WOLRDPART LIMITED,MAHARASHTRA vs. DCIT INTERNATIONAL TAXATION 2(2), CHENNAI

PER MANJUNATHA. G, ACCOUNTANT MEMBER:

This appeal filed by the assessee is directed against the order passed by the learned Commissioner of Income Tax (Appeals)-16, Chennai, dated 25.06.2018 and pertains to assessment year 2014-15.

:-2-: IT(TP)A. No: 36/Chny/2018 section 143(3) read with section 144C of the income-tax Act, 1961 (the Act') dated 28 February, 2017 by the Deputy Commissioner of Income Tax (International Taxation) 2(2). Chennai (ld.AO) on the following grounds of appeal: Ground No. 1 On the facts and circumstances of the case, the ld. AO has erred in concluding that the Appellant is not the "beneficial owner of interest income and consequently denied benefits under India-Cyprus Double Taxation Avoidance Agreement (DTAA). a) While arriving at the above conclusion, the ld. AO has erred in observing that the Appellant does not have a business purpose and acted only as an intermediary or a distribution channel and that the Appellant did not determine the 'economic fate' of the interest income received by it. b) While making the above observations, the ld. AO has disregarded the fact that the Appellant is incorporated with a definite business purpose as laid down in its charter documents, it has separate legal existence distinct from its shareholders and that the distribution of income is within the ambit and as permitted by the extant Cypriot laws with requisite court approvals. The Appellant thereby prays that the ld. AO be directed to allow benefits available under the DTAA and compute tax on the interest income at the rate of 10 percent as per the DTAA. Ground No. 2- Without prejudice to Ground No. 1, on the facts and circumstances of the case, the ld.AO erred in treating XE Advisors India Private Limited(XE Advisors') as the beneficiary of interest income attributable to Vitelina Holdings Co. Limited (Vitelina'). a) The ld. AO has disregarded the Appellants submission that none of the ultimate owners are resident of India and thus, erred in concluding that XE Advisors is the beneficiary of income attributable to Vitelina. Further, the above grounds are independent and without prejudice to each other. The Appellant craves leave to add, alter, amend or withdraw all or any of the Grounds of Appeal herein and to submit such statements, documents and papers as may be considered necessary either at or before the appeal hearing.

:-3-: IT(TP)A. No: 36/Chny/2018 3. The brief facts of the case are that, M/s. World Part Ltd is a company incorporated in Cyprus and is a tax resident of Cyprus. The assessee company holds 1,63,55,435/- Fully and Compulsorily Convertible Debentures (FCCD) of INR 100/- each in RGE Construction and Development Pvt Ltd. During the financial year relevant to assessment year 2014-15, the assessee has earned interest income of Rs. 22,89,76,090/- from FCCD. M/s. RGE Constructions and Development Pvt Ltd has deducted tax @ 30% on the interest income as per the provisions of section 94A of the Income-tax Act, 1961 (hereinafter referred to as “the Act”). The assessee has filed its return of income and offered interest income received from RGE Construction and Development Pvt Ltd on FCCD and paid tax @ 10% in terms of Article 11 of India-Cyprus Double Taxation Avoidance Agreement (DTAA). The case was selected for scrutiny and during the course of assessment proceedings, the Assessing Officer noticed that the assessee has made investment in RGE Construction and Development Pvt Ltd, out of equity and loan funds received from Catalyst Samsara India Opportunity Fund I LP, Jersey, i-Star DH Holdings Trc. Inc. Cayman, Islands and XE Advisors India Private Limited, India and thus, opined that the assessee is not

:-4-: IT(TP)A. No: 36/Chny/2018 a beneficial owner of interest income received from RGE Construction and Development Pvt Ltd on FCCD and thus, called upon the assessee to explain as to why assessee should not be treated as beneficial owner to give the benefit of Article 11 of India-Cyprus Tax Treaty. In response, the assessee submits that the appellant company is incorporated in Cyprus and is a tax resident of Cyprus is consortium for various shareholders (representing different PE funds) residing in multiple jurisdiction. The primary objective of the shareholder in set up of the company was to incorporate an independent projects, entering into joint ventures with real-estate developers etc. The appellant company has received capital funds from various shareholders and has deployed the funds in investment in RGE Construction and Development Pvt Ltd in FCCD. Further, the appellant is a separate legal entity and maintained its affairs independently without any intervention from the shareholders to manage the funds and thus, just because the surplus funds available with the assessee company has been paid back to the shareholders to reduce share capital, it cannot be held that the appellant is a conduit of shareholders and not beneficial owner of interest income earned from FCCD.

