Beneficial Ownership-Indian Issues-KRS V2

5/14/2018 Beneficial Ownership-Indian Issues-KRS V2 - slidepdf.com

http://slidepdf.com/reader/full/beneficial-ownership-indian-issues-krs-v2 1/36

Beneficial Ownership

Indian Issues

K R Sekar

20 March 2010



©2010 Deloitte LLP. All rights reserved.

Contents

2

Meaning / Concept

Indian Issues

Carry forward and set off of lossesDeemed Dividend

Royalty

Intermediary / Investment Company Jurisdiction

Trust

Way Forward



Concept


http://slidepdf.com/reader/full/beneficial-ownership-indian-issues-krs-v2 4/36 ©2010 Deloitte LLP. All rights reserved.

Concept of beneficial owner

• Under common law, the term, “beneficial owner”, would exclude a legal ownerwho is trustee for another

• The terms “beneficial owner”, “legal owner” and “registered owner” have different

implications Legal owner: one who holds legal title to property

Beneficial owner: one who ultimately enjoys the income on the asset and also controlssuch income receipts and the asset itself

Registered owner: one in whose name the asset is registered e.g. registeredshareholder. A registered owner may merely be holding the shares as a nominee forsomeone else (beneficial owner)

• Black’s Law dictionary: A beneficial owner is “one recognized in equity as theowner of something because use and title belongs to that person, even thoughlegal title belongs to someone else.”

• Law Lexicon defines “beneficial owner” as “one who, though not having apparentlegal title, is in equity entitled to enjoy the advantage of ownership.”

4



Concept of beneficial owner – Contd.

• Resorted to by most countries to ensure that any tax incentive is availed only bythe targeted tax payer Beneficial owner should be made liable for taxes

• Embedded as an anti-avoidance measure in the treaty law in respect ofdividends (Art. 10), interest (Art. 11) and royalties (Art. 12) under OECD / UNmodels

• Technical explanations to US model convention: The “beneficial owner” of adividend / payment of interest / royalty payment is understood generally to referto any person resident in Contracting Sate to whom that State attributes therespective income for the purpose of its tax.

• As per Prof Klaus Vogel, the issue of control is the most important factor indeciding the beneficial ownership. Beneficial owner is the person who is free todecide whether or not the capital or other assets should be used or made available for use by

others; on how the yield therefrom should be used; or

both5


http://slidepdf.com/reader/full/beneficial-ownership-indian-issues-krs-v2 6/36 ©2010 Deloitte LLP. All rights reserved.6

Illustrative example of the concept

US Co

INDIA

USAInterest

15% w/h tax

India Co Tax Haven

India Co

Loan USA

TAX HAVEN

Loan

0% w/h tax[Tax Haven

domestic taxlaw]

Loan

INDIA

0% w/h tax[India/ Taxhaven treaty]

Tax Haven Cosubject to 3%corporateincome tax on“spread”

Is Tax Haven Co the “beneficial owner” of the interest paid by India Co?

US Co



Beneficial Ownership & Domestic Tax Issues

7

Carry forward and set off of losses

Deemed Dividend

Royalty

Investment Structures

Trust

The domestic tax issues arising out of the concept of beneficial ownership canbe discussed under the following broad heads:



Carry forward and set off of losses




Section 79 – Carry forward and set off of losses

• Section 79(1)(a) of the Income Tax Act, 1961 (“the Act”) provides that:“Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place in a previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year

shall be carried forward and set off against the income of the previous year unless on the last day of the previous year the shares of the company carrying not less than 51% of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than 51% of the voting power on the last day of the year or years in which the loss was incurred.

• Exception

Provided further that nothing contained in this section shall apply to any change in the shareholding of an Indian company which is a subsidiary of a foreign company as a result of amalgamation or demerger of a foreign company subject to the condition that 51% shareholders of the amalgamating or demerged foreign company continue to be the shareholders of the amalgamated or the resulting foreign company.

