall be deemed to be indeterminate or unknown unless the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable, are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed. 166. Direct assessment or recovery not barred. Nothing in the foregoing sections in this Chapter shall prevent either the direct assessment of the person on whose behalf or for whose benefit income therein referred to is receivable, or the recovery from such person of the tax payable in respect of such income. Before proceeding to discuss these provisions, it is necessary to deal with two preliminary ob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in India, cash disbursements to the winners in excess of ₹ 10,000 could be disallowed under section 40A(3) of the Act. The Authority rejected the application for the simple reason that the question sought to be raised relates not to the applicant but to a resident Indian subsidiary . This objection is not maintainable here in the view of the Authority. The IC, as a non-resident, is entitled to file an application under Chapter XIX-Band, though the definition of advance ruling in section 245N(a) places no specific restrictions regarding the nature of the questions to be asked, the Authority is of opinion that the question raised should be one which directly involves or affects the income-tax liability of the non-resident. That requirement is fulfilled in the present case. In the case cited, the question pertained to the assessment of an Indian company. The applicant, a totally different entity, was affected only in a remote and indirect manner in that any disallowances of expenses in the hands of the subsidiary might result in larger profit distributions to it. But here the applicant company and the CT are connected as beneficiary and trustee and the provisions of Chapter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... plicable and the officer assessing the trust should hold-though it is perhaps unlikely-that section 161 would apply, neither the CT nor the IC would have any grievance. On the other hand, if the Authority should hold section 161to be applicable and the officer assessing the trust should take a contrary view and the IC should be affected, it will have to raise a contest but, whether this is done in another application under section 245Q or raised before the authorities in some other proceedings, the ruling of the Authority will have to be given effect to. However, what steps should be taken in the matter in that eventuality, is a matter for the IC to decide at the appropriate time, and, if the IC is prepared to risk a ruling even now, it is not for the Authority to say nay to it. It is difficult to see how any ruling given by the Authority could be infructuous. The objection is overruled. The second objection raised to the maintainability of the application is on the basis of clause (c) of the proviso to section 245R(2). It is pointed out that the scheme for making investments in India in infrastructural and other core sectors has been initiated by the American company and th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India does not as yet welcome foreign investment in the financialservices sector. If the management company were to be set up in India, the foreign investors would need the approval of the Foreign Investment Promotion Board (FIPB). As per the internal guidelines of Ministry ofFinance, in case the foreign management company wishes to hold a controlling interest, in the Indian asset management company, it is required to invest a higher amount of capital, e.g., for a 51 per cent. -75 per cent. stake, such companies are generally required to invest US $5 million whereas for holding more than 75 per cent. stake, they may be required to invest up to US $ 50 million, although the management company as such, does not require much capital. In one of the cases, we have received a letter from Ministry of Finance stating that the application has been rejected on the ground that the applicant does not satisfy the capitalisation norms for non-banking finance companies (attachment). Generally, FIPB takes approximately 90 days to approve a proposal. In the case of offshore funds, many a time, core investors insist to hold a stake in the management company. It would be a very cumber-some ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The IC was set up only to demonstrate a commitment of the American company group to contribute to it and give other Indian investors a feeling of confidence inspired by the commitment of a member of the American company family to involve itself therein. It is also pointed out that there is no reason to doubt the bona fides of the American company s desire to help development of infrastructural sector in India with international help. It should not be overlooked that several benefits flow to India and the Indian financial service company from the arrangements made under this dispensation. The Authority has carefully considered these contentions. The set-ting up of a large number of subsidiaries of the American company group with their headquarters at Mauritius no doubt generates a first impression that there may be some deeper purpose underlying such creations. In the first place, the share capital of the IC is a nominal amount. Mention has earlier been made that the IC has been incorporated with a share capital of only $4. This might seem to indicate that the company was a mere front, an insignificant entity incapable of