Zaheer Mauritius v DDIT (Intl Taxation)  (W.P.(C) NO. 1648 OF 2013 dated 30.07.2014) – Delhi High Court

Background:

The petitioner is a company incorporated in Mauritius and is engaged in the business of investment into Indian companies engaged in construction and development business in India. The petitioner entered into a Securities Subscription Agreement (‘SSA’) and a Shareholder’s Agreement (‘SHA’) with Vatika and its JV Company. As per the SSA, the petitioner agreed to acquire 35% ownership interest in the JV Company by making a total investment of Rs. 100 crores in five tranches. The petitioner agreed to subscribe to 46,307 equity shares having a par value of Rs. 10/- each and 88,25,85,590 zero percent CCDs having a par value of Rs. 1/- each in a planned and phased manner. The SHA provided for a call option given to Vatika by the petitioner to acquire all the aforementioned securities during the call period and likewise, a put option given by Vatika to the petitioner to sell to Vatika all the aforementioned securities during the determined period.

On 08.04.2010, Vatika partly exercised the call option and purchased 22,924 equity shares and 43,69,24,490 CCDs from the petitioner for a total consideration of Rs. 80 crores. The Petitioner filed an application before the AAR for advance ruling on the taxability of the consideration received with respect to CCDs. AAR held that gains received/receivable by the petitioner resulting from transfer of the investments held by the petitioner in the JV company, was interest under Section 2(28A) of the Act. 

Assessee’s / Petitioner’s contentions:

• CCDs were held as capital assets by the petitioner and the transfer of the said investment was a transfer of a capital asset and any gains arising therefrom were liable to be treated as capital gains. 
• Consequently, such gains could not be subjected to income tax in India in terms of the DTAA between India and Mauritius.

HELD:

• A Compulsorily Convertible Debenture is a debt which is compulsorily liable to be discharged by conversion into equity. Any amount payable by the issuer of debentures to its holder would usually be interest in the hands of the holder.
  
• Whether a Compulsorily Convertible Debenture is a loan simplicitor or whether it is in the nature of equity, is not material in determining whether the gain on the sale of the debentures by its holder is a capital gain or not. This depends entirely on whether the debentures are capital assets in the hands of its holder.
• Under normal circumstances, it is undeniable that gains arising from transfer of a debenture, which is a capital asset in the hands of the transferor, would be capital gains and not interest. 
• The dispute in the present case arises only because it has been held that the transaction between the petitioner and the Vatika is a sham transaction and is essentially a transaction of loan to Vatika which has been camouflaged as an investment in shares and CCDs of the JV company. 
• Article 10(1) of the SHA entitles Vatika to call upon the petitioner to sell its investment at a price to be computed in the manner as provided in the clause. Article 10.2 of the SHA contains a provision whereby the petitioner could call upon Vatika to purchase its investment. It is to be noted that Article 10 only provided for options either to Vatika to buy out the stake of the petitioner in the JV Company, or to the petitioner to exit the JV Company by calling upon Vatika to buy its shares.
• In the event none of the options were exercised, the CCDs held by the petitioner would mandatorily be convertible into equity shares and the petitioner would be entitled to the benefits that would accrue to an equity shareholder in respect of the equity shares issued by the JV Company on conversion of the CCDs. 
• Merely because an investment agreement provides for exit options to an investor, would not change the nature of the investment made.
• It would also be relevant to note that if the gains are considered as payment of interest by Vatika, as is contended by the Revenue, the same would also mean that the quantum of interest is a deductable expenditure in the hands of Vatika. Viewed from this perspective, it would be erroneous to conclude that the whole transaction had been structured to ensure avoidance of tax on income.
• The Supreme Court in the case of Vodafone International Holdings BV v. Union of India and Anr.: [2012] 6 SCC 613 had held that Court must look at the entire transaction as a whole and not adopt a dissecting approach.
• There is sufficient commercial reason for the petitioner to have routed its investment in the real estate project through equity and CCDs. The pre-mature exit options as recorded in the SHA and the minimum return assumed by Vatika on its investment are clearly commercial agreements between the parties. These by itself do not change the legal nature of the transaction entered into between the parties.