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TAX NEWS - may 2010

India Tax: AAR rules on beneficial ownership concept for taxing capital gains under tax treaty

The Indian Authority for Advance Rulings (AAR) recently held that a Dutch company deriving capital gains from the sale of an Indian subsidiary to another nonresident would not be subject to tax in India and that the Dutch company's ultimate parent company cannot automatically become the beneficial owner of such gains if the subsidiary has its own board of directors and management system (KSPG Netherlands Holding B.V.).


Facts

A Dutch company (Applicant) was incorporated on 11 August 2021 and on 6 November 2021 it acquired all the shares of an existing Indian company from another group company located in Germany. The shares were acquired for INR 100 million. After the acquisition, the applicant made a further investment of INR 1100 million in the Indian subsidiary. The Dutch company and the German company are ultimately held by another German company with extensive manufacturing operations in Europe. The Dutch company is proposing to sell the shares of the Indian subsidiary to another nonresident entity and has taken the position that the exemption under the capital gains article of the India-Netherlands tax treaty means that gains on the sale would not be taxable in India.

The Indian tax authorities contended that the beneficial owner of any capital gains on the transfer of the shares of the Indian company would be the ultimate German holding company, so the India-Germany treaty should apply. That treaty does not provide an exemption for capital gains. Further, the authorities argued that, because the shares of the Indian company were held by a German company in the group before the acquisition, the interposition of the Dutch company was a part of a scheme to avoid Indian capital gains tax liability so it should not be entitled to receive benefits under the treaty.


AAR ruling

The AAR stated that, although the Dutch company is a subsidiary of an ultimate German holding company, it is a distinct legal entity with an independent board of directors and management system and its actions relating to the investment in the Indian company all point to the Dutch company being the beneficial owner.

The applicant acquired the shares of the Indian company at a price determined under the Indian foreign exchange regulations and it made substantial investments in the subsidiary after the acquisition. It is not possible to presume that the Dutch company was simply a conduit to siphon off gains to the ultimate German holding company by means of a scheme contrary to its corporate status and the stake in the Indian subsidiary. There is no factual basis to conclude that the German parent is the real beneficial owner of the shares and the capital gains derived from the sale. The AAR did note that the tax authorities have the right to examine the facts at the time of transfer, but, on the basis of the facts in the AAR ruling request, the AAR could not conclude that the beneficial ownership in the gains resulting from the transfer of shares is vested with the ultimate German holding company. Thus, the applicant is not liable to pay tax on the capital gains by virtue of article 13(5) of the India-Netherlands tax treaty.


Conclusion

Based on the facts, the AAR concluded that the applicant is the beneficial owner of the shares in the Indian subsidiary. The significant additional investments made by the applicant in the Indian subsidiary subsequent to the acquisition of shares from the German company were considered in support of the applicant being the beneficial owner of the shares.
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