substantial investment handling. Such an inference, howev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... trustee company acting in the fiduciary capacity on behalf of the beneficiaries as representative assessee . However, in accordance with the provisions of section 161 of the Income-tax Act, 1961, even if the trustee company is assessed to taxing respect of income of the beneficiaries, tax shall be levied upon and recovered from the trustee company in like manner and to the same extent as it would be liveable upon and recoverable from the beneficiaries. An advance ruling is being sought from the Indian revenue authorities on this matter. In view of the particularized nature of tax consequences, each investor is advised to consult its own tax adviser with respect to the specific tax consequences of being an investor of the fund. Mauritius tax considerations: The company in Mauritius has been established as an offshore company for the purpose of the Mauritian Offshore Business Activities Act, 1992, with the result that its income will not be subject to income-tax in Mauritius unless it elects to pay tax at specified rates not exceeding35 per cent. It is the intention of the company in Mauritius that it may elect to pay tax on income distributions received from its investme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -tax. In the light of these considerations, the Authority has come to the conclusion that, certain suspicious features notwithstanding, a ruling cannot be declined on the ground that the transaction was designed for the avoidance of Indian income-tax. With the preliminary objections disposed of, one may turn now to the basic issue raised in one of the applications, viz., whether the CT is assessable to tax under section 161 or section 164 of the Act. That the trustee is a representative assesse within the meaning of section 160(1)(iv)of the Act and that it can be assessed in its name in a representative capacity on the income that it receives or is entitled to receive on behalf of the beneficiaries is beyond doubt. Section 161(1), however, declares that such assessment shall be made and the tax thereon shall be levied upon and be recovered from it in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him . In other words, in a case to which section 161(1) applies, the trustee cannot be assessed on the aggregate income received by it. The assessment in the name of the trustee in terms of the sub-section can be made in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Indian companies and infrastructure projects in India. The trust fund s direct investment participations will generally take the form of equity, quasi-equity, equity-related, preferred stock and convertible debt instruments. The trust fund will focus on opportunities that will seek to take advantage of India s expanding infrastructure requirements, increasingly active consumer product appetites and growing new technology base as well as opportunities arising from restructuring and reorganisation strategies, among other areas. Investment may be spread across the focus sectors in new projects, expansions and diversifications, opportunities arising from restructuring and reorganisation, product development efforts, privatisations and the like. The trust fund will only invest in projects that at the time of investment comply with all relevant Indian State and Central Government legislation regarding environmental protection and such guidelines on environmental protection and social and rehabilitation issues which may be adopted by the Asian Development Bank, a core investor. In addition, trust fund investments may include holdings of listed companies that could be of particular ben ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 23F) does not include the infrastructure sector and that is why the investor company could not seek for any approval thereunder. The Authority is of opinion that this is not a question on which a ruling can be given at this stage. It does appear that the Regulations contemplate only investments and not business operations. But the sense in which this expression is used by parties will not be conclusive. Whether the activities that may be carried on by the CT will only be in the nature of investment or whether the income resulting from any activities embarked upon by it could or would amount to profits and gains of a business will depend on the facts and circumstances of the activities actually put through. It may be that the primary objective of the CT is only to invest capital and derive income therefrom but it has a very wide range of operations. Even temporary investments in debt instruments, if indulged in frequently, might give rise to business profits. Even changes in shares and investments carried out systematically at periodic intervals could amount to a business. It cannot be postulated in the abstract that none of the surpluses of the activities carried on by the CT co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y to distribute any part of the income to any beneficiary at any time at their absolute discretion. The AR replied to this saying that these criticisms are not justified as clauses 5 and 7 of the TD are clear on this and the provisions of paragraph 6.01 have to be read along with those of the TD which place the matter beyond all doubt. The Authority is of opinion that the provisions of the TD in this behalf are clear but the provisions of the CA are