Bombay HC decision in Indostar case eases withholding tax pains

Mumbai: The Bombay High Court’s recent decision directing tax authorities to release tax deducted at source (TDS) in the Everstone Capital-Indostar Capital deal comes as a major relief for companies operating from jurisdictions like Mauritius and Singapore.

Players are expecting that the jurisdictional tax officers will take note of the court ruling and issue ‘nil’ withholding certificates after a preliminary examination of the genuineness of the transactions in the future.

The High Court set aside the order passed by the tax authorities under Section 197 of the Income Tax Act, 1961 (ITA), which denied benefits under the India-Mauritius Double Taxation Avoidance Agreement to a Mauritius company (Indostar Capital) which was selling shares of an Indian company (Indostar Capital Finance Limited, or IFCL) under an initial public offering, on the grounds that the concerned transaction was a sham and colourable device to avoid tax.

However, by setting aside this order, the court established that for the purpose of issuing a nil or lower withholding tax certificate, the tax authorities are not required to conduct a detailed enquiry, and if there was no prima facie evidence demonstrating that the transaction was a sham from its very inception, the tax authorities could not reject the application.

This petition was filed by one Indostar Capital to challenge a June 20, 2018 order passed by Assistant Commissioner of Income Tax under Section 197 of the ITA.

The high court settled that the proceedings under section 197 of the ITA could not conclusively decide the taxability of the receipts in the hands of the payee. Despite issuing a nil withholding certificate under section 197 (197 Certificate), the tax authorities could tax the income in the regular assessment proceedings and conversely if a 197 Certificate was not granted the taxpayer could still contest the taxability of the income in the normal assessment.

Therefore, the court accepted the taxpayer’s contention that at the stage of deciding whether a 197 Certificate should be issued, a detailed inquiry is not required and if the taxpayer prima facie proved its case, the tax authorities could not deny the 197 Certificate.

Thereafter, the High Court confirmed that it would prima facie appear that gains arising to the taxpayer on sale of ICFL-- the NBFC promoted by Indostar Capital--shares were not taxable in India.

The order directed tax authorities to issue necessary certificate of no requirement of deducting tax at source to the petitioner under Section 197 of the Act.

It also directed IT department to release the tax already deducted by the payer as per the directives of the Assessing Officer and deposited in the government revenue along with interest, if any payable.

But directed that the company should maintain a minimum 50 lakh shares of ICFL to protect the interest of the revenue department.

“Nil withholding certificates are important from the seller’s perspective but it is often seen that the tax authorities reject applications without giving sound reasons. The buyer ends up withholding tax as directed. In such situations, the seller of the shares has to claim refund of taxes after filing the returns at the year-end. This decision should bring relief to such taxpayers. It is expected that the jurisdictional tax officers will respect the decision and issue Nil withholding certificates after a preliminary examination of the genuineness of the transaction," said Suresh Swamy, Partner, PwC Financial services.