INSIGHT: Applicability of ‘Beneficial Owner’ under the India–Mauritius Tax Treaty

HSBC Bank (Mauritius) Ltd (HSBC or taxpayer) is a limited liability company which is incorporated, a tax resident of Mauritius and a registered foreign institutional investor. HSBC also has a bona fide banking business license in Mauritius and earns interest income from investments made in securities like treasury bills, bonds of Indian companies and external commercial borrowings.

HSBC had e-filed its tax return declaring nil total income in India by claiming benefit under Article 11(3)(c) of the India–Mauritius tax treaty (tax treaty) based on the cumulative condition to claim interest income exemption in India being satisfied:

• interest should be derived and beneficially owned by the taxpayer; and
• entity should be a bank carrying on bona fide banking business in Mauritius.

Subsequently, the taxpayer’s case was selected for tax review since no interest income was offered to tax in India to seek an explanation on the basis to claim tax treaty benefits.

On analyzing HSBC’s claim, the Revenue Authorities (revenue) denied the claim under Article 11(3)(c) of the tax treaty because it failed to qualify as a beneficial owner of the interest income, and also interest income paid to the Mauritius resident taxpayer bank was an alleged transaction for “treaty shopping” purposes acting in the capacity of agent or nominee, which is inconsistent with the objective and purpose of relief under the tax treaty.

The revenue strongly favored the view that HSBC was an agent, nominee, conduit company acting as a fiduciary or administrator of the recipient of the interest income and disregarded it as the “beneficial owner” of the interest income dealt by the CBDT Circular No. 789 (circular), since it neither had full right to use and enjoy the interest received nor owned the interest income to assess the interest income to tax under Indian domestic laws.

The issue was disputed by HSBC before the first appeal where the case was concluded in favor of the taxpayer by relying on jurisprudence to conclude that income received in Mauritius was not taxable in India. The revenue, aggrieved by the first appeal order, filed an appeal before the Income Tax Appellate Tribunal (tribunal).

Tribunal Ruling

The tribunal primarily dealt with the issue of whether the beneficial provisions envisaged in Article 11(3)(c) of the tax treaty are applicable to the interest income received by the taxpayer during the year; relying on its own case for the preceding years on an identical fact pattern, the appellate authorities consistently held that under Article 11(3)(c) of the tax treaty the interest income would not be exigible to tax in India.

The tribunal relied on the circular which specifically applied in the context of incomes by way of dividend and capital gains arising on the sale of shares, to infer the same principles to consider the taxability of interest income under Article 11(3)(c) of the tax treaty. In applying this analogy, HSBC relied on the rationale of the Bombay High Court case of Universal International Music B.V. to determine the taxability of royalty under the India–Netherlands tax treaty where the Court followed the circular to grant tax treaty benefit to the royalty income.

Correspondingly, the tribunal, relying on the principles of the circular, treated the taxpayer as the “beneficial owner” of the interest income on the strength of the certificate of residency issued by the Mauritian authorities in the context of interest income earned under the provisions of Article 11(3)(c) of the tax treaty. Reliance was placed on the Hyundai Motor India Ltd ruling, which observed that the recipient of income was the “beneficial owner” of the interest income qua the provisions of Article 11(3) of the tax treaty.

The co-ordinate bench in an unequivocal manner had consistently concluded that the taxpayer is a “beneficial owner” of the interest income. Further, undisputedly the tribunal confirmed that the nature of interest income in the year of tax review under appeal is ceteris paribus to the preceding years where the tribunal had upheld the appellate appeal order and regarded the revenue’s appeal sans merit.

The tribunal observed that on due consideration including the preceding year’s tribunal order, no material evidence was presented by the revenue on record to substantiate that HSBC was a conduit company and not the beneficial owner of interest income. Hence, the tribunal regarded the case to be squarely covered by its earlier year’s orders passed favorably in HSBC’s own case based on the identical facts to conclude that interest income received under Article 11(3)(c) of the tax treaty is not exigible to tax in India.

Planning Points

The issue of beneficial owner is a contentious one to be addressed when it comes to claiming tax treaty benefit for recurrent income like dividends, interest and royalties; however the applicability of beneficial owner may differ contextually under the Indian domestic laws particularly aimed at dividends and capital gains via the circular.

The tribunal ruling is likely to settle similar cases being disputed by numerous Indian courts predominantly on the issue of beneficial owner.

Interestingly, the issue of beneficial owner is relatively resolved internationally by the cases of Indofood International Finance Ltd v. JP Morgan Chase Bank, N.A., London Branch” [2006] EWCA Civ. 158, [2006] STC 1195, Prevost Car Inc. v. The Queen, 2008 TCJ 231 (TCC). Further, the 2017 OECD Model Tax Commentary explains the term “beneficial owner” as, where the recipient of income has the unfettered right to use and enjoy such income without any restriction by a contractual or legal obligation to pass on the amount of income received to another person, such recipient is the “beneficial owner” of that income.

Even if countries like Mauritius do not form part of the covered tax agreement under the multilateral instrument, having satisfied the requirements of the principal purpose test, the General Anti-Avoidance Rule and related anti-abuse provisions, any tax treaty benefits claimed with the intention of structuring transactions, leading to tax losses for the revenue, will obligate taxpayers to carefully evaluate payments to ensure that the transactions do not create situations of non-taxation or reduced taxation or causing artificial tax evasion or avoidance, including treaty shopping arrangements.

Shailendra Sharma is a Chartered Accountant associated with a multinational financial services firm, India.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.