ambiguous. Paragraph 6.01 no doubt states that the distribution will be made as set out in the succeeding paragraphs but paragraph 6.04, which talks of proportionate distribution, only refers to income other than portfolio investments. Also, special distributions are not even made subject to paragraphs 6.02 to 6.07. But the second criticism of the DR does not appear to be correct: the discretion vested in the trustees pertains to the periodicity of the distributions rather than their mode of distribution. When all this was brought to the notice of counsel for the applicant, he agreed that the parties would be willing to recast the wording of paragraph 6.01 placing this beyond all doubt. The proposed modification was as follows: 6 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... utors-cum-beneficiaries only institutional investors who agree to sign an agreement on the lines of the CA. Paragraphs 2.02 and 2.03 of the first CA also permit such a course.In other words, after the modification, the trustees will have no discretionto admit any person as a beneficiary; the beneficiaries to the trust at anypoint of time will be an ascertainable and definite body, defined in theTD to be those institutions who have committed themselves to definedcontributions and executed the initial CA or entered into a CA on samelines with the trust and the IM later. The Authority would also like to point out that, question No. 3, in the revised list of questions (see paragraph 24 (at page 498) above), indicated that the parties may be willing to delete altogether the trustees power of addition under clause 7 of the TD. To do so would alter the scope of the CT and restrict it to the parties to the TD. If, however, the parties are willing for this and modify the T.D. accordingly, the beneficiaries will only be those stated in the TD and their shares will be proportionate to their contribution and the DR s objection would no more be valid. The second objection based on paragraph ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or an allocation among the investors of all income, loss or expenses attributable to a particular portfolio investment in proportion to their capital contribution. His first point was that a similar rule has not been explicitly stated in paragraph 6.02. This contention has been dealt with earlier and it has been pointed out that the trust deed and paragraph 6.01 (as agreed to be modified) make it clear that even income from portfolio investments is distributable only in proportion to the contributions made. There is, in other words, no difference between the mode of allocation of income arising out of portfolio investments and other investments. His second objection was that it would be difficult for the CT to apportion the income earned from portfolio investment and others, to attribute the income earned to a particular contribution or to allocate expenses as between income arising out of portfolio investment and others. It is no doubt true that these are difficult exercises to carry through but they have to be done in any business and usually achieved by applying a rule of three. Moreover, these factors may have some impact on the determination or computation of the distributable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... effective unless voted for by a majority of the directors of the trusteecompany present and voting at a meeting. However, counsel by their letterdated June 27, 1996, have intimated that they have since amended thedraft deed by substituting the following sub-clause (d) in place of theearlier one: 17. (d) The trustee shall only delegate its powers by a majorityvote of its directors voting at a meeting of the board of directors of thetrustee. This amendment deletes the clause objected to by the DR and nothingmore needs to be said about it. An important point made by the DR, however, deserves serious notice.He said that a good deal of uncertainty is cast regarding the shares of themembers by the provisions in the trust deed (clause 7) authorising theaddition of further contributors to the trust at different points of time (inaddition to the initial contributors who are parties to the trust deed andwhose names find a place in the Third Schedule to it and the provisionenabling contributions to be called up from time to time (paragraph 2.04of the CA) as well as by the provision in the CA regarding the rights ofmembers who default in payment of the contributions demanded fromthe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... default occurs.In compliance with the instructions of the Authority, the applicant hasfiled detailed workings of the mode of distribution in such cases. It is notnecessary to go into these meticulously; it is sufficient just to say that,complicated as the scheme is, it is not possible to say that the share incomeof the beneficiaries cannot be determined or known from the TD. The next argument of the DR is that section 164 will be applicableunless the individual shares of the persons who are the beneficiaries aredeterminate and known and that these two expressions have to be under-stood in the light of the Explanation. It can hardly be said that the sharesof the beneficiaries here are expressly stated in the trust deed or are ascer-tainable as such on the date of the TD. He points out that the Explanationlays down two conditions and that they should be both fulfilled. The construction of the section and its Explanation is indeed a matterof some