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Taxability at a Concessional Rate Based on the India-Cyprus DTAA

Prefatory Note

In the case of Little Fairy Ltd. v Commissioner of Income Tax, International Tax[i], the Income Tax Appellate Tribunal, Delhi (‘ITAT’) decided on the issue of concessional tax rate as per the India-Cyprus Double Tax Avoidance Agreement (‘DTAA’) when a Cyprus based company invested in compulsory convertible debentures (‘CCDs’) of an Indian based company and earned interest on the same.

Factual Matrix 

  • Little Fairy Ltd. (‘assessee’), a wholly owned subsidiary of a Mauritius-based company, was incorporated in Cyprus and was a tax resident there.

  • In 2012, the assessee entered into an agreement with India Bulls, a company incorporated in India, and subscribed to certain CCDs of the Indian company.

  • For the interest earned by the assessee on the CCDs, it applied for the tax at a concessional rate as per the DTAA between India and Cyprus, as per which the beneficial owner of the interest income was to be taxed at a rate of 10% on the gross amount of interest[ii].

  • When the case reached the assessing officer (‘AO’), he observed that the assessee hardly performed any activities and acted as merely a conduit for channelling the interest funds for the parent company in Mauritius.

  • Thus, the AO denied the benefit available under the DTAA and held that the parent company based in Mauritius was the actual beneficial owner of the interest income that accrued from the CCDs. Accordingly, the interest income was charged to tax at the rate of 40% on the gross amount of interest.

  • On appeal, the commissioner of appeals confirmed the order passed by the AO and held against the assessee.

  • Being aggrieved, the assessee approached the ITAT.

Held

The ITAT ruled in favour of the assessee and held that the Cyprus-based company was the actual beneficial owner of the interest income earned from the CCDs of an Indian company. Thus, granting the benefit under the DTAA to the assessee made it eligible to be taxed under the 10% slab on the gross interest amount. The ITAT dealt with the aspects of the order passed by the AO thus:

Beneficial Ownership: The ITAT reiterated the settled principle that shareholders of a company are distinct and separate from each other. Based on the same, the ITAT observed that the parent company of the assessee is only a beneficial owner of the shareholders of the assessee (being 100% shareholder), and this does not give any rights / beneficial ownership over the assets of the assessee.

Need to undertake business activity: The AO observed that the assessee did not perform any business activity in Cyprus and acted merely as a channel for its parent company. However, the ITAT took note of the fact that the assessee had made an investment in the said CCDs in its own name through proper banking channels. It was further noted that the said investment fetched interest income or capital gains to the assessee. Thus, there was no need to carry out any other business activity, such as manufacturing or trading, and the investment in CCDs was a legitimate business activity.

Control over the interest income: The ITAT also referred to the tax residency certificate issued to the assessee by the Republic of Cyprus. Based on the same, the ITAT observed that the assessee had complete control over the interest income earned from the subscription of the CCDs and was not under any contractual obligation or compulsion to pass on the same to any other person. Further, the assessee completely borne the foreign currency risk and the counterparty risk in relation to the said interest income. Hence, the benefit of the DTAA in getting a concessional rate of tax at 10% was available to the assessee in the present case.

Our Analysis

The ITAT stressed the importance of looking beyond the mere form of transactions to understand their true substance. The assessee invested in the CCDs in its own name and received interest income directly. This direct involvement and control over the investment and income indicated that the assessee was the true investor and beneficial owner of the income.

A central point in the ITAT’s analysis was the concept of beneficial ownership. It determined that the assessee had full control over the interest income from the CCDs. There was no contractual or legal obligation to transfer this income to any other entity, including its Mauritius-based parent company.






End Notes

[i] [2024] 162 taxmann.com 766 (Delhi - Trib.)

[ii] Article 11(2) of the DTAA.






Authored by Sanyam Aggarwal, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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