:-5-: IT(TP)A. No: 36/Chny/2018 4. The Assessing Officer, however was not convinced with the explanation furnished by the assessee and according to the Assessing Officer, the assessee company acted only as a conduit or an intermediary to facilitate investments of three shareholders in FCCDs of RGE Construction and Development Pvt Ltd. The Assessing Officer, further observed that the appellant company has been used by CSIOF I LP and others merely for the purpose of obtaining unjustified tax benefits, specifically of the interest based on Tax Treaty and thus, observed that the assessee is not a beneficial owner of interest income earned from FCCD to give the benefit of Article 11 of India-Cyprus Tax Treaty. The Assessing Officer, has observed the issue at length in light of shareholdings pertains to appellant company and investment made in RGE Construction and Development Pvt Ltd to arrive at a conclusion that the assessee is only an intermediary for three shareholders, which is evident from fact that interest income earned from financial year 2009 to 2014 has been distributed by way of capital reduction. Therefore, rejected arguments of the assessee and assessed interest income received from RGE Construction and Development Pvt Ltd, without giving the benefit of Article 11 of India-Cyprus Tax Treaty and computed taxation liability of Rs.

:-6-: IT(TP)A. No: 36/Chny/2018 5,12,98,604/-. The relevant findings of the Assessing Officer are as under: “The OECD directive's definition of beneficial owner for corporate recipients is the following: "A company of a Member State shall be treated as the beneficial owner of interest or royalties only if it receives those payments for its own benefit and not as an intermediary, such as an agent, trustee or authorized signatory, for some other person". The expression "its own benefit" might implicate directed at investigating whether the company, in addition of being the legal owner of the income, has also sufficient powers of enjoyment or disposition over the income, and has an economic return from the income, so that it can be considered the actual economic owner of the income concerned. i.e. a company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties. A direct recipient of the interest income is not the "beneficial owner" because that recipient's right to use and enjoy the income is constrained by a contractual or legal obligation to pass on the payment received to another person. Such an obligation will normally derive from relevant legal documents but may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the right to use and enjoy the income unconstrained by a contractual or legal obligation to pass on the payment received to another person. In this regard it is to be noted that the Article 11 of the treaty refers to the beneficial owner of interest. With the above background, an analysis of the assessee's case from a substance-over form or economic substance approach reveal the following facts: It would be inconsistent with the object and purpose of the tax treaties for the state of source to grant relief or exemption where a resident of a contracting state, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. A conduit company cannot normally be regarded as the beneficial owner if it has very narrow powers in relation to the income concerned. In the case of assessee, catalyst Samsara India opportunity Fund ILP, Jersey (CSIOF I LP) and I Star DH Holding TRS Inc, Cayman Island, (I Star) XE Advisors India private Limited only has the powers in relation to the Interest Income.

:-7-: IT(TP)A. No: 36/Chny/2018 Assessee, the recipient of this income, directly or indirectly, transfers almost all this income to other entities which would not benefit from the tax treaty provisions if it would receive such income directly. World Part Limited, did not determine the subsequent "economic fate" of the Interest Income received, since the entire amount passed on upwards in the ownership chain; Assessee had no business risk consisting in the potential loss of its own investment; i.e if ownership chain; interest is not received it would not pay the same to its investors by way of capital reduction. Almost all of the Interest Income received by the assessee are transferred to its shareholder: of the 460,19,45.75USD in Interest during 2009-2014, the World Part has distributed 425,36,87.37 by way of capital reduction. INTEREST INCOME CAPITAL REDUCTION (in USD) 27 Dec 2009 429,923.63 13 Mar 2008 430,000.00 24 April 2012 475,275.14 24 Jun 2012 412,379.07 31 July 2012 243,5076.64 20 Aug 2012 & 204,15,52.02 To 15 Oct 2012 210,000.00 01 Oct 2012 27 Aug 2013 29 Sep 2011 102,2669.02 04 Oct 2011 4,60,829.00 03 Feb 2014 239,001.32 08 Apr 2014 2,50,000.00 460,19,45.75 425,36,87.37 The residual interest income were used by the assessee inter alia towards compliance costs. The Indian investment is the only investment of the assessee and the same is being managed by the fund managers at CSIOF ILP, Jersey. There is a direct correlation between payment by RGE Construction of interest payment and amount paid to the shareholders by way of capital reductions. Interest income of assessee is similar to its capital reduction expenses both quantitatively and qualitatively World part does not have any business purpose and neither an adequate level of functions, assets and risks attributable to business Even though, World part Limited, the direct recipient of the income can qualify as a resident and can obtain the certificate of the tax residence from the tax authorities, this does not automatically mean that it is a beneficial owner of the income.