difficulty. It may appear also that there is a slight redundancyin the language of the Explanation which, having required that the sharesshould be expressly stated in the TD, proceeds to say that they should alsobe ascertainable from i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard ofRevenue issued the following circular (see [1980] 123 ITR (St.) 159): 49. (iv) Under the existing provisions, the flat rate of 65 per cent.is not applicable where the beneficiaries and their shares are known inthe previous year, although such beneficiaries or their shares have notbeen specified in the relevant instrument of trust, order of the court orwakf deed. This provision has been misused in some cases by givingdiscretion to the trustees to decide the allocation of the income every yearand in other ways. In such a situation, the trustees and beneficiaries areable to manipulate the arrangements in such a manner that a discretionarytrust is converted into a specific trust whenever it suits them tax-wise. Inorder to prevent such manipulation, it is proposed to provide that unlessthe beneficiaries and their shares are expressly stated in the order of thecourt or the instrument of trust or wakf deed, as the case may be, andare ascertainable as such on the date of such order, instrument or deed,the trust will be regarded as a discretionary trust and assessed accord-ingly. From these extracts it would seem that the object of the amendmentsto the provision was only that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thatabsurdity and mischief may be avoided. Where the plain literal interpre-tation of a statutory provision produces a manifestly absurd and unjustresult which could never have been intended by the Legislature, the courtmay modify the language used by the Legislature or even do some violenceto it, so as to achieve the obvious intention of the Legislature and producea rational construction. In CIT v. Gotla [1985] 156 ITR 323, the Supreme Court was con-cerned with the question whether the assessee was entitled to set off thelosses incurred by him in his individual business in earlier years andcarried forward by him against the share income of his wife and minorchildren in a firm of which he was not a partner but which was includedin his total income for the year under consideration by applying theprovisions of section 16(3) of the Indian Income-tax Act, 1922. Section 24of the said Act permitted a set off only against the profits and gains ofany business carried on by the assessee in the subsequent year. The literalmeaning of the section was extended by the court which observed(headnote): If a strict and literal construction of the statute leads to an absurd result, i.e., a r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ever, it is not even necessary to invoke these principles of extended construction in the present case. Literally also, what the section requires is that the shares of the several beneficiaries should be stated and be ascertainable, not from an extraneous source at a later point of time but from the trust deed on the date on which it is executed. There is no redundancy in the language of the Explanation either. If the shares are expressly stated in the deed they must necessarily be ascertainable from it; what the second phrase means is that they should be so ascertainable on the date of the trust deed. It should be noticed that the section does not require that the names of the beneficiaries should be mentioned in the trust deed. Indeed, it would be impossible to do this where future settlements are involved. It no doubt requires that the individual shares of the beneficiaries should be expressly stated in the trust deed. But this requirement can also be said to be satisfied where the proportion of sharing is clearly specified in the instrument although some computation may be needed to find out the individual shares. For e.g., if a deed were to say that four beneficiaries should s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e trust deed. In any event, such a practical interpretation, in the light of the objects of the amendment Acts would clearly be warranted and justified by the Supreme Court decisions cited by the AR. The Supreme Court, in CWT v. Trustees of H. E. H. Nizam s Family (Remainder Wealth) Trust [1977] 108 ITR 555,was concerned with the interpretation of the words, when the shares of the persons on whose behalf or whose benefit any such assets are held are indeterminate or unknown employed in section 21(4) of the Wealth-tax Act, 1957. The court observed (headnote): The question in regard to the applicability of sub-section (1) or (4) of section 21 has to be determined with reference to the relevant valuation date. The Wealth-tax Officer has to determine who are the beneficiaries in respect of the remainder on the relevant valuation date and whether their shares are indeterminate or unknown. It is not at all relevant whether the beneficiaries may change in subsequent years before the date of distribution, depending upon contingencies which may come to pass in future. So long as it is possible to say on the relevant valuation date that the beneficiaries are known and their shares are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income to which he is entitled. The class of persons who become contributories subsequent to the date of the trust deed are also expressly defined in the instrument and the manner in which the share of each of them should be ascertained is