9




Rationale

• To prevent trading in losses

• Not applicable to companies in which the public are substantially interested

• Genuine cases of reorganisation (as mentioned in proviso to Sec 79)excluded from the purview of Section 79

• Earlier, there was a second condition attached to Sec 79 for the carry forwardof losses i.e. the satisfaction of the Assessing Officer (AO) that the change inshareholding was not effected with a view to avoid or reduce any tax liability

However, there were controversies with regard to whether the conditions arecumulative or independent and the burden of proof, to show that the change inshareholding was effected with a view to avoid or reduce the tax liability, was on theAO or the assessee. This section was eventually deleted* to set at rest thecontroversies.

* omitted w.e.f 1 April 1989

10




Section 10A (9)

• Earlier, Section 10A(9)* had provisions similar to Section 79Where during any previous year, the ownership or the beneficial interest in the undertaking is

transferred by any means, the deduction u/s 10A (1) shall not be allowed to the assessee for the assessment year relevant to such previous year (PY) and the subsequent years.

For the purposes of this section, in the case of a company, where on the last day of the PY, the

shares of the company carrying not less than 51% of the voting power are not beneficially held by persons who held the shares of the company carrying not less than 51% of the voting power on the last day of the year in which the undertaking was set up, the company shall be presumed to have transferred its ownership or the beneficial interest in the undertaking.

• Introduced to prevent trading in incentives by shell companies formed only for thatpurpose

• However, not intended to cover cases of genuine business reorganisation whilemaintaining the major portion of ownership / beneficial interest with the same personswho were the owners of the business before such reorganisation.

• Different from Sec 79 as regards the date of comparison of holding of beneficial interest

* omitted w.e.f 1 April 2004

11

Section 79 Section 10A (9)

Comparison of ownership between the year inwhich loss suffered and the year in which claimfor set off of loss is made

Comparison of ownership between the year ofsetting up of the undertaking and the year inwhich deduction u/s 10A is claimed




Case Study 1

• Co 2 has brought forward losses

• Co 1 (100% holding company ofCo 2) transfers the shares of Co 2

to Co 3

• Will Co 2 be entitled to carryforward and set off of its lossesincurred prior to the transfer even

after the change in shareholding?

• Will the answer above change ifCo 1 is a Company listed in aninternational stock exchange?

12

Co 1

Co 2

100%

Co 1

Co 2

Co 3

100%

Pre-transfer Post-transfer

OutsideIndia

India




Case Study 1 – Contd.

• Non-discrimination clause in a double tax avoidance treaty:Enterprises of a Contracting State, the capital of which is wholly or partially owned or controlled, directly or indirectly, by one or more residents of the other Contracting State,shall not be subjected in the first-mentioned State to any taxation or any requirement

connected therewith, which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State, are or may be subjected [OECD model].

• When an Indian subsidiary has an Indian parent company, shares of which are listed on

any recognised stock exchange in India, the Indian subsidiary is treated as a company inwhich the public are substantially interested and hence, out of the scope of Sec 79.

• Therefore, when an Indian subsidiary has a parent company (outside India), shares ofwhich are listed on any stock exchange in its domicile country, the Indian subsidiary, byvirtue of the non-discrimination clause discussed above, should also be treated as acompany in which the public are substantially interested. Hence, the disability on carryforward and set off of losses u/s 79 should not be extended to that Indian subsidiary offoreign parent – Daimler Chrysler India Pvt Ltd v. DCIT*

* ITA No. 968/PN/03

13




Case Study 1 (a)

• Will the answer toCase Study 1 changeif:

the change inshareholding of Co 2 is

by reason ofamalgamation of Co 1with Co 3; and

Co 4 holds 55% and75% of Co 1 and Co 3

respectively?

• Will the answer toabove change if Co 4holds only 30%

shares of Co 3?

14

Co 1

Co 2

100%

Co 1

Co 2

Co 3

100%

Pre-transfer Transfer

OutsideIndia

India

Co 4

55% 75%

Co 4

55%

MergerCo 3

Co 2

100%

Co 4

75%

Post-transfer




Case Study 2

Co 1

Co 2

100% 55%

Co 1

Co 2

Co 3

45% 6%

Co 1

Co 2

Co 3

45%

Co 4

49%

• Co 2 is a whollyowned subsidiaryof ABL

• Co 2 had incurredlosses prior to 2000

• In 2000-01, Co 1 transferred45% of holding in Co 2 to Co 3

(its wholly owned subsidiary)

• In 2002-03, Co 1 transferred 49%holding in Co 2 to another company,

Co 4

100%subsidiary

100%subsidiary

15

Till 2000

Is Co 2 allowed to carry forward and set off of

its losses?

