Direct Tax Alert: Delhi Tax Tribunal grants treaty benefits basis valid TRC
BACKGROUND
Multilateral Instrument (MLI) to implement tax treaty-related measures to prevent Base Erosion and Profit Shifting (BEPS) is a global framework designed to modify and prevent the exploitation of tax treaties for tax avoidance purposes. One of the key provisions of the MLI is the Principal Purpose Test (PPT). It provides that tax treaty/ DTAA benefits will not be granted if it is reasonable to conclude, based on relevant facts and circumstances, that one of the principal purposes of an arrangement or transaction was to obtain those benefits. Such benefits may be allowed if it is established that granting them aligns with the objective and purposes of the relevant tax treaty.
The MLI introduced significant amendments to various tax treaties, including the India-Luxembourg Double Taxation Avoidance Agreement (DTAA). The amendments in the India-Luxembourg DTAA included a revised preamble and the incorporation of PPT, to ensure that the DTAA is not used for tax avoidance or tax evasion.
In this regard, recently, the Delhi Tax Tribunal1 had the chance to examine treaty benefit entitlement under the India-Luxembourg DTAA. The primary issue under consideration was whether the taxpayer is entitled to DTAA benefits in absence of any evidence placed by the tax authorities against taxpayer to rebut the commercial substance.
We, at BDO in India, have analysed and summarised the key aspects of the said decision and provided our comments on its impact hereunder:
FACTS OF THE CASE
- The taxpayer, a Limited Liability Company incorporated in Luxembourg was a Category II Foreign Portfolio Investor (FPI) registered with the Securities and Exchange Board of India (SEBI). It was a 100% subsidiary of a company based in Cayman Islands, functioning as a special purpose vehicle for pooling of funds from various investors.
- During Fiscal Year (FY) 2020-21, the taxpayer earned income from its investments in Indian AIF, securitisation trusts, interest from debt investments, and sale of debentures of Indian companies. In its return of income, taxpayer claimed benefits under the India-Luxembourg DTAA with respect to the interest income, business income, and capital gains.
- The tax officer denied DTAA benefits by concluding that:
- Scheme of arrangement employed by the taxpayer is tax avoidance through treaty shopping,
- The taxpayer was a conduit entity and the real owner was its holding entity in Cayman Islands,
- TRC is not sufficient to establish the tax residency,
- The taxpayer was not the beneficial owner of the income, and
- There was no commercial rationale for establishment in Luxembourg.
- The tax officer further alleged that the taxpayer was established in Luxembourg merely to take the benefit of India-Luxembourg DTAA since India does not have a tax treaty with Cayman Islands.
- Aggrieved, the taxpayer preferred objections before the Dispute Resolution Panel (DRP), which confirmed the denial of DTAA benefits and thereafter, the taxpayer filed an appeal before the Delhi Tax Tribunal.
DELHI TAX TRIBUNAL RULING
The Hon’ble Delhi Tax Tribunal while granting the benefits under the India-Luxembourg DTAA made the following observations:
- Taxpayer was incorporated in Luxembourg in the year 2015 as an investment-holding company and had made investments in India only in FY 2018-19. The geographical concentration of investments made by the taxpayer indicated that the activities of the taxpayer were beyond Indian jurisdiction. Further, it had also filed tax returns and paid taxes in Luxembourg on its worldwide income.
- Additionally, the taxpayer had incurred substantial operational expenditure relating to investments in Luxembourg in the nature of consulting fees, legal and litigation fees, and other professional fees apart from administrative expenses. The taxpayer controlled both assets and income on its own and could not be termed as a conduit since it continues to exist till date in Luxembourg and hold substantial investments.
- Reliance can be placed on Delhi High Court ruling in the case of Tiger Global International III Holdings2 (Tiger Global) wherein it was held that the validity and sanctity of TRC issued by the competent authority must be considered as sacrosanct. It further stated that the circumstances under which the tax authorities could pierce the corporate veil of a TRC-holding entity is restricted to extremely narrow circumstances of tax fraud, sham transactions, camouflaging of illegal activities, and the complete absence of economic substance. The establishment of those charges would have to meet stringent, onerous standard of proof and based on cogent and convincing evidence, not merely suspicion alone.
- Tax authorities have to accept the TRC issued by the competent authorities and if the facts on record satisfy the conditions specified in Article 29 on Limitations of Benefits (LOB), they cannot go beyond the given mandates unless they bring on record cogent and convincing evidence to prove that the taxpayer acted as a conduit. In the present case, tax authorities have not brought any cogent material on record to indicate that the taxpayer was in substance a conduit, except expressing their views and presumptions.
BDO IN INDIA COMMENTS
This decision is the first on the issue of entitlement of tax treaty benefits pursuant to PPT introduced by the MLI. It has emphasised that a valid TRC should be accepted as evidence of fiscal residence and beneficial ownership, unless there is evidence of fraud or sham transactions. Further, treaty benefits should not be denied solely on the grounds of assumptions and underscores the need for tax authorities to provide substantial evidence while applying anti-abuse provisions. The findings of this decision are welcome and taxpayers should consider the impact of the findings to their set of facts and also be in a state of preparedness for a more in-depth scrutiny from the tax authorities, while granting treaty benefits.
1 SC Lowy P.I. (LUX) S.A.R.L. v. ACIT, I.T.A. No. 3568/DEL/2023 (Delhi Tax Tribunal)
2Tiger Global International III Holdings v. AAR, W.P.(C) 6764/2020 & CM APPL. 23479/2020 (Delhi High Court)