Any foreign investment coming into India is naturally planned in a manner that the tax liability remains at the minimum possible level. The current legal position prevailing in India is that any planning which results in lowering of tax liability in India, which is within the four corners of law, is treated as valid planning permissible in law. (Refer AzadiBachaoAandolan263ITR706).
In this context, a recent judgment of Authority for Advance Ruling (AAR) in the case of A Ltd, in re dated 22.03.0212 is worth considering. The facts of the case are as under:
A Ltd was duly incorporated in India in the year 1953. 48.87 % shares of A Ltd are held by a US company, 25.06% by ‘A’ (Mauritius) in Mauritius, 27.37% by a Singaporean company and 1.76% by the general public.
xA Ltd. has been consistently paying dividend until introduction of Section 115O (relating to Dividend Distribution Tax) in the Indian Income-tax Act. After introduction of Section 115O no dividend was paid by A Ltd. As a result of non-payment of dividend, the reserves of the company grew substantially, resulting in increase in the value of shares of A Ltd. Subsequently, A Ltd. proposed a scheme of buy-back of its shares from existing shareholders. A(Mauritius) accepted the offer of buy-back. Therefore, A (Mauritius) became entitled to receive from A Ltd the increased price of shares as against the price at which such shares were originally purchased by them. This resulted in earning of capital gains by A (Mauritius). In this manner profits earned by A Ltd were passed on to A(Mauritius) as capital gains instead of dividend.
A Ltd approached the Authority for Advance Ruling with the following question:
Whether the capital gains arising to A (Mauritius) from the buy-back of shares by A Ltd is taxable in India.
The counsel for A Ltd relied on the Indo-Mauritius Double Taxation Avoidance Agreement (DTAA) and submitted that in view of provisions contained in Article 13(4), the capital gain arising to A(Mauritius) is liable for tax in Mauritius and therefore, should not be taxed in India.
The revenue on the other hand contended that what would have been payable as tax on distribution of profits in India, is now evaded and the funds are being transferred out of the country under the guise of a buy-back of shares scheme. This amounts clearly to avoidance of tax in India.
The Authority ruled that “We are, therefore, satisfied that the proposal projected before us of buy-back is a scheme devised for avoidance of tax. In fact, it is a colorable device for avoiding tax on distributed profits as contemplated in Section 115-O of the Act.”Accordingly, the payment by A Ltd. is liable to be taxed as “dividend” in India.
In the above context, it is worth noting that the AAR while adjudicating the transaction as a “colourable device” has not referred to any of the decisions of the Hon’ble Supreme Court wherein the issue of colourable device has been specifically dealt with.
The Hon’ble Apex Court in the famous case of Vodafone [341 ITR 1] observed that “genuine strategic tax planning has not been abandoned by any decision of the English Courts till date. Applying the above tests, we are of the view that every strategic foreign direct investment coming to India, as an investment destination, should be seen in a holistic manner.”
In the case of Azadi Bachao Aandolan (supra), the Hon’ble Supreme Court observed as under:
"The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity."
However, in the instant case, the AAR without applying the principle laid down by the Hon’ble Apex Court straight away came to the conclusion that since there is saving of dividend distribution tax, the transaction of buy-back is a colourable transaction.
With utmost respect, the decision of the AAR requires a review because the said decision completely upsets the principle laid down by the Hon’ble Apex Court.
H P Agrawal The author is a Sr. Partner in S.S. Kothari Mehta & Co.