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India Income Tax Appellate Tribunal Holds Beneficial Ownership Requirement May Not be Assumed with Respect to Capital Gains Under Treaty with Mauritius — Orbitax Tax News & Alerts

The Mumbai Income Tax Appellate Tribunal (ITAT) recently issued an order regarding beneficial ownership requirements and the provisions of Article 13 (Capital Gains) of the 1982 income and capital tax treaty with Mauritius. In particular, the order addresses whether beneficial ownership requirements must be met in order to benefit from paragraph 4 of Article 13, which essentially provides that gains from the alienation of property not specified in Article 13 are only taxable in the Contracting State of residence of the Alienator.

In the case at hand, a company established in Mauritius (the assessee), and wholly owned by a company in the Cayman Islands, claimed an exemption from tax on capital gains derived from India according to paragraph 4 of Article 13. The exemption was claimed in respect of long-term capital gains from the alienation of shares in the 2016-17 assessment year. At the time, an amending protocol to the treaty was not yet effective to provide for the taxation of gains from the alienation of shares, meaning the gains could be exempt. However, the assessing officer (AO) determined that the exemption could not be applied because the beneficial owner of the capital gains in question is an entity based outside Mauritius (i.e., the parent in the Cayman Islands) and the assessee is not entitled to the treaty protection in respect of the capital gains. As such, an assessment order was issued.

While the AO put forward an elaborate argument of the reasoning for the assessment, the ITAT found that the argument could not be evaluated until a fundamental assumption is dealt with, which is that the assessee must be the beneficial owner to apply the benefits of Article 13. The ITAT found that unlike in Article 10 (Dividends) or Article 11 (interest) of the India-Mauritius tax treaty, which specifically provide a beneficial ownership requirement in order to be entitled to treaty benefits, there is no such provision in Article 13 (Capital Gains). In the ITAT's view, the requirement for beneficial ownership cannot be inferred or assumed in the absence of a specific provision to that effect. Further, the ITAT noted that, as a look at the international tax literature shows, such an omission may not be inadvertent or unintentional.

Considering this, the ITAT found that the AO had clearly fallen in error in proceeding on the basis that the concept of beneficial ownership is relevant in the context of Article 13, without assigning any specific and cogent reasons in support of this inference, which is an approach the ITAT cannot approve. Therefore, the ITAT deemed it fit and proper to vacate the impugned assessment order and remit the matter back to the AO for deciding the fundamental issue as to whether the requirement of beneficial ownership can be read into Article 13 of the India-Mauritius tax treaty. Only in the event that the answer is in the affirmative can the question of the beneficial ownership of the assessee in respect of the shares be examined.

Note, the amending protocol to the India-Mauritius tax treaty amended Article 13 (Capital Gains) with effect from the 2018-19 year of assessment to provide for the taxation of capital gains from the alienation of shares with some transitional provisions, although no specific beneficial ownership provisions were added.