Can “other income” be taxed in India under the India-Mauritius tax treaty?

by | Jun 10, 2021

The question before the Mumbai Income-tax Appellate Tribunal (the “ITAT”) was whether the amount received by Morgan Stanley was chargeable to tax in India?

Facts

Morgan Stanley Mauritius Company Limited (“MSMCL”) is a company incorporated in Mauritius and holds a valid tax residency certificate issued by the Mauritius tax authorities. In the financial year 2014-15, MSMCL invested in Indian Depository Receipts (“IDRs”) issued by Standard Chartered Bank, India Branch (“SCB India”), with the underlying asset being the shares of Standard Chartered Bank, United Kingdom (“SCB UK”). The IDRs were held by the depository’s custodian, Bank of New York Mellon, USA (“BNY US”).

SCB UK is a company listed on the London Stock Exchange, and the IDRs that were issued in respect of the shares of SCB UK, are listed in India. The IDRs were issued in accordance with the Companies (Issue of Indian Depository Receipts) Rules, 2004, and the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009.

During the relevant financial period, MSMCL received INR97,466,595 (approx.US$1,335.158) from SCB India. The Indian tax authority (the “ITA”) proposed to tax this amount as dividend income under section 115(1)(a) of the Income-tax Act (the “IT Act”) at the rate of 20% plus applicable surcharge and cess, on the basis, that dividends were received by the IDR holders when they were first deposited into their bank accounts in India.

Issue

The question before the Mumbai Income-tax Appellate Tribunal (the “ITAT”) was whether the amount received by MSMCL was chargeable to tax in India?

The Ruling

Based on facts and the documents provided by the parties, the ITAT held that:

  1. IDRs are derivative financial instruments that draw value from the underlying shares that are traded on the approved stock exchanges in India. IDRs are issued by an Indian depository, and the benefits accruing from the underlying shares are passed on to the IDR holders as beneficiaries. There is a custodian involved, BNY US in this case, that holds custody of the shares.
  2. While the payment consideration flowed from SCB UK to BNY US, BNY US was only a custodian, and the actual recipient was SCB India. Thus, the benefits accrued to the IDR holders, and there was a significant business connection with India.
  3. The provisions of section 9(1)(i) of the IT Act are attracted as any income accruing or arising, whether directly or indirectly, through or from any business connection in India, or though or from any property in India, or through or from any assets or source of income in India” will be deemed to accrue or arise in India. The shares may have been held by an overseas custodian, but these shares constitute the property of the Indian depository, i.e., SCB India. Accordingly, the payments are chargeable to tax under the IT Act, subject to any beneficial provisions of the India-Mauritius double taxation avoidance agreement (the “Mauritius DTAA”).
  4. Under Article 10 of the Mauritius DTAA, the income in question cannot be treated as dividend income, because the dividend has not been paid by an Indian resident company. As such, the income will have to be characterized under the residuary Article 22 of the Mauritius DTAA as “other income.”
  5. Under Mauritius DTAA applicable in the financial year 2014-15, items of income of a resident of a Contracting State (i.e., MSMCL in Mauritius), wherever arising, which are not expressly dealt with in the articles of the Mauritius DTAA, shall be taxable only in Mauritius. On this basis, the amount received by MSMCL was not chargeable to tax in India.

Our Comments

The ITAT ruling is fact specific and is in line with similar rulings of other courts. However, it should be noted that on May 10, 2016, India and Mauritius signed a protocol amending the Mauritius DTAA, under which, among other matters, India can tax income (i.e., the other income residuary) not addressed in any other provision of the Mauritius DTAA. So, the ITAT ruling would have been different had the income of MSMCL or payments made to the IDR holders pertained to a subsequent period, i.e., on or after May 10, 2016.

In our view, the protocol has caused foreign investors to rethink using Mauritius entities (not only for equity investments in India but also on incomes that can be recharacterized as “other income” by the ITA). This has resulted in investors assessing investments through other jurisdictions such as The Netherlands or the UAE. There no longer remains a straitjacket formula for foreign investors to minimize Indian tax costs by investing through Mauritius entities. Depending on investment strategies, nature of investment, whether portfolio or direct, nature of instruments (debt or equity), different structuring options can be explored.

About the Author

Ravi S. Raghavan

Ravi S. Raghavan has more than 25 years of experience in corporate tax advisory work, business re-organizations, international taxation (investment and fund structuring, repatriation strategies, treaty analysis, advance rulings, exchange control regulations, FPI taxation), tax litigation services, and other tax issues (including withholding taxes, capital gains tax, permanent establishment concerns, employee taxation, and tax holiday schemes).

Ravi has spoken at different forums on various tax matters, including at the Annual India Tax Forum in New Delhi, and at the Annual Symposium on India’s Taxation Regime at the National Law School of India University, Bangalore.

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