- Copal Partners Ltd., Jersey (“CPL Jersey“), held 100% shares in Copal Research Ltd., Mauritius (“CRL Mauritius“).
- CRL Mauritius, in turn, held 100% of the shares in both, Copal Research India Pvt. Ltd., India (“CRIPL India“) and Copal Market Research Ltd., Mauritius (“CMRL Mauritius“). CMRL Mauritius, in turn, held 100% of the shares in Exevo Inc., USA (“Exevo USA“). Exevo US, in turn, held 100% of the shares in Exevo India Pvt. Ltd., India (“Exevo India“).
- Approximately 67% of the shares in CPL Jersey were held by Copal Group shareholders and the remaining 33% (approximately) were held by banks and financial institutions.
The Copal Group and Moody Group (non-resident companies) entered into the following Share-Purchase Agreements:
- Transaction I: CRL Mauritius sold its entire shareholding in CRIPL India to Moody’s Cyprus Ltd (“Moody’s Cyprus“)
- Transaction II: CMRL Mauritius sold its entire holding in Exevo USA to Moody’s Analytics Inc., US (“Moody’s USA“)
- Transaction III: Copal Group shareholders sold their 67% holding in CPL Jersey to Moody’s Group UK Ltd (“Moody’s UK“).
An application was filed with the Authority for Advance Rulings (AAR) to determine-
- whether Transaction I and Transaction II are chargeable to tax in India;
- the head under which the said transactions should be taxed;
- the year and head under which the deferred consideration should be taxed, and
- the applicability of withholding tax.
- The said transaction would not be chargeable to tax in India.
- The deferred consideration was a part of the full consideration and as such would be taxable under the head, Capital Gains.
Aggrieved by this, the Revenue Dept. filed a writ before the Delhi High Court.
- Whether the transactions for sale of 100% shareholding in CRIPL India and Exevo USA (i.e. Transactions I and II) were designed prima facie for avoidance of income tax under the Act.
- Whether the transactions resulting into direct/indirect transfer of two underlying Indian subsidiaries were taxable in India.
On ISSUE 1
- The transactions for sale of shares of Exevo-USA and CRIL must not be viewed in isolation but in conjunction with the sale of shares of Copal- Jersey to Moody-UK. All the transactions, i.e. Transaction-I, Transaction-II and Transaction- III were an integral part of a single transaction.
- The commercial understanding between Copal Group Shareholders and Moody- UK was to structurally transfer the entire businesses and interest of the Copal Group to the Moody Group and the same was effectuated by the three transactions (Transaction-I, Transaction-II and Transaction-III).
- Copal Group Shareholders held approximately 67% shareholding of Copal-Jersey and Banks and Financial Institutions held the balance shares constituting approximately 33% of the share capital of Copal-Jersey. Given the shareholding structure of the Copal Group, the transfer of shares of Copal-Jersey by the Copal Group Shareholders would consummate the transfer of the entire Copal Group i.e. the businesses and the downstream subsidiaries of Copal-Jersey, to the Moody Group. This, it was contended, was the real transaction between the Copal Group Shareholders and Moody-UK.
- The sale and purchase agreements read together indicated that, structurally, the entire Copal Group was transferred to the Moody Group.
- Without the separate sale transactions in respect of shares of CRIL and Exevo-US (i.e SPA-I and SPA-II) executed one day prior to the sale of shares of Copal-Jersey (i.e SPA-III), the gains arising from sale of shares of Copal-Jersey in the hands of Copal Group Shareholders would be taxable under the Act, as the shares of Copal-Jersey would derive their value substantially on account of the value of the assets situated in India namely shares of Exevo-India and CRIL.
- By virtue of Section 9(1)(i) of the Income Tax Act read with Explanation 5 thereto, the capital gains arising in the hands of the Copal Group Shareholders (who were non-residents) would be taxable under the Act as the said gains would be deemed to accrue and arise in India.
- In order to avoid this incidence of tax, the transaction of sale of the businesses and interests of the Copal Group to the Moody Group was structured in a manner so as to include two separate transactions for sale of shares of CRIL held by CRL to Moody-Cyprus and shares of Exevo-USA to Moody-USA. Sellers in both these transactions, namely, CRL and CMRL were companies incorporated in Mauritius and the tax chargeable on gains arising from sale of shares in the hands of the Mauritius entities could be avoided by virtue of India-Mauritius Double Taxation Avoidance Agreement.
- In the given circumstances, the transactions in question, namely, sale of shares of CRIL and Exevo-US, were interspersed and as such were transactions structured prima facie for avoidance of tax.
