The Bombay High Court (the High Court) has delivered a
landmark precedent while disposing the writ petition filed by a
Mauritian company (the petitioner). The issue involved the
granting of a capital gains tax exemption for the purpose of
obtaining a nil withholding tax (WHT) certificate where
benefits as per the India-Mauritius double taxation avoidance
agreement (the tax treaty) were at play.
About nil/lower WHT certificates
The Income-tax Act, 1961 (the Act) casts the WHT obligation
on the payer responsible for paying any sum to a non-resident
which is chargeable to tax under the Act. Consequently, no
obligation is cast on the payer where the income arising to a
non-resident is not chargeable to tax under the Act or
applicable tax treaty. If such a payer fails to withhold the
tax, then the payer is deemed to be an assessee in default and
penal consequences would follow.
Subject to fulfillment of specified conditions, section 197
of the Act recognises the facility and procedure to issue a
lower or nil WHT certificate. Where a 197 certificate is
issued, the payer shall be undertaking lower/nil WHT as per the
rates specified in the certificate.
A certificate under section 197 of the Act helps the payer
to arrive at the WHT rates so as to imbibe immunity for
non-compliance and avoid any risk of being declared as an
assessee in default. Thus, the section strikes a delicate
balance between the WHT liabilities of a payer, release of
requisite cash flow to the payee and discharge of tax dues at
the earliest opportunity.
Transaction before the High Court
The petitioner is a Mauritian company incorporated to
undertake business of investment holdings. It was set up by
many well-recognised and well-established foreign institutional
investors to explore opportunities of investment in India. The
Board of the petitioner consists of nominees from each of the
institutional investors. The petitioner held a valid tax
residency certificate (TRC) and other prescribed documents
essential for obtaining benefits under the tax treaty.
The petitioner is a promoter and equity stakeholder of a
non-banking financial company ('I Co'). These investments were
made over a period of four years, all before April 1 2017.
During the initial public offering of shares of the I Co, the
petitioner had sold a portion of its investments under offer.
The petitioner had, on the resultant capital gain, moved an
application under section 197 of the Act (the application) to
the assessing officer requesting a nil WHT certificate,
claiming exemption from capital gains tax in India under the
Article 13(4) of the tax treaty.
The assessing officer rejected the petitioner's claim,
stating that the entire holding structure was not genuine and
had been created to avoid taxes in India. The officer denied
benefits under the tax treaty to the petitioner.
A WHT certificate was issued under section 197 of the Act
with an effective rate of 10% (plus applicable surcharges and
cess) on the capital gain computed in accordance with section
112 of the Act.
The assessing officer had in his order (the 197 order) for
rejection of the application specified that Nil WHT could not
be adopted as the petitioner was not engaged in any other
business, nor had any place of establishment or any employees.
Further, he also held that the TRCs of stakeholders of the
petitioner or details of the ultimate beneficiary were not
submitted by the petitioner.
Aggrieved by the assessing officer's 197 order, the
petitioner filed a writ before the High Court.
Decision of the High Court
The petitioner and the income tax department of the Central
Board of Direct Taxation (CBDT) advanced their argument on the
matter. Having heard both sides, the High Court specifically
ruled on the prima facie ground being the correctness
of the 197 order passed. The High Court order also touched upon
various other aspects including preliminary views on taxability
of the capital receipts in hands of the petitioner. The High
Court has, in its ruling, observed that the petitioner's
application was valid and that the petitioner was entitled to
claim tax treaty benefits.
Based on the detailed evaluation, the plea was accepted and
the writ was disposed of holding conclusive actions as
- Quashing of the 197 order;
- Issue of a fresh Nil WHT certificate;
- Directing issue of refund of WHT already
deposited along with applicable interest.
The High Court also instructed the petitioner to maintain a
certain portion of holding of its equity interest in I Co until
the completion of assessment.
While delivering the order, the High Court observed the
- That, prima facie, if TRC is
available, the capital gains arising out of sale of shares
shall not be taxable under the tax treaty. It placed reliance
on various ruling and CBDT Circular while observing the
- That despite existence of the tax treaty,
in case of fraudulent and fictitious/sham transactions, the
revenue authority might still have a case to tax such capital
gains. However, in the present case the allegation of the
assessing officer of the transaction to be a sham was not
backed by sufficient reason and material on record to
demonstrate the same; and
- That the observations made by the
assessing officer in the 197 order while rejecting the
applications are only indicative but not sufficient. Further,
such aspects need to be taken into consideration at the time
of assessment proceedings.
In the times where such capital gains transactions are under
intense scrutiny and the tax department explores every
opportunity to deny tax treaty benefits, the High Court order
is a welcome and balanced move. The High Court has affirmed
that at 197 stage, tax treaty benefits cannot be denied once
there is a valid TRC in place and transaction is genuine. In
tandem, the High Court Order does not, in any way, extend the
ability of the assessing officer to deny tax treaty benefits in
case of sham/fraudulent/bogus transaction.
It is noteworthy that the conditions for maintaining
security (as discussed above) by the petitioner appears to be
only for safeguarding the interest of revenue since it involved
the 'refund of taxes' to a non-resident. There are no such
conditions/restrictions attached for the purposes of issuing a
nil/lower 197 certificate. Further, there are no provisions
under the Act governing this. Section 197 of the Act does not
envisage any form of security being provided as a pre-condition
for issuance of 197 certificate.
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