:-8-: IT(TP)A. No: 36/Chny/2018 Thus, Worlpart did not perform any other functions except for acting as an intermediary or a distribution channel and did not bear any risks. Worldpart was specifically established for the purpose of the single investment in Chennai. The assessee had no employees but support services for Account, Administration etc. had been rendered by a secretarial services firm. Almost all the income of assessee is distributed up in its ownership chain. The decision to infuse equity into Worldpart and subsequent loan arrangement with RGE was made effectively by CSIOF I LP, I Star DH Holding and XE Advisors India Private Limited which proves the intermediary nature of activities of Worldpart.

Since, assessee is not the beneficial owner of interest income, the interest are to be taxed in the contracting state in which they arise i.e in India, according to the laws of that state. Assessee does not retain any economic benefit in relation to the receipt of the interest income it receives (acting more like an administrator of fiduciary on account of the final beneficiary of the income), assessee cannot be treated as the "beneficial owner" of the income and the treaty benefits should not be available. Reliance in this regard is placed on the Arbitration Court of Moscow (the Court) decision in case No. A40-241361/2015 The recent decision of the UK Court of Appeal in the Indo food case, Indofood International Finance Ltd v JPMorgan Chase Bank N.A., London Branch (formerly J P Morgan Chase Bank, London Branch) It applied the beneficial owner requirement according to its "international fiscal meaning", and held that no treaty benefits would be available even in a case in which the financial subsidiary earned a profit and satisfied substance requirements under its home country's law. Based on the above, Worldpart should not be considered as beneficial owner of interest income received from RGE, as this company acted only as a conduit or an intermediary company. The World Part has been used by CSIOF ILP and others merely for the purpose of obtaining unjustified tax benefits, specifically of the interest based on Tax Treaty vis a vis non DTAA entitlement.

:-9-: IT(TP)A. No: 36/Chny/2018 On the basis of the above discussion, the total income of the assessee is computed as under: Interest Income : Rs.22,89,76,090/- 5,50,45,852 @ 30% : Rs. 1,65,43,759/- 17,39,24,238 @ 20% : Rs. 3,47,84,848 Rs. 5,12,98,604/- Tax and computation sheet which is to be considered as part of the assessment order enclosed separately.

:-10-: IT(TP)A. No: 36/Chny/2018 is not a beneficial owner of interest income earned from FCCD and consequently not entitled for Article 11 of India-Cyprus Tax Treaty. Thus, rejected arguments of the assessee and upheld the findings of the Assessing Officer. Aggrieved by the CIT(A) order, the assessee is in appeal before us.

:-11-: IT(TP)A. No: 36/Chny/2018 alleged by the Assessing Officer. Further, the assessee has every right and discretion to decide its affairs without any obligation from the shareholders except approval of shareholders for certain decision in accordance with Companies Act. Therefore, merely for the reason that the assessee has repaid money out of interest income to its shareholders, it cannot be said that shareholders are the beneficial owners of the interest income earned by the assessee and hence, the benefit of Article 11 of India-Cyprus Tax Treaty is not applicable. The Assessing Officer and CIT(A) without understanding relevant facts simply denied benefit of Article 11 of India-Cyprus Tax Treaty. In this regard, he relied upon the decision of ITAT Mumbai, in the case of M/s. Golden Holdings Ltd vs DCIT in ITA No. 6958/Mum/2017.

:-12-: IT(TP)A. No: 36/Chny/2018 three shareholders. Further, the assessee has transferred interest income to its shareholders and reduced capital. From the above, it is very clear that the assessee does not have any control over interest income earned from FCCD and ultimate beneficiary of interest income is shareholders. The Assessing Officer, after considering relevant facts has rightly held that the assessee is not a beneficial owner of interest income and consequently, not entitled for benefit of Article 11 of India- Cyprus Tax Treaty.