Is Co 2 now allowed to carry forward and setoff of its losses after 49% shares are

transferred to Co 4?





• Under the first situation, as 51% shareholding of Co 2 remains with Co 1, Section 79 isnot attracted and hence, Co 2 is entitled to the benefit of carry forward and set off of itslosses incurred prior to the year of transfer

• Under the second situation, although Co 1 directly holds only 6% of the shares of Co 2,yet Co 3, being a 100% subsidiary of Co 1, it may need to be seen whether Co 1

continues to remain the beneficial owner of 51% shares in Co 2. This is also possible ifthe Board of Directors (BOD) of Co 3 is controlled by Co 1. (Section 79 does not talk about the ownership of the share – A company is said to a subsidiary of a holding company also if the board of such company is controlled by the holding company ).

• Similar was the AAR ruling in the case of Amco power Systems Limited*

The ITAT referred to the Companies Act which states that a subsidiary company is one in whichits BOD is controlled by its holding company. Further, as per Companies Act, the BOD shall bedeemed to be controlled by another company if that other company at its discretion can appointor remove the holders of all or majority of the directorship.

Because of the holding pattern, board decisions of APIL were controlled by ABL and accordinglyABL had control over the affairs of Amco

Since the BOD of APIL is controlled by ABL, such voting power held by APIL was actuallybeneficially held by ABL. Thus there was no actual change in beneficial shareholding of Amco.

Carry forward and Set-off allowed

* ITA No. 889/Bang/07

16



Deemed Dividend




Deemed Dividend – Section 2 (22) (e)

• Section 2 (22) (e) of the Act provides that any payment made by a company inwhich the public are not substantially interested by way of advance or loan:

to a shareholder who is a beneficial owner of shares holding not less than 10% of thevoting power; or

to any concern in which such shareholder is a member or a partner and in which he hasa substantial interest; or

any payment made by any such company on behalf, or for the individual benefit, of anysuch shareholder

to the extent to which the company in either case possesses accumulated profitswould be deemed as dividend.

18




Rationale

• Closely held companies, which are controlled by a group of members, eventhough the company has accumulated profits, would not distribute such profit asdividend because the same would be taxable in the hands of the shareholders.

• Instead, companies distribute them as loan or advances to shareholder or toconcern in which such shareholders have substantial interest or make anypayment on behalf of or for the individual benefit of such shareholder to avoid thesame from being taxed in the hands of the shareholder.

• The intention behind the provisions of this section is to tax such dividend (in theform of loan or advance) in the hands of the shareholder.

19



20

Case Study 3

Shares were held in the name of 3trustees for and on behalf of the Trustand there were 5 beneficiaries.

The beneficial owners, in this case, are

the beneficiaries of the trust

Would the loan to Co 1 be taxable in thehands of Co 1 as deemed dividend?

If a person is a registered shareholderbut not the beneficial shareholder, thenthe provisions of section 2(22)(e) will notapply.

Trust

Co 1

20% 10%

Loan

Co 2

3 Trustees 5 beneficiaries

None of the trustees are beneficiaries of the trust

C St d 3 ( )



21

Case Study 3 (a)

Co 2 grants a loan to Co 1 (in which the ultimateparent Co 4 has a substantial interest)

Would such loan be taxed as deemed dividendin the hands of Co 4?

As per the provisions of Sec 2(22)(e), the loanhas to be given to a shareholder (who is also abeneficial owner) or to a concern in which theshareholder has substantial interest

In the instant case, Co 3 is a registeredshareholder but the loan has not been grantedto Co 3

The loan has been given to Co 1 in which Co 4has substantial interest. However, although C 4

is the beneficial owner of the shares in Co 2, it isnot the registered shareholder.

If a person is a beneficial shareholder but not aregistered shareholder, then also the provisionsof section 2(22)(e) will not apply.