also mentioned in the instrument. Ultimately despite the very complicated structure the position is very simple. All persons who contribute to the trust are entitled to receive the benefits of income distribution. The total distributable income is distributed among these beneficiaries in proportion to the respective contribution made by each of them to the fund. There is no discretion left in anybody to manipulate the beneficiaries or their shares. The Authority is, there-fore, of the opinion that the present case does not fall within the vice of section 164 and that the provisions of section 161(1) will be applicable to the income of the trust, otherwise than from business. The next point for discussion relates to the nature of the income received from the CT by the IC, in the latter s hands. As will be presently seen, this question assumes great importance in the light of the provisions contained in the Agreement for Avoidance of Double Tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on securities, had changed when it reached the hands of the assesse. The Supreme Court did not agree. It explained the scope of section41 of the Indian Income-tax Act, 1922 (to which section 161 of the Actc or responds) thus (at page 682): Under this section the Revenue has the option to levy or collect tax from the trustee or the beneficiary; the tax can be levied upon and recoverable from the trustee in the like manner and to the same amount as it would be leviable upon and recoverable from the person on whose behalf such income, profits or gains are receivable. In short, it imposes a vicarious liability on the trustee. The expression all the provisions of this Act shall apply accordingly indicates that there is no distinction in the matter of assessability of the income in the hands of a trustee or the beneficiary, as the case may be. Indeed, section 41 of the Act comes into play only after the income is computed in accordance with Chapter III of the Act. In the case of income from securities section 8 applies and under the second proviso thereto, the income-tax payable on the interest receivable on any security of the State Government issued income-tax free shall be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 1958, 1959, 1960 and 1961 had no application. The High Court was right in answering the third question referred by the Tribunal in favour of the trustees. The AR also referred to the decision of the Madras High Court in CIT v. Trustees, T. Stanes and Co. [1993] 200 ITR 396. In this case the assessees were the trustees of the company s staff pension fund. Under the terms of a trust, the balance of income remaining after payment of pension to the four beneficiaries was to be paid to the company. The beneficiaries having died, the entire income became payable to the company itself. The income of the assesse was from dividends and the Income-tax Officer was of opinion that since the recipients of the dividends were the trustees (an association of persons) no relief could be given under section 80M relating to inter-corporate dividends. The High Court held, applying the ratio of the Nizam s case that the assessment of the trustee would have to be made in the same status as the beneficiary, i.e., as a company, and hence relief under section 80M would be available. This decision also illustrates the same principle, viz., that, in making an assessment on an assessed in respect of a b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts which is subjected to the same taxation treatment as income from shares by the laws of the Contracting State of which the company making the distribution is a resident . . . Article 11 INTEREST (1) Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. (2) However, subject to the provisions of paragraphs 3 and 4 of this article, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State. (3) Interest arising in a Contracting State shall be exempt from taxing that State provided it is derived and beneficially owned by: (a) the Government or a local authority of the other Contracting State; (b) any agency or entity created or organised by the Government of the other Contracting State; or (c) any bank carrying on a bona fide banking business which is a resident of the other Contracting State . . . (5) The term interest as used in this article means income from debt-claims of every kind whether or not secured by mortgage and whether or not carrying a right to participate in the debtor s profits, and, in particular, income from Go ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r fixed base. In such case, the pro-visions of Article 7 or Article 14, as the case may be, shall apply. Starting from the position earlier explained that the dividends, interest and capital gains earned by the CT and distributed to the investor company should be treated as dividend, interest and capital gains in the hands of the latter as well, the distributed income would be liable to tax in India at five per cent. or 15 per cent. (in the case of dividend income) and at the normal rates of tax in India (in the case of interest) and to no tax in the case of capital gains. Learned counsel for the IC sought to wriggle out even from this liability on dividends and interest by taking advantage of the language of articles 10 and 11. The point made by him was that article 10 would be attracted only where an Indian company pays a dividend to a resident of Mauritius; likewise, article 11 would be applicable