:-13-: IT(TP)A. No: 36/Chny/2018 is only a conduit or an intermediary for funds belongs to three shareholders and has facilitated investment in Indian company and thus, the benefit of Article 11 of India-Cyrpus Tax Treaty cannot be given. The Assessing Officer has discussed the issue at length in light of shareholdings pattern of appellant company, capital infusion and loan funds received from shareholders and also transfer of funds to shareholders and reduction of share capital and he, came to the conclusion that the entire interest income, leaving portion of income for operating expenses has been transferred to shareholders. Therefore, the Assessing Officer opined that the beneficial owner of interest income is ultimate shareholders but not assessee and thus, the assessee cannot avail the benefit of Article 11 of India-Cyprus Tax Treaty.

:-14-: IT(TP)A. No: 36/Chny/2018 other than the hypothetical observation in light of definition of beneficial owners and shareholding pattern of assessee company and movement of funds between appellant and those shareholders. It is an admitted fact that neither the Act, nor the DTAA between India and Cyprus defined the term beneficial ownership. Therefore, the term beneficial owner needs to be understood in the context, it was stated internationally. The term is used to mean the entity which is the legal owner of a property and who has dominion and control over the property. The appellant in the present case is a company incorporated at Cyprus and a tax resident of Cyprus. The assessee has invested in FCCD and received interest income thereon for its own exclusive benefit, and not for or on behalf of any other entity, in that sense, the appellant is a true owner of the interest income as it has complete control on the application or use of the income it received. The Assessing Officer’s findings to the effect that the appellant is not a beneficial owner of the interest income is solely on the basis of capital infusion and funds received from shareholders and subsequent transfer of funds to shareholders out of interest income. In our considered view, the mere fact that investment was funded out of portion of interest free

:-15-: IT(TP)A. No: 36/Chny/2018 shareholder loan and share capital does not affect the appellant status as a beneficial owner of interest income, because the entire interest income was the sole property of the appellant and was at its disposal. Further, the mere fact that the appellant as transferred surplus funds to shareholders for reduction of share capital does not mean that the entire interest income has been transferred back to shareholders to allege that the shareholders are the ultimate beneficial owners of interest income. In order to bring the theory of beneficial owner, the important fact needs to be considered is the recipient does not have a full right to use or enjoy the interest that it receives and this interest is not its own. If the recipient of interest income is a beneficial owner of that interest, where he has full right to use and enjoy the interest unconstrained by a contractual or legal obligation to pass on the payment received to another person, the person who receives is the real beneficial owner.

:-16-: IT(TP)A. No: 36/Chny/2018 the recipient of interest does have the right to use and enjoy the interest unconstrained by a contractual or legal obligation to pass on the payment received to another person, the recipient is the beneficial owner of that interest. In the instant case, although the funding for investment in FCCD is fully received from shareholders in the form of capital infusion and loan, but the shareholders fund was fully available with the appellant company at its disposal in investment. Further, interest income received by the appellant company is at its disposal and for benefit. The mere fact that the appellant has transferred surplus funds out of interest income to shareholders for reduction of share capital does not mean that it is a back-to-back transaction between appellant company and shareholders. In our considered view, to treat the appellant company as a beneficial owner, the Assessing Officer has to find that the appellant did not have exclusive possession and control over the interest income received and further the appellant was required to seek approval or obtain consent from any entity to invest its funds or to utilize the interest income received for its own discretion and finally appellant was not free to utilize the interest income received at its sole and absolute discretion. In the present case, the sole

:-17-: IT(TP)A. No: 36/Chny/2018 basis for the Assessing Officer to arrive at the conclusion that the appellant is not a beneficial owner of the interest income was transfer of surplus fund to shareholders for reduction of share capital. The Assessing Officer alleged that entire interest income after meeting all operating expenses has been transferred back to shareholders. In our considered view, the Assessing Officer is completely erred in coming to the conclusion, on the basis of transfer of funds back to the shareholders without appreciating fact that when the appellant is not in need of any funds, it is free to pay back to its shareholders to reduce share capital. But what is to be seen to consider the appellant is not a beneficial owner is, the control of funds and disposal of interest income. In case, the appellant is having discretion and full control over funds and investments, and further authority to dispose of its income on its own without any control or approval from shareholders, then the assessee can be treated as beneficial owner of said income. In the present case, there is no doubt of what so ever with regard to the fact that, the appellant is having absolute control over interest income and said income was at the disposal of appellant. The fact that the appellant has transferred surplus fund back to shareholders does not affect

:-18-: IT(TP)A. No: 36/Chny/2018 on appellant status as a beneficial owner of interest income. Therefore, we are of the considered view that the Assessing Officer and CIT(A) are erred in coming to the conclusion that the appellant is not a beneficial owner of interest income and consequently not entitled for benefit of Article 11 of India- Cyprus Tax Treaty.

