Facts
The applicant („A‟) is a closely held Public Limited company incorporated in India in the year 1953.
A‟s shareholder included A (USA) 48.87%, A (Mauritius) 25.06%, A (Singapore) 1.76% and general public holding a small 1.76%.
In June 2010, board of directors of A Ltd passed a resolution proposing a scheme of buy-back of its shares.
A (Mauritius), a company incorporated in April 2001 accepted the offer of buy-back.
Issues before the AAR
Whether capital gains arising on the proposed buy-back to A (Mauritius) is chargeable to tax in India, having regard to the provisions of paragraph 4 of Article 13 of the Double Taxation Avoidance Convention between India and Mauritius („DTAA‟)
If the answer to the above is in the affirmative, whether A is required to withhold tax on the remittance of the buy-back proceeds to A (Mauritius).
Observations and Ruling of the AAR
„A‟ has not paid any dividend to its shareholders since April 2003 when Section 115-O of the Income-tax Act, 1961 („Act‟) was introduced which required domestic Companies to pay Dividend Distribution Tax (DDT) on the amount of any dividend distributed to its shareholders.
Due to non-payment of such dividend, in the earlier years, the reserves increased considerably and accumulated over time.
„A‟ did not put forth any proper explanation as to why prior to the introduction of section 115-O of the Act dividends were being distributed as compared to no dividends being declared subsequent to the year 2003 despite the fact that A was regularly making profits.
The other key shareholders viz. A (USA) and A (Singapore) did not accept the offer of buy-back, obviously because in the case of „A‟ USA, it would have been taxable in India as capital gains and in the case of A (Singapore), the taxability would have depended on certain conditions being fulfilled. A similar offer of buy back in year 2008 was also not accepted by such shareholders. Whereas in the case of A (Mauritius) under the DTAA, capital gains would be not be taxable in India
The payment of dividend in the normal course by a company making profits would have meant that the applicant would have been obliged to pay DDT on distribution of profits.
The buy-back proceeds by A Mauritius would be considered as capital gains, by virtue of paragraph 4 of Article 13 of the DTAA and such capital gains would not be liable to tax in India.
Dividend in terms of the definition includes any distribution by a company of accumulated profits to its shareholders. The exemption is only in respect of genuine buy-back of shares.
The proposed buy-back would mean that considerable sums would be repatriated to A (Mauritius) without payment of tax on the distributed profits. Hence the proposal of buy-back could be considered as a colorable device for avoidance of dividend distribution tax on the distributed profits.
Being a colorable device, it is not a transaction in the eye of law and therefore the arrangement can only be treated as a distribution of profits by a company to its shareholders which does not attract Section115-O of the Act
The payment against buy-back of shares in the present case would satisfy the definition of dividend as per paragraph 4 of Article 10 of the DTAA and such proposed payment would be taxable in India as dividend in terms of paragraph 2 of Article 10 of the DTAA. A is required to withhold taxes on the proposed remittance of the proceeds to A (Mauritius).
Conclusion
Distribution of accumulated profits through a scheme of buy back of shares could be deemed as colorable and therefore subject to tax withholding under a tax treaty.
Source: A (AAR No. P of 2010 dated 22nd March, 2012)
The applicant („A‟) is a closely held Public Limited company incorporated in India in the year 1953.
A‟s shareholder included A (USA) 48.87%, A (Mauritius) 25.06%, A (Singapore) 1.76% and general public holding a small 1.76%.
In June 2010, board of directors of A Ltd passed a resolution proposing a scheme of buy-back of its shares.
A (Mauritius), a company incorporated in April 2001 accepted the offer of buy-back.
Issues before the AAR
Whether capital gains arising on the proposed buy-back to A (Mauritius) is chargeable to tax in India, having regard to the provisions of paragraph 4 of Article 13 of the Double Taxation Avoidance Convention between India and Mauritius („DTAA‟)
If the answer to the above is in the affirmative, whether A is required to withhold tax on the remittance of the buy-back proceeds to A (Mauritius).
Observations and Ruling of the AAR
„A‟ has not paid any dividend to its shareholders since April 2003 when Section 115-O of the Income-tax Act, 1961 („Act‟) was introduced which required domestic Companies to pay Dividend Distribution Tax (DDT) on the amount of any dividend distributed to its shareholders.
Due to non-payment of such dividend, in the earlier years, the reserves increased considerably and accumulated over time.
„A‟ did not put forth any proper explanation as to why prior to the introduction of section 115-O of the Act dividends were being distributed as compared to no dividends being declared subsequent to the year 2003 despite the fact that A was regularly making profits.
The other key shareholders viz. A (USA) and A (Singapore) did not accept the offer of buy-back, obviously because in the case of „A‟ USA, it would have been taxable in India as capital gains and in the case of A (Singapore), the taxability would have depended on certain conditions being fulfilled. A similar offer of buy back in year 2008 was also not accepted by such shareholders. Whereas in the case of A (Mauritius) under the DTAA, capital gains would be not be taxable in India
The payment of dividend in the normal course by a company making profits would have meant that the applicant would have been obliged to pay DDT on distribution of profits.
The buy-back proceeds by A Mauritius would be considered as capital gains, by virtue of paragraph 4 of Article 13 of the DTAA and such capital gains would not be liable to tax in India.
Dividend in terms of the definition includes any distribution by a company of accumulated profits to its shareholders. The exemption is only in respect of genuine buy-back of shares.
The proposed buy-back would mean that considerable sums would be repatriated to A (Mauritius) without payment of tax on the distributed profits. Hence the proposal of buy-back could be considered as a colorable device for avoidance of dividend distribution tax on the distributed profits.
Being a colorable device, it is not a transaction in the eye of law and therefore the arrangement can only be treated as a distribution of profits by a company to its shareholders which does not attract Section115-O of the Act
The payment against buy-back of shares in the present case would satisfy the definition of dividend as per paragraph 4 of Article 10 of the DTAA and such proposed payment would be taxable in India as dividend in terms of paragraph 2 of Article 10 of the DTAA. A is required to withhold taxes on the proposed remittance of the proceeds to A (Mauritius).
Conclusion
Distribution of accumulated profits through a scheme of buy back of shares could be deemed as colorable and therefore subject to tax withholding under a tax treaty.
Source: A (AAR No. P of 2010 dated 22nd March, 2012)
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