only where interest is paid by a person in a Contracting State to a resident of Mauritius. Here, however, the AR argues, the dividends and interest are paid by the companies and other investees to the CT and not to the IC. Hence, he argues, these receipts will not attract articles ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t 20 per cent. and not at the maximum marginal rate. To take up the first contention, the rate of five per cent. will be available only where the recipient of the dividends is the beneficial owner of the dividends and that, too, when it holds directly at least 10 per cent. of the capital of the company paying the dividend. In the present case, the Indian companies pay dividends to the CT as trustee and not as beneficial owner. It may seem that the logic of treating the investor company as the direct recipient of the dividends by reason of the application of section 161should be extended here also but such a view would run counter to the explicit language used in article 10(2)(a) of the treaty (see words in italics*) and also to its manifest intent that no concessional tax treatment will be available if the person holding the shares in the company is not its beneficial owner. In any event, even if such interpretation be acceptable, the relief asked for can be available only if the holding of the Mauritian company (through the CT) exceeds 10 per cent. of the share capital of the company paying the dividend. The dividends, therefore, will be taxable at the rate of 15 per cent. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dent, - (i) the amount of income-tax payable on the total income as reduced by the amount of long-term capital gains, had the total income as so reduced been its total income; and (ii) the amount of income-tax calculated on such long-term capital gains at the rate of thirty per cent. He says, therefore, that a tax rate of only 20 per cent. can be applied to the CG whether an assessment is made on the trustee under section164 directly or under section 161 as representative of the individual beneficiaries qua their shares. There is no difficulty in accepting the argument if the assessment is made under section 161. In that case, the trustee, being assessable in the same status as the beneficiary, will be assessable as a foreign company attracting the provisions of section 112(c) or section 115A read with section 2(3) of the relevant Finance Act (set out later). Section 112 and section 115A will then apply as if the investor company were the direct recipient of the CG from the investee and the tax will be chargeable at 20 per cent. The legal position where the assessment is made under section 164, however, bristles with difficulties. The first question is regarding the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the beneficiary as well.(But there will be difficulties in this course as well as no one beneficiary can be made liable for the tax liability of another beneficiary and the postulate of section 164 is that the extent of share income of the beneficiary or beneficiaries in question is indeterminate or unknown). The assessee is a company and an assessment on it must be made in that status. Turning now to the second question, should the CT be taxed at the maximum rate (40 per cent.) as stipulated in section 164 or at the rates of 20 per cent. or 30 per cent. mentioned in section 112 ? In the case of any assessee who is directly assessed under section 4 of the Act read with the provisions of the relevant Finance Act, the rates mentioned in section112 in respect of capital gains will prevail over the rates prescribed under the Finance Act. This is so because Chapter XII contains provisions for certain special cases and will prevail over the general rates. This is also made clear by section 2(3) of the relevant Finance Act (the Act of 1995is considered here but there is a similar provision in other Finance Acts as well): Section 2(3). In cases to which the provisions of Chapter XII ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eaning of the DTAA. That definition is contained in article4 of the DTAA which reads as follows (see [1984] 146 ITR (St) 214, 216): Article 4 RESIDENTS (1) For the purposes of this Convention, the term resident of aContracting State means any person who under the laws of that State,is liable to taxation therein by reason of his domicile, residence, place ofmanagement or any other criterion of similar nature. The terms residentof India and resident of Mauritius shall be construed accordingly. (2) Where by reason of the provisions of paragraph 1, an individualis a resident of both Contracting States, then his residential status for thepurposes of this Convention shall be determined in accordance with thefollowing rules: (a) he shall be deemed to be a resident of the Contracting Statein which he has a permanent home available to him; if he has a per-manent home available to him in both Contracting States, he shall bedeemed to be a resident of the Contracting State with which his personaland economic relations are closer (hereinafter referred to as his centreof vital interests ); (b) if the Contracting State in which he has his centre of vitalinterest cannot be d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... subsidiaries of the samecompany) with registered offices in different countries (except to the extentof 27 per cent. in the case of the investment manager which is with theIndian financial service company and