Mumbai Tribunal rules buyback transaction taxable as capital gains, exempt under India-Mauritius Tax Treaty; even if considered as dividend, tax withholding does not apply

This Tax Alert summarizes a recent ruling of the Mumbai Income Tax Appellate Tribunal (Tribunal) in the case of Goldman Sachs (India) Securities Pvt. Ltd. (Taxpayer) . The Taxpayer is a wholly-owned Indian subsidiary of a Mauritian parent. The Taxpayer had undertaken a buyback transaction and remitted the proceeds to its only shareholder in Mauritius.

The Tax Authority regarded such buyback as capital reduction and the amount remitted as distribution of accumulated profit. This was taxed as dividend in the hands of the recipient Mauritian shareholder. As the Taxpayer had not paid Dividend Distribution Tax (DDT) or withheld any taxes on such payment , the Taxpayer was treated as a taxpayer-in-default (TID). Furthermore, the transaction was considered as a colorable device having the objective of avoiding payment of DDT in India.

The Tribunal ruled that the amount remitted under the buyback transaction was taxable as capital gains. As the shareholder was a resident of Mauritius, such capital gains was exempt from taxation in India under Article 13 of the India-Mauritius Double Taxation Avoidance Agreement (DTAA). Even if the amounts were treated as dividend, it would have been subject to DDT in the hands of the Taxpayer under the Indian Tax Laws (ITL) and, hence, exempt in the hands of the shareholder. Thus, withholding provisions would not apply in such a case as well. The Tribunal held that the transaction of buyback is distinguishable from that of capital reduction. Furthermore, if a taxpayer enters into a transaction which does not violate any provision of the ITL, the transaction cannot be termed as a colorable device because it results in non-payment or lesser payment of taxes in that year.

The Tribunal has held that the transaction of buyback is distinguishable from that of capital reduction. Furthermore, if a taxpayer enters into a transaction which does not violate any provision of the ITL, the transaction cannot be termed a colorable device just because it results in non-payment or lesser payment of taxes in that year.

Interestingly, one may recall the ruling of the Authority for Advance Rulings, which held that if the company does not distribute dividend but buys back its shares instead, it was to be regarded as dividend and subjected to withholding tax at the rate of 5% in terms of Article 10 of the DTAA.