Where cumulative convertible preference shares were issuedprior to 1-4-2017 but conversion took place after said date,capital gain derived from sale of such shares would be exemptunder India-Mauritius DTAA.

Issue of the Case:

• Sarva Capital LLC (hereinafter referred to as “the Assessee”) is a non-resident corporate entity. The Assessee had made investment in India in cumulative convertible preference shares (CCPS) which were issued prior to 01.04.2017 and got converted into equity shares after the said date and by selling those equity shares, the Assessee derived income under the head ‘long-term capital gain’ during the relevant year. The Assessee has offered these gains to tax which were arise from the transfer of equity shares which were converted from CCPS and claimed exemption for other long term capital gains arisen from transfer of other equity shares under India-Mauritius DTAA.
• The Assessee’s return was taken up for scrutiny and assessing officer (AO) held that the Assessee was not entitled to the benefit of DTAA as TRC is not sufficient to establish the tax residency if the substance establishes otherwise and the Assessee was just a conduit and the real owner was the shareholders/investors who were tax residents of different countries and subsequently passed the draft assessment order in which AO had taxed entire long-term gains. The Assessee went to dispute resolution panel (DRP) however, DRP also passed the order against the Assessee.
• Subsequently, the Assessee went to ITAT against the order passed by the AO in accordance with directions issued by DRP. The Assessee also appealed before ITAT that the long-term gains which were arise on transfer of equity shares which got converted from preference shares, were also not taxable as per India-Mauritius DTAA and were wrongly offered to tax in the ITR.
• The question before ITAT was whether AO was right in his contention that TRC is not sufficient to establish the tax residency and whether long term capital gains arisen from transfer of CCPS which got converted after 01.04.2017 into equity shares but were issued before 01.04.2017.

Observation And Conclusion:

Hon’ble ITAT held that:

• Hon’ble Supreme Court in case of Union of India vs. Azadi Bachao Andolan, held that once the TRC has been issued by the competent authority of the other country, it will demonstrate the tax residency of the entity and the concerned entity would be eligible to avail the benefits under the DTAA. Thus, AO had committed a mistake in denying the benefit of DTAA to the Assessee having a valid TRC.
• As per the reading of Article 13(3A) of DTAA, the expression used therein is “gains from alienation of shares” and the word ‘shares’ will take all type of shares within its ambit, including preference shares. Since, the Assessee had acquired the CCPS prior to 01.04.2017, the capital gain derived from sale of such shares would not be covered under Article 13(3A) and accordingly it will fall under Article 13(4) of the DTAA and would be exempt from tax in India as the capital earned is taxable only in the country of residence of the Assessee.
• Even if the Assessee had offered to tax such gains, nothing will preclude the Assessee from claiming the benefit under Article 13(4) of the DTAA. Hence, the matter was decided in the favour of Assessee.

Lakshay Prakash Jonwal, Tax Associate, SW India