Co 3

Co 1

20% 100%

Loan

Co 2

Co 4

C St d 3 (b)



22

Case Study 3 (b)

Would the answer to Case Study 3change if the common shareholder is acompany (say Co 3) holds the shares ofCo 1 as a beneficial owner?

In that case, Co 3 would be both theregistered shareholder and the beneficialowner of the shares in Co 2.

Hence, the provisions of section 2(22)(e)

will be applicable and the loan from Co 2to Co 1 will be taxed in the hands of Co 3by virtue of being the shareholder (bothregistered & beneficial owner).

Co 1

20% 10%

Loan

Co 2

Co 3

Case Study 3 Contd



23

It was held in the case of Bhaumik Colour (P) Ltd* that the expression shareholder

referred to in Sec 2(22)(e) refers to both a registered shareholder and beneficialshareholder

The requirement of holding of shares both as a legal registered owner and beneficialowner of such shares were not satisfied in the case of Bhaumik Colour. Thereforeprovisions of Sec 2(22)(e) were not applicable in the case of the Assessee.

Deemed dividend can be assessed only in the hands of a person who is a shareholder ofthe lender company and not in the hands of a person other than a shareholder

The Madras High Court in the case of Govindarajulu Naidu (G.R.) V.CIT** has held that itis not possible to construe that Section as importing two fictions i.e., one that the loangranted to the shareholder should be deemed to be a dividend and other that, thebeneficial owner of the shares is deemed to be a registered shareholder of the Company.

Hence, loan advanced to a shareholder would be deemed as dividend u/s 2(22)(e)only if the loan is advanced to a registered shareholder

* 27 SOT 270 (Mum, SB)** 90 ITR 13 (Mad, HC)





Madura Coats (P) Ltd - AAR 274 ITR 609

CHL

CPL CFL

• A loan given by a step downsubsidiary to another company,which is a subsidiary of the superparent not treated as deemeddividend u/s 2(22)(e)

• Borrower is not the directshareholder of the lendercompany

• Hence, borrower is not thebeneficial owner of the shares ofthe lender company

Subsidiary

24

Subsidiary

LoanJPC

MCPL

99.998%

Subsidiary



Royalty



26

Treaty definition of Royalty

Article OECD Model UN Model

1 Royalties arising in a Contracting state and beneficially owned by a resident

of the other contracting state shall be taxable only in that other State

Royalties arising in a contracting state and paid to a resident of the

other contracting state may be taxed in that other state

2 However royalties may also be

taxed in the Contracting state in which they arise… but if the beneficial owner of royalties is a resident of the Other Contracting State, the tax shall not exceed … %

C f b fi i l hi R l



©2010 Deloitte LLP. All rights reserved.27

Concept of beneficial ownership – Royalty

• Article 12 of the Model Conventions: Treaty benefits on royalty available only if recipient isthe ‘beneficial owner’ of such payments

• The terms ‘beneficial owner’ and ‘economic owner’ can be equated – in contrast to ‘legalowner’ – International Bureau of Fiscal Documentation

• Klaus Vogel on Double Taxation Conventions (1991)

Treaty benefits should not be granted with a view to formal title to royalties (or interest or dividend), but to

the ‘real title’

• The dispute of ‘form versus substance’ should be decided in favour of ‘substance’

1986 OECD Conduit Companies Report

• The test of beneficial ownership for tax treaty purposes must be an economic one, the beneficial ownermust be the person that economically benefits from the assets

OECD Model Convention 2005 – Commentary on Article 12

• Requirement of beneficial ownership was introduced to clarify how Article 12 applies in relation topayment made to beneficial owners

• State of source is not obliged to give up taxing rights over royalty income• Where income is received by a resident of a Contracting State acting in the capacity of an agent or

nominee, it would be inconsistent with the object and purpose of the Convention for the State of Sourceto grant relief or exemption

• However the limitation of tax in the state of source remains available when an intermediary is interposed

between the payer and the beneficial owner. States which wish to make this more explicit can do so inbilateral negotiations

C St d 4



©2010 Deloitte LLP. All rights reserved.28

Case Study - 4

Consortium

Licensee LicenseeLicensee Licensee

• Members of the consortium are the ownersof the technology and the IPR;

• C, Canada acts as an agent for licensing thetechnology to potential licensees;

• C, Canada identifies potential licensees,grants the license, undertakes collection andremittance;

• C receives a commission / fee for itsactivities;

• Assume the case of an Indian licensee;• In determining the tax implication, which

DTAA would apply –

Indo-Canada; or

The DTAA between Indian and therespective country of the owners of theIPR

• Whether C receives the royalty or licenseefee in his own right or as a mere agent?

