A taxpayer's intentions at the time of a transaction will significantly affect a court's opinion
The Madras High Court issued a tax avoidance judgment in the case of Redington India Limited (Corporate) on December 10, 2020. The company had transferred its entire stake in a foreign company to another newly formed subsidiary overseas for no consideration. She requested the transaction as a gift and was therefore exempt from tax under national tax law.
The case before the Madras High Court mainly concerned whether the transaction was a valid gift within the meaning of national law and therefore not within the scope of capital gains tax and the applicability of transfer pricing laws to the transaction.
Facts of the case
Redington is headquartered in Chennai, India and provides end-to-end global supply chain solutions for all IT, telecommunications, lifestyle, healthcare and solar products.
Redington's business in the Middle East and Africa was conducted through its wholly owned subsidiary Redington Gulf FZE (RG), which has been incorporated in the Jebel Ali Free Trade Zone in the United Arab Emirates since 2004. RG in turn had subsidiaries in various countries in the region. Redington's total investment in RG as of March 31, 2008 was INR 2.14 billion (US $ 29.3 million).
Redington India's business in the Middle East and Africa as of March 31, 2008
The group intended to raise capital overseas to grow its business. To meet the needs of a prospective investor who was a private equity fund headquartered in the Cayman Islands, the company formed a wholly owned subsidiary in Mauritius in July 2008 known as Redington International Mauritius Limited (RM) who in turn held a new subsidiary incorporated in the Cayman Islands, known as Redington International (Holdings) Limited (RC).
On November 13, 2008, the company transferred to RC without considering its entire stake in RG. RC did not hold any interest in RG until after the transfer of shares and had no other assets or income. The United Arab Emirates Free Trade Area (RG) company became a direct subsidiary of RC and a subsidiary of the company held indirectly through the Mauritius and Cayman Islands companies.
RC's value rose after RG transferred its shares to the Cayman Islands. On November 18, 2008, the private equity fund acquired 27.17% of RC equity for $ 65 million. At that time, RG was reported to be worth $ 239 million.
Transfer of Shares by Redington India
The agreement enabled the Cayman Islands private equity fund (the investor) to acquire RC's shares in the Middle East and Africa. This arrangement therefore enabled Redington India to raise capital through the future sale of shares without them being taxable in India or the Cayman Islands (the Cayman Islands had no corporate income tax).
The Cayman Islands private equity fund then left the RC in 2011-2012 by selling its shares in RM. This transaction took place because the Redington Group was unable to meet the terms of the share purchase agreement, including RG's listing on a recognized stock exchange.
Regarding the taxation of the transfer of shares, Remington India contended that the transfer was a gift that was not taxable as a capital gain under Section 47 (iii) of India's Income Tax Act of 1961. The company alleged that a transfer of shares was not a divestment of investments and the company continued to have effective control over all subsidiaries and any economic benefits arising therefrom.
The view of the tax authorities
Upon review, the evaluating Indian tax officer found that the inclusion of RM and RC immediately prior to the share transfer is a means of avoiding capital gains taxes. These two companies had no commercial substance of their own and were used as a means of avoiding taxes.
The Transfer Pricing Officer also denied the right to characterize the sale of shares as a gift, and the transfer of shares was considered a taxable business. The transaction was also determined to be an international transaction and its market price was established.
The tax officer also believed that by transferring the shares, the company was relocating the proceeds of a future sale of the asset to a country outside of India and the dividend income to a country outside of India. This agreement resulted in the tax base being relocated from India.
The first Dispute Resolution Panel upheld the tax officer's decision.
However, the Income Tax Appellate Tribunal, the second level appellate body, accepted the taxpayer's objections, treated the transfer of shares as a valid gift, and approved the non-taxability of the transaction for capital gains under Section 47 (iii) of the Income Tax Act. The share transfer was also not considered to be an international transaction subject to the Transfer Pricing Act.
The tax authorities were affected by the order of the tribunal and brought the matter to the High Court. Before the court, the tax authorities asserted, among other things, that the transaction had only been carried out as a restructuring of the appraiser and the transaction as a gift upon approval by the board of directors never came to mind.
The company denied the tax officer's decision on a number of grounds, including the fact that RM and RC were set up for commercial reasons. Transfer pricing provisions apply only when income is generated, the gift of shares is excluded from the definition of a transfer, and the transfer of shares as a gift was for a commercial purpose.
The view of the high court
The High Court examined contemporaneous documents such as minutes of a board meeting, deeds of transfer of shares, statements of the chief financial officer, correspondence with the central bank, as well as domestic law relating to the transfer of property and various court pronouncements, and overturned the tribunal's order on. The court ruled that the transaction did not pass any of the checks of a valid gift under Section 125 of the Transfer of Property Act, for example, voluntarily, without consideration and acceptance by the recipient.
The High Court also considered the title of the document, the content and intent of the transaction, the events that occurred prior to the Board's approval of the share transfer and the execution of the share deeds.
The High Court referred to the Supreme Court's decision in the case of Mc Dowell & Co. Limited, in which the court said that tax planning could be legitimate if it is within the law. The court ruled that the tax authorities need to examine whether the taxpayer has used sophisticated tax avoidance methods and that they are entitled to step behind the veil to examine the real intent of the parties.
“So when you look at the chain of events it is obviously clear that the incorporation of the company in Mauritius and the Cayman Islands immediately prior to the transfer of shares is undoubtedly a means of avoiding taxation in India and the two companies mentioned became than used lines to avoid income taxes, ”the court found.
The Company's establishment of two overseas subsidiaries and the transfer of shares in favor of a third party investor within a short period of less than a week with a stake sale of more than 27% and the surrounding circumstances categorize the transaction as a transfer of capital assets. The High Court said the two companies that were formed as a subsidiary and subsidiary should create a tax avoidance line.
The transaction relates to 2008, and India's General Anti-Avoidance Rule (GAAR) did not apply that year. The court discussed the content of the transaction and the events that led to the transaction.
It should be noted that India and the UAE amended their tax treaty with effect from April 1, 2008 by a protocol signed on March 26, 2007. The amended contract stipulated that the profits from the sale of shares in a company could be taxed in his country of residence. The taxation of the transaction according to the provisions of the tax treaty has not been taken into account by the tax officer nor claimed by the taxpayer.
It could have been difficult to prove that RG was a UAE resident for tax purposes and capital gains were UAE taxable (although the UAE did not levy taxes) as a company resident in a country must be included in that country , and its control and management should also be in this country.
The central theses
The court placed great emphasis on the documents, the taxpayer's intent at the time of the transaction, and the chain of events that led to a private equity investor's investment. The decision suggests that the principle of substance over form remains a guiding principle for the courts.
The taxpayer is advised to create and maintain documents at the same time to prove the right to a tax advantage or the characterization of a transaction. The tax administration is more likely to challenge a taxpayer's unsupported claims.
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