an Asian Bank). They have no doubtsome Mauritians as directors but the real and effective management maywell come from the location of the American company or the othershareholding companies: say USA or Hongkong or the like. Interesting as these contentions are, they are concluded, so far asthis authority is concerned, by its own earlier decisions. In MohsinallyAlimohammed Rafik s case [1995] 213 ITR 317 (AAR) this Authority hasheld that an individual living in Dubai would be a resident of Dubaiwithin the meaning of article 4(1) of the DTAA between India and theUnited Arab Emirates though actually no tax is collected from individualsthere. The applicants in the present case are in a better position. Thereis an Income-tax Act in Mauritius and it is said that a minimum tax at15 per cent. is payable by them, though earlier they had an option to paytax or not. Hence, the IC and the IM should both be treated as residentin Mauritius. It was also held by the Authority in Mohsin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e kept at the registered office; 8. The company has an ordinary status. Firstly, it is difficult to say that the effective management of theaffairs of the company is not in Mauritius in the above situation unlessthere are facts to at least prima facie indicate that such control emanateselsewhere than from Mauritius. (The factual position in the case of IM isseparately dealt with in its application). Secondly, in its ruling reportedas Advance Ruling No. P. 9 of 1995, In re, [1996] 220 ITR 377 (AAR) theAuthority has pointed out that article 4(3) is intended to break the tie onthe issue of residence as between the two Contracting States. The com-panies are, on article 4(1), resident both in India and Mauritius and underarticle 4(3), the seat of effective management as between these two Con-tracting States, should be taken to be in Mauritius. Article 4(3) does notauthorise the exploration of a possibility that the effective management,despite the company s location and residence in Mauritius, could lieelsewhere, in a third country. The Authority would, therefore, hold thatthe investor company is a resident of Mauritius entitled to claim the benefitof the DTAA. The next point ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company to manage theaffairs of the CT. The investment proposals are to be finally approved anddecided upon by the board of directors of the company which paragraph13.01 of the IMA specifically says will be done at its meetings outside ofUnited States and India. But in carrying out its duties, the investmentmanager will be helped by various other bodies. Firstly, there is theinvestment committee which will consist of seven members with thechairman appointed by the Indian financial service co. Four members ofthe committee will be from the AIG and the ILFS will nominate threemembers of the committee. The investment committee will act by majorityvote but the American company retains a veto right on any recommen-dation of the investment committee. It will be seen that though thenominee of the Indian financial service co. will be the chairman of theinvestment committee, the decisions of the committee will always bedominated by the American company and that organisation has also aright of veto. It is not quite clear from where the investment committeeis to function. The second body to assist the investment manager is theadvisory board. This is a body comprised of professional business a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts functioning by theintroduction of other bodies such as the investment committee, the invest-ment advisor, the advisory board, and the service units, it appears clearthat the last word and decision on any of the functions of the investmentmanager rests with its own board of directors. From paragraph 13.04, itis clear that, regardless of any delegation, the investment manager shallremain responsible for all decisions and acts of any delegate if it wouldhave been liable under the Act for such act or omission if it had beendone by itself. It is no doubt true that, in carrying out its functions, theinvestment manager will rely to a considerable extent on the investmentadvisors such as the Indian financial service co. But as pointed out, thesebodies are not decision-making bodies but are just advisors whose exper-tise is taken advantage of by the investment manager. The Indian finan-cial service has a great experience in advising on such matters and itscredentials in this regard have been set out at page 37 in the placementmemorandum. It would, therefore, appear that the effective managementof the IM is in Mauritius. This company has, therefore, also to be treatedas a resident of Maur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fund. Having considered the pros and cons of these arguments, the Autho-rity is of the view that it is not possible to give any ruling on the questionwhether the investment manager has a permanent establishment in Indiaor not, unless more details are available regarding the actual functioningand the activities performed by or on behalf of the company in India. Inthe first place, the passage at page 40 of the placement memorandumclearly shows that the memorandum does not exclude the possibility, atleast in future, of the IM having to have a permanent establishment inIndia. It is no doubt true that the word company referred to in the saidparagraph refers to the IC and its tax advantages. But the reference to