- The shares of CRIL and shares of Exevo-USA were sold to Moody Group as they insisted on acquiring 100% shareholding of these companies. However, with respect to shares of Copal-Jersey only 67% of its shares were sold to a separate entity of the Moody Group. That transaction, thus, ought to be considered as a transaction independent of Transaction-I and Transaction- II.
- There is a commercial rationale for the sale of shares of CRIL and Exevo-US as those companies represented holding interest in Indian companies and Moody’s had insisted on acquiring the entire 100% capital of those companies. Accordingly, the transfer of those shares took place at the Mauritian level and not by sale of shares of the upstream holding company/companies at the Jersey level. Sale of shares of the ultimate holding company i.e. Copal-Jersey could be effected only to the extent of 67% of the shareholding which was held by the Copal Group Shareholders as the balance 33% was held by banks and financial institutions and their shares were not being acquired by Moody-UK. There were no material to indicate that this commercial transaction was not bona fide.
On ISSUE 2
- Rishi Khosla is the prime mover of the Copal Group. He alongwith one Jeol Perlman, left their earlier employment and promoted Copal-Jersey and were in de facto control and management of the entire Copal Group.Other companies / subsidiaries of the Copal Group were only shell companies.
- CRL and CMRL were not operative since their revenues were being generated from within the Copal Group.
- Since Rishi Khosla was a resident of the United Kingdom, the situs of CRL and CMRL ought to be taken as United Kingdom – from where the affairs of the Copal Group, including CRL and CMRL were alleged to be conducted – and not Mauritius.
- Rishi Khosla had also varied the terms of the transactions which indicated that management of the companies was synonymous with Rishi Khosla.
- Companies were managed by their respective Board of Directors. CRL and CMRL were in fact operative companies. Both CRL and CMRL held category-I Global Business Licenses (GBL) w.e.f. 18.03.2004 and 03.04.2008 respectively. CRL received substantial revenues from provision of services relating to business of financial research and CMRL also received revenues from provision of services relating to business of market research. The financial statements of both the said companies indicated that the companies had received substantial revenues.
- CRL and CMRL were not shell companies. The said companies were companies with substance.
- The India-Mauritius Double Taxation Avoidance Agreement did not include a Limitation of Benefits (LOB) clause and thus, it was not open for the revenue to contend that the said companies should be denied the treaty benefit with India.
SUMMARY OF JUDGMENT
The Hon’ble Delhi High Court held that the contention of Revenue that the transaction was done only for the purposes of avoiding tax and as an alternative to sale of shares by shareholders of Copal-Jersey (which would not be as tax friendly) is not sustainable as the transaction structured in the manner as suggested by the Revenue i.e. sale of shares of Copal-Jersey alone, would not achieve the same commercial results and thus, could not be considered as a real transaction which was structured differently to avoid an incidence of tax.
Even though it is assumed that the sale of shares by the Copal Group Shareholders to Moody-UK was structured in the manner as suggested by the Revenue, there would be no incidence of tax. The Delhi High Court took into consideration the Vodafone International Holdings BV vs. Union of India ((2012) 6 SCC 613)case where the Supreme Court had held that the transaction of sale and purchase of a share of an overseas company between two non-residents would fall outside the ambit of Section 9(1)(i) of the Income Tax Act.
While the Court dismissed the contentions of the Revenue on the issue of prima facie avoidance of tax, it went on to elaborate the applicability of Indian tax implications on account of the Revenue’s contentions on Indian taxability. The Court was of the opinion that indirect transfer tax provisions should not apply to Transaction 3. The High Court examined the consideration paid for all three transactions to come to the conclusion that, since USD 93.5 million was the consideration allocable to assets situated outside India and only USD 28.53 was allocable to the Indian assets, Copal Jersey could not be said to derive substantial value from Indian assets.
The High Court has also expanded on how the term “substantially” as used in Explanation 5 should be interpreted to mean “principally”, “mainly” or at least “majority”. It has stated that a restrictive approach should be employed while interpreting a legal fiction such as Explanation 5 and concluded that for the indirect transfer tax provisions to apply, the overseas company should derive at least 50% of its value from Indian assets.
There should be no Indian tax liability on Copal Group or withholding tax obligations on the Moody’s group as a result of the acquisition.
The object of section 9(1)(i) of the Income Tax Act is to levy tax on gains arising out of capital assets which are situated in India and the scope of section 9(1)(i) should not be extended to levy tax on income that has no nexus with India.
Author: Akshay Goel & Miti Shrivastava
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