:-19-: IT(TP)A. No: 36/Chny/2018 given below. The appellant-company was incorporated on 01.08.2011 under the laws of Cyprus. Its objective was to undertake business activities of an investment holding company. As at 31.03.2012, the appellant’s capital base consisted of equity share capital of USD 7,200 and debt capital of USD 21,500,000 in the form of unsecured interest-free shareholder loans from its immediate shareholder. The appellant has been issued a TRC by the tax authorities in Cyprus. The appellant applied for 5000 CCDs in ABPL, an Indian Pvt. Ltd. company, each having a face value of Rs.10 at a premium of Rs.1,99,990/- per CCD, and carrying a coupon of 15% on the face value, for an aggregate consideration of Rs.100,00,00,000/-. The premium at which the appellant proposed to apply for such CCDs was determined based on a valuation report dated 21.10.2011 obtained by ABPL valuing its equity shares at Rs.1,17,717/- per share using DCF method. The appellant applied for such CCDs on its own account, using a portion of the share capital and the interest-free shareholder loan raised from its immediate shareholder. Even after, the investment was made, the appellant continued to have cash balance of USD 1,354,761 available to it. The said CCDs were allotted to the appellant w.e.f. 28.03.2012. The above details were filed by the assessee before the AO. We find that the appellant invested in CCDs and received interest income thereon for its own exclusive benefit, and not for or on behalf of any other entity. The mere fact that the investment was funded using a portion of an interest-free shareholder loan and share capital does not affect the appellant’s status as the “beneficial owner” of interest income, as the entire interest income was the sole property of the appellant. In this context, we may refer to para 10.2 of the OECD Commentary (2017) on Article 11 (Interest) of the ‘Model Tax Convention’ to appreciate the meaning of “beneficial owner” and the same reads as under : “Where the recipient of interest does have the right to use and enjoy the interest unconstrained by a contractual or legal obligation to pass on the payment received to another person, the recipient is the ‘beneficial owner’ of that interest”. The issue is simple because the mere fact that the CCDs were funded using monies received by the appellant from its immediate shareholder does not make the arrangement a back-to-back transaction. The appellant had the absolute control over the funds received from its immediate shareholder. Further, in the instant case the appellant wholly assumed and maintained the foreign exchange risk on the CCDs (as they were INR denominated), and the counter party

:-20-: IT(TP)A. No: 36/Chny/2018 risk on interest payments arising on the CCDs. In the instant case, the AO/DRP have failed to prove that (i) the appellant did not have exclusive possession and control over the interest income received, (ii) the appellant was required to seek approval or obtain consent from any entity to invest in ABPL, or to utilize the interest income received at its own discretion and (iii) the appellant 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. In view of the above factual scenario, the transaction between the appellant and ABPL cannot be considered a mere back-to-back transaction lacking economic substance. Therefore, we direct the AO to accept the return of income filed by the appellant for the impugned assessment year disclosing a total income of Rs.15,16,43,840/- from interest on CCDs in ABPL, wherein it has offered such interest to tax @ 10%.”

:-21-: IT(TP)A. No: 36/Chny/2018 13. In the result, appeal filed by the assessee is allowed. Order pronounced in the court on 19th July, 2023 at Chennai. Sd/- Sd/- (वी दुगा� राव) (मंजुनाथ. जी) (V. DURGA RAO) (MANJUNATHA. G) �याियकसद�य/Judicial Member लेखासद�य/Accountant Member चे�ई/Chennai, �दनांक/Dated: 19th July, 2023 JPV आदेश क� �ितिलिप अ�ेिषत/Copy to: 1. अपीलाथ�/Appellant 2. ��यथ�/Respondent 3. आयकर आयु�/CIT 4. िवभागीय �ितिनिध/DR 5. गाड� फाईल/GF