permanent establishment is clearly related to the investment manager.This is also quite understandable because the investor company has nothingto do in India except to invest funds under the contribution agreement.It is really the investment manager that has to take all action in regardto the selection of investments, the placing of investments, the manage-ment of investments and the collection of the proceeds of the investmentson behalf of the CT. Secondly, the facts bef ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in India or the carrying out of systematic operations in India in somemanner or the other, then it may be necessary to consider, on the factsas they emerge, whether a permanent establishment has been created inIndia or not. The other three questions raised by the applicant depend for theiranswer on the first. The Authority has already concluded that, on the factsso far disclosed and on the provisions of the various agreements that havebeen placed before it, it can be said that the applicant does not have apermanent establishment in India at present. This being so, the applicantwill not be liable to tax in respect of the management fees or carriedinterest received from the CT. Consequently, the CT will not be under anobligation to withhold tax in respect of the payment of the managementfees and carried interest to the investment manager. However, as hasalready been made clear more than once, it will be open to the assessingauthorities, should necessity arise, to examine the modus operandi of theinvestment manager in carrying on its business under the agreement and,if at any time, a conclusion is reached that a permanent establishmenthas been set up in India, the fees and interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that, underthe statute, the rulings of the Authority are binding only in respect of thetransactions on the basis of which the questions have been raised by boththe applicants and the income-tax authorities. But this will not be decisiveof the present issue. The scheme of advance rulings has been introducedfor the benefit of non-residents and to enable them to have an advanceruling on matters of doubt and ambiguity arising under the Act. Thoughthe rulings of the Authority are generally given on the basis of stated factsand background, they also have a general value as guides to the interpre-tation of the various provisions of the Act, the rules, the Double TaxAvoidance Agreements and so on. Many of these rulings deal with ques-tions of law also. Hence, irrespective of the binding nature of the rulinggiven in a particular case vis-a-vis other cases, the Authority is of theopinion that it is in public interest that the rulings be published particularlywhere they deal with general questions of far-reaching importance. TheAuthority is aware that, when parties are proposing to enter into trans-actions in India, the applications may sometimes contain confidentialparticulars, the disclosur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceivedfrom the CT ? Question No. 4: Based on the facts and circumstances of the case,if the answer to above question is yes, will there be a withholding taxliability on the CT, in respect of the payment of management fees andcarried interest to the applicant ? Answer Nos. 2, 3, 4: The answer to these questions will depend uponthe answer to question No. 1 as it will emerge on a full examination ofthe facts and circumstances of the carrying on of the business by theapplicant. It may, however, be stated that, if on the facts, the conclusionis reached that there is no permanent establishment in India for theapplicant, questions Nos. 2, 3 and 4 have to be answered in the negative.In that event, the applicant will not be liable to Indian Income-tax on themanagement fees and carried interest received from the CT and conse-quently the CT will not be liable to withhold tax from such paymentsmade to the company. If, however, it is held that there is a permanentestablishment of the applicant in India, the profits attributable to thepermanent establishment will be taxable in India and questions Nos. 2,3 and 4 will have to be answered in the affirmative. (ii) Application of IM: Qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned, they will be required to withhold tax from the amountspaid to the CT at the rates appropriate in the case of an Indian companyon all payments made by them in accordance with the provisions of therelevant Finance Act. It may, however, be open to the CT or to the applicantto apply to the Assessing Officer praying that tax may not be deducted,or should be deducted at a smaller rate on the whole or part of suchincome held on behalf of the IC in view of section 161 and the DTAA. Question No. 6: Whether, on the facts and circumstances of the case,the character of the applicant s proportionate share in the income of thecontributory trust will be same as in the hands of the contributory trust ? Answer No. 6: The answer to this question is in the affirmative. Question No. 7: Based on the facts and circumstances of the case,whether the applicant s share in the dividend earned by the contributorytrust will be chargeable to tax and if so at what rate ? Answer No. 7: The answer to this question is in the affirmative. Therate of tax payable under article 10 of the DTAA will be 15 per cent. Question No. 8: Based on the facts and circumstances of the case,will the applicant s ..... 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