Inbound Investments McDowell Dead or Alive

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Inbound Investments McDowell Dead or Alive?

• By
• Pradeep Dinodia
• Sr. Partner
• S.R.Dinodia Co.
• Chartered Accountants

K-39 Connaught Place, New Delhi 110 001 Email
pradeepdinodia_at_srdinodia.com Ph 23418016, Fax
5151366
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Supremacy of Domestic Law VsThe Double Taxation
Avoidance Agreement/Convention

• .

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FDI Made into India by a Non-resident

• Financial Profit in terms of -
• a) Dividend
• b) Capital gain

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Dividend

• Profit distribution tax levied on Indian
  companies u/s 115-0 of the Income Tax Act, 1961
• Investors Income is exempt u/s 10(34) of the
  Income Tax Act, 1961
• - Irrespective of Domicile
• The withholding tax section 195 is not applicable
  to Dividends that have suffered the Dividend
  Distribution Tax u/s 115-0 of the Income Tax Act,
  1961

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Capital Gains

• Capital Gains tax levied on hard currency gain
  after indexing the gain and disregarding the
  depreciation of the Indian Rupee vs. the foreign
  currency
• Listed securities which have suffered Securities
  Transaction Tax and which have been held for more
  than 12 months there is no capital gains tax
  thereon u/s 10(38) of the Income Tax Act, 1961 by
  Finance (No. 2) Act, 2004.
• No need for Mauritius route or any other tax
  efficient route.
• Securities held for Investment for less than 12
  Months.
• - Reduced Capital Gains of 10
• - Prerequisite
• - Listed Security
• - Has suffered Securities Transaction Tax

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Capital Gains

• Non Listed securities and not suffered Security
  transaction tax, rule prior to Finance Act (No.2)
  2004 would apply
• - Non Listed security taxed at 22.95
• - Tax on Short term capital gain by a Foreign
  investor at 44.625

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Relevance of Treaty Shopping

• Long Term Capital Gains
• Listed securities that have not suffered
  securities transaction tax .
• - Un listed Securities

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DTAC India and Mauritius

• Article 13, Sub Article (4)
• Article 13 states that the Capital gain derived
  by a resident of a contracting State from
  alienation of any property (sale of shares) shall
  be taxable only in the State of which the person
  concerned is a resident.
• Article 4 of DTAC defines the expression
  resident to mean any person under the laws of
  that State who is liable to tax therein by
  reason of his domicile, residence, place of
  management or any other criteria of a similar
  nature.

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Union of India v/s Azadi Bachao Andolan 2003
263 ITR 706 (SC)

• Main Issues Before the Supreme Court
• 1. Whether section 90 of the Income Tax Act
  enables and empowers the Central Government to
  issue notification for implementation of the
  terms of a Double Taxation Avoidance Agreement
  and ancillary to the question was whether the
  provision of such an Agreement would operate even
  if inconsistent with the provisions of the Income
  Tax Act ?
• Held that section 90 of the Income Tax Act
  empowers and enables the Central Government to
  issue notification towards the implementation of
  the terms of DTAAs which would automatically
  over-ride the provisions of the Income Tax Act in
  the matter of ascertainment of chargeability to
  tax and ascertainment of total income to the
  extent of inconsistencies vis-a-vis the terms
  of DTAC.

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Union of India v/s Azadi Bachao Andolan

• Whether Circular No.789 (2000) 243 ITR Statute
  57 is within the meaning of section 90 of the
  Income Tax Act and, therefore, must have legal
  consequences contemplated in sub-section (2) of
  section 90 of the Act
• Held That the Circular shall prevail even if
  inconsistent with the provisions of the Income
  Tax Act of 1961 in so far as the assessees
  covered under the provisions of DTAC are
  concerned.
• Is the Double Taxation Avoidance Agreement
  between India and Mauritius bad for excessive
  delegation?
• The Supreme Court held that this Convention was
  not bad and was within the powers of the Central
  Government.