F, France G, Germany

C, Canada

J, Japan



Intermediary / Investment Company

Jurisdiction

KSPG AAR Ruling




PG

GmbH

KSPGN

PG India

Germany

Netherlands

India

Facts• Initially German company was the holding

company of the Indian company.• The shares of the Indian company were transferred

to a Netherlands company in 2008

• The Netherlands company had made majorinvestments in the subsequent period

Question before the AAR• Whether the capital gain on sale of shares of

Indian company to another non-resident is liable totax in India?

Assessee’s contention• As per the Indo-Netherlands treaty the capital gain

on alienation of shares of Indian company is liableto tax in Netherlands

100%

100%

KSPG – AAR Ruling

30

KSPG AAR Ruling Contd




Revenue Authorities• The beneficial owner of shares is the German company and therefore the Indo-

German Treaty should be applied• Till 2008 the German company was the holding company and to avoid the capital gains

tax, the intermediary holding company in Netherlands was incorporated

AAR held• Netherlands company is a different legal entity and having separate board of directors

and management systems• Netherland company also had made substantial investments in Indian company

• Netherland company is not a conduit company• Transaction cannot be treated as device to avoid the capital gains

Capital gains is not liable to tax in India

KSPG – AAR Ruling – Contd.

31

E Trade Mauritius Limited Vs ADIT (Int Taxation)




• E-Trade Mauritius is a limited companyand a subsidiary of E-Trade FinancialCorporation, a US based company.

• E-Trade Mauritius sold shares of an Indiancompany (IL&FS) Ltd to another Mauritius

company, HSBC Violet Investments(Mauritius) Ltd and claimed capital gainsexemption under Indo-Mauritius DTAA.

• Whether Mauritian based purchaser ofshares of an Indian company is required todeduct tax at source while paying saleconsideration to another Mauritian basedsubsidiary of US based company? Assessee company in Mauritius is just

an instrument of the US parent

company for routing investments intoIndia. Therefore, Indo-USA Tax treaty is

applicable and the purchasing companyis liable to deduct tax at source whileremitting consideration to the assessee.

E Trade Mauritius Limited Vs. ADIT (Int. Taxation)

32

E-TradeFin Corp

E-TradeMauritius

IL&FS

USA

Mauritius

India

HSBC

Share

transfer



Apex Court Ruling - Azadi Bachao

Andolan



Key takeaways

Key Takeaways



35

y y

• No clear definition available anywhere, either in the treaties or in the domestic tax law of

any jurisdiction - Imminent need to have a commonly understood meaning across jurisdictions

• India to have a clear definition of beneficial ownership in its domestic tax laws which is insync with the internationally accepted meaning thereof

• Similar provisions exist in the proposed Direct Tax Code but beneficial ownership has also

not been defined therein. So, the present judicial precedents should hold good eventhereafter

• Intermediary holding company structures and their status as beneficial owner of theinvestments: In what situation the corporate veil is to be lifted is based on the facts of the

case Every intermediary holding company needs to pass the substance test and establish itsindependence and authority to claim itself as the beneficial owner of the investments

• In the advent of the landmark judgement of the apex court in the case of Azadi BachaoAndolan, it appears that inbound investments into India through treaty network may not be

faced with many hurdles in claiming beneficial ownership and corresponding treatybenefits provided it is a legal transaction.

• However, outbound investments from India may need to establish the facts based on theinterpretation of the law of the respective source countries, who may decide the availabilityof treaty benefits that can be claimed.

Undoubtedly, the ratio of Azadi Bachao’s case is widely acknowledged internationally and hence, thedecision should benefit even deserving outbound investors



Thank You

Beneficial Ownership-Indian Issues-KRS V2

Documents

Transcript of Beneficial Ownership-Indian Issues-KRS V2