Facts of the Case

  • Copal Research Limited (CRL), a Mauritius company, sold its entire shareholding in Copal Research India Private Limited (CRIL) to Moody’s Group Cyprus Ltd. under a Share Purchase Agreement dated 03.11.2011.
  • Copal Market Research Limited (CMRL), another Mauritius entity, sold shares of Exevo Inc., USA to Moody’s Analytics, USA under another Share Purchase Agreement. Exevo Inc. indirectly held shares in Exevo India Private Limited.
  • Simultaneously, shareholders of Copal Partners Limited, Jersey entered into another transaction with Moody’s Group UK Ltd. involving sale of approximately 67% shares of Copal-Jersey.
  • The Revenue contended that all three transactions formed part of one composite arrangement intended to transfer the entire Copal Group while avoiding Indian tax liability.
  • Applications were filed before the AAR seeking advance rulings regarding taxability of capital gains and withholding obligations under Section 195. The AAR ruled in favour of the assessees. 

Issues Involved

  1. Whether capital gains arising from offshore transfer of shares by Mauritian companies were taxable in India under Section 9(1)(i) read with Explanation 5.
  2. Whether the transactions were designed prima facie for avoidance of income tax under proviso to Section 245R(2).
  3. Whether shares of overseas companies deriving value from Indian assets could be deemed situated in India.
  4. Whether the buyers were liable to deduct tax at source under Section 195.
  5. Whether the expression “substantially derives value from assets located in India” included situations where only a minor portion of value was attributable to Indian assets.

Petitioner’s Arguments (Revenue)

  • The Revenue argued that the transactions could not be viewed independently and had to be read together as a composite transaction intended to transfer the entire Copal Group to Moody’s Group.
  • It was contended that separate sale transactions involving Mauritian entities were deliberately structured to avoid Indian tax by taking advantage of the India-Mauritius DTAA.
  • The Revenue asserted that but for the splitting of transactions, gains arising from transfer of shares of Copal-Jersey would have been taxable in India under Explanation 5 to Section 9(1)(i).
  • It was further argued that the Mauritius companies were shell entities lacking commercial substance and that effective management was controlled from the United Kingdom.

Respondent’s Arguments

  • The assessees submitted that the transactions had genuine commercial rationale because Moody’s insisted on acquiring complete ownership of the Indian operating entities.
  • It was argued that only 67% shares of Copal-Jersey were being transferred since banks and financial institutions held the remaining shares, making the Revenue’s suggested structure commercially impractical.
  • The respondents denied allegations of tax avoidance and contended that the Mauritius entities were genuine operational companies earning substantial revenues.
  • The respondents further relied upon the India-Mauritius DTAA and argued that the treaty did not contain any Limitation of Benefits clause denying treaty protection.

Court Findings / Court Order

The Delhi High Court dismissed the Revenue’s writ petitions and upheld the AAR ruling.

The Court held:

  • The transactions had commercial substance and were not sham arrangements designed solely for tax avoidance.
  • The structure suggested by the Revenue would not have achieved the same commercial objectives and therefore could not be treated as the “real transaction.”
  • Explanation 5 to Section 9(1)(i) applies only where shares derive substantial value from assets situated in India. The Court interpreted the word “substantially” to mean “principally”, “mainly”, or at least “majority”.
  • The Court observed that if less than 50% of the value of overseas shares is derived from Indian assets, such offshore transfers would not be taxable in India.
  • The Court relied upon international tax principles, OECD Model Convention, UN Model Convention, and recommendations of the Shome Committee while interpreting Explanation 5.
  • Since the gains were not chargeable to tax in India, there was no obligation to deduct tax under Section 195.

 

Important Clarification by the Court

The Court clarified that the expression “substantially derives value from assets located in India” under Explanation 5 to Section 9(1)(i) cannot include situations where only a minor fraction of value is attributable to Indian assets.

The Court effectively accepted the internationally recognised threshold approach and observed that “substantially” should be understood as more than 50% value being derived from Indian assets.

 

Sections Involved

  • Section 9(1)(i) of the Income Tax Act, 1961
  • Explanation 4 to Section 9(1)(i)
  • Explanation 5 to Section 9(1)(i)
  • Section 195 – TDS on payments to non-residents
  • Section 245R(2) – Authority for Advance Rulings
  • Section 245N
  • Section 90(2)
  • Section 115JB
  • India–Mauritius Double Taxation Avoidance Agreement (DTAA)
  • Article 13 of DTAA
  • Article 7 of DTAA
  • Article 22 of DTAA

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2014:DHC:3909-DB/VIB14082014CW20332013.pdf

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