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Union of India v/s Azadi Bachao Andolan

• Is the Double Taxation Avoidance Convention
  illegal and ultra vires of the powers of the
  Central Government u/s 90?
• Held That held that the purpose of DTAC is to
  effectuate the objectives in clauses (a) and (b)
  of sub-section (1) of section 90. The validity
  and the vires of the legislation, primary, or
  delegated have to be tested on the anvil of the
  law making power. The Supreme Court held that if
  the authority is clothed with the requisite
  power, irrespective of whether the legislation
  fails in its object or not, the vires of the
  legislation is not liable to be questioned.

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Union of India v/s Azadi Bachao Andolan

• What is the meaning of the expression liable to
  taxation for purposes of determining fiscal
  residence?
• Held That the liability to tax is not the same
  as payment of tax. Liability to taxation is a
  legal situation and payment of tax is a fiscal
  act. What is to be seen is the legal situation
  and not the fiscal effect of actual payment
• The Supreme Court rejected the argument that a
  decision by the Authority for Advance Ruling
  would be binding on other tax-payers in the
  country.
• The Supreme Court reproduced section 245R of the
  Income Tax Act to hold that such a ruling has
  only a persuasive value and is not binding like
  the judgments of the High Courts and Supreme
  Court in India.

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Union of India v/s Azadi Bachao Andolan

• 6. Treaty Shopping is it illegal?
• Specific Query raised -
• If the residents of State C qualify for a
  benefit under the treaty, can they be denied the
  benefit on some theoretical ground that treaty
  shopping is unethical and illegal?
• Held that it is the duty of the Court to decide
  what the law is and apply the same and not to
  make it. Therefore, all the questions raised on
  morality, of the recommendations of the Working
  Group on non-resident Taxation per se do not
  render an attempt by a resident of a third
  country to take advantage of the existing
  provisions of the DTAC illegal.

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Union of India v/s Azadi Bachao Andolan

• The Principles adopted in the interpretation of
  treaties are not the same as those in
  interpretation of statutory legislation.
• Some considerations for treaties are that they
  are-
• Negotiated and entered into at a political level
  and have several other considerations as their
  basis.
• The treaties have encouraged mutual trade and
  investments between the two countries
• Implementing the treaties for non-tax reasons is
  the rule in several developed countries.
• These are also used to attract foreign enterprise
  and off-shore activities.
• Treaty shopping is often regarded as tax
  incentive to attract scarce foreign capital and
  technology.
• Therefore, it was held that the Supreme Court
  could not judge on the legality of Treaty
  shopping merely because one section of thought
  considered it to be improper and a holistic view
  had to be taken to adjudge what was perhaps
  regarded in contemporary thinking as a necessary
  evil in a developing economy.

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Rule in Mc Dowell

• The respondents criticized the Act of
  Incorporation of FIIs under the Mauritius Act as
  a sham and a device actuated by improper motives.
  They urged upon the Court to render the
  incorporation in Mauritius as non est and for
  this relied upon the judgment of the Supreme
  Court in the case of McDowell and Company Ltd.,
  Vs. Commercial Tax Officer (1985) 154 ITR 148
• As per the English jurisprudence it was held
  that -
• It thus appears to us that not only is the
  principle in Duke of West Minster's case (1936)
  AC 1 (HL) 19 TC 490 alive and kicking in
  England, but it also seems to have acquired
  judicial benediction of the Constitutional Bench
  in India, notwithstanding the temporary
  turbulence created in the wake of McDowells case
  (1985) 154 ITR 148 (SC).

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Rule in Mc Dowell

• The Supreme Court further held that the
  observations of Justice Chinappa Reddy were not
  shared by the majority judgment in the McDowells
  case itself. The Court then finally held -
• We are unable to agree with the submission that
  an act which is otherwise valid in law can be
  treated as non est merely on the basis of some
  underlying motive supposedly resulting in some
  economic detriment or prejudice to the national
  interest, as perceived by the respondents.

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McDowell Dead or Alive ?

• Conclusion
• The supreme court therefore put to rest the
  controversy created by McDowells decision in
  interpreting the Indian Income tax Act and
  reiterated the well known and accepted principle
  of respecting the legally constituted corporate
  structures in legally permissible jurisdiction
  entering in to legally permissible contracts
  which may result in benefits to the tax payers
  under the statute