In a recent decision in the case of M/s Golden Bella Holdings Ltd v Deputy Commissioner of Income Tax (International Taxation), Income tax appeal number: 6958/MUM/2017, the Mumbai bench of Income Tax Appellate Tribunal (ITAT) examined the concept of ‘beneficial ownership’ in relation to interest income and held the taxpayer, a Cyprus company, to be the ‘beneficial owner’ of such income and accordingly eligible to a lower tax rate under the India-Cyprus tax treaty (Cyprus Treaty).
This ruling assumes significance as it is the first judicial pronouncement on the issue of ‘beneficial ownership’ of interest income from a tax treaty standpoint. To establish ‘beneficial ownership’, the key determinants which emerge from this ruling are (i) exclusive possession and control over the interest income received; (ii) no requirement for the recipient to seek approval or obtain consent from another person for making investment; and (iii) freedom to utilize the interest income received at recipient’s sole and absolute discretion, unconstrained by any contractual, legal, or economic arrangements with any other third party. This ruling also highlights the criticality of burden of proof to be discharged by the revenue - the tax authorities were not able to prove non-existence of the aforesaid factors. At the same time, it does give taxpayers an insight into the extent of details looked at by the income-tax authorities in examining a claim of ‘beneficial ownership’.
Under Indian tax law, interest income arising to a foreign company on rupee loans is subject to tax at the rate of 40% (plus applicable surcharge and cess); 5% applies in certain cases, subject to conditions. The tax treaties generally cap the tax rate on interest at a lower rate which is usually 10% or 15% (depending on applicable tax treaty), provided that the recipient is the ‘beneficial owner’ of the interest income. In the absence of a definition and lack of judicial precedents, the determination as to whether the recipient is a beneficial owner is fact based and to some extent subjective.
This case deals with a Cyprus taxpayer which was earning interest income from India (on debentures issued by an Indian group company). Under the Cyprus Treaty, the tax rate applicable to interest income is capped at 10% provided that the recipient is the beneficial owner of such interest income. M/s Golden Bella Holdings (Taxpayer) had a Mauritian parent company. For the year in question, the India – Mauritius tax treaty did not provide any benefit with respect to interest income and it was to be taxable as per domestic law (the current treaty caps the tax rate at 7.5%).
The Taxpayer had invested in Compulsorily Convertible Debentures (CCDs) of ADAMAS Builders Private Limited (ABPL), an Indian private limited company. A week before investing in the CCDs, the Taxpayer had received an unsecured interest-free shareholder loan from its parent company in Mauritius, M/s Green World Development Limited (Parent Co). The interest income earned on such CCDs was offered to tax by the Taxpayer at the rate of 10% by virtue of the beneficial provisions of the Cyprus Treaty.
The tax authorities denied the benefit of the Cyprus Treaty on the basis that the Taxpayer was not the beneficial owner of the interest income. Accordingly, interest income was taxed at the rate of 40% (plus surcharge and cess) under domestic law. This was based on the following observations:
The Taxpayer argued that the tax authorities disregarded its factual submissions and arrived at arbitrary conclusions without discharging the burden of proof which lies on the revenue. Following were the key arguments:
The ITAT ruled in favour of the Taxpayer based on the following observations:
- the Taxpayer did not have exclusive possession and control over the interest income received,
- the Taxpayer was required to seek approval or obtain consent from any entity to invest in ABPL, and
- the Taxpayer was not free to utilize the interest income received at its sole and absolute discretion, unconstrained by any contractual, legal, or economic arrangements with any other third party.
Notably, in the context of royalty income, the ITAT in DIT v Universal Music International B.V. (2011) 45 SOT 219 (Mum) had relied on CBDT Circular 789 dated 13 April 2000 to hold that TRC is sufficient evidence of beneficial ownership – this ‘finding of fact’ was not interfered with by the Bombay High Court  214 Taxman 19 (Bombay). This argument was raised by the Taxpayer also, but the ITAT did not comment on the same in this ruling.
Given the inherent subjectivity in the determination of beneficial ownership, the underlying facts such as group structure, substance in the entities, rights of the income recipient - whether such rights are unfettered by any contractual, legal or economic constraints and such facts being supported by underlying documentation would remain key. This case pertains to an earlier year when anti-abuse rules were not in force. Going forward, a more robust analysis may be warranted in similar circumstances in view of the wide anti-abuse rules under domestic law and ‘Principal Purpose Test’ under tax treaties as amended by the OECD’s Multilateral Instrument.
- Ritu Shaktawat (Partner), Jimmy Bhatt (Principal Associate) and Dhruv Kapadia (Associate)
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