Delhi HC rules sale of CCDs is capital gains and exempt under India-Mauritius DTAA

This tax alert summarizes a recent ruling of Delhi High Court (HC) in the case of Zaheer Mauritius (Taxpayer) wherein the issue was whether sale of equity shares and Compulsory Convertible Debentures (CCDs) is a loan transaction disguised as investment and, accordingly, whether the gains arising on sale of such CCDs can be regarded as interest under the Indian Tax Laws (ITL) as well as India-Mauritius Double Taxation Avoidance Agreement (DTAA). The HC ruled that gains arising on sale of CCDs is in the nature of capital gains and exempt by virtue of India-Mauritius DTAA. The HC also noted that the transaction involving CCDs and understanding between the Taxpayer and the other joint venture partner represented a genuine commercial venture and there was no reason to ignore the legal nature of CCDs or to lift the corporate veil to treat the underlying joint venture company and the joint venture partner to be a single entity meriting characterization of part of the transfer price as interest.

The HC ruling reiterates “look at test” to evaluate tax implications of the transaction. It acknowledged that in terms of SC ruling in the case of Vodafone, the courts cannot start with a question of whether the transaction is a tax saving device but instead are expected to ascertain the true legal nature of the transaction and determine tax consequences accordingly. Having noted the commercial considerations of investing funds in accordance with the applicable regulatory provisions, on facts, the HC came to the conclusion that the agreements between the parties reflected genuine commercial venture and that the legal terms of the arrangement agreed to by the parties for commercial reasons cannot be ignored or the corporate veil of the entity may not be lifted.