'Renewed debate on anti-tax avoidance'

A landmark Canadian federal court case has renewed debate on application of anti-tax avoidance provisions in the Indian context. The Lipson decision relates to circumstances that could lead to Revenue invoking General anti avoidance rules (popularly referred to as GAAR in international tax parlance) by the Revenue and the Prevost case relates to availability of Double Tax Treaty benefit to residents of state, who are beneficiaries and the literal interpretation of the term.

From an Indian context, the debate on such matters is far from over, given the approach of the tax administration to bring tax offshore transactions, in absence of GAAR in the Indian context. A case in point is the most debated Vodafone tax dispute, wherein the Revenue is attempting to tax offshore sale of shares arguing transfer of beneficial ownership or for that matter, our treaty policy that there should be a limitation of benefits clause.

Facts of the case:
In Prevost case, the issue for determination was whether dividends paid by a Canadian resident (Prevost) to the Dutch holding company were entitled to a reduced rate of Canadian withholding tax. The Dutch holding company was held jointly by a Swedish and UK resident company. The Dutch Company did not have an establishment or material operations, other than holding stock of Prevost.

Canada Revenue Agency denied treaty benefits under the Canada-Netherlands treaty, holding that the ultimate beneficiaries were UK and Swedish residents and hence, benefit could not be granted to the Dutch entity, which was merely a legal owner and conduit or funnel for the UK and Swedish shareholders. The Canada Revenue Agency assessed Prevost for the difference between the amount withheld and the withholding tax that would have been payable had the dividends been paid directly to the ultimate shareholders, who the Canada Revenue Agency contended, were the beneficial owners of the dividends paid to the Dutch Company.

Decision of the Canadian Court:
Before the Tax Court, the Crown argued that Prévost should have withheld tax under the Canada-Sweden and Canada-UK Tax Treaties, respectively as opposed to the Dutch treaty.

The primary basis for the Crown’s contentions was a shareholders agreement which provided that 80 per cent of the profits of Prévost and the Dutch company are to be distributed between the UK and Swedish shareholders.

The Tax Court ruling in favor of Prevost observed that "beneficial owner" is the person who receives the dividends for own use and enjoyment and assumes the risk and control of such income.

Further, the stock and dividends were an asset of the Dutch company, available to its creditors and there was no predetermined flow of funds to the Swedish or the U.K. company. On the principle of piercing the corporate veil, the court observed that it can be invoked where a corporation is acting as a conduit for another and has absolutely no discretion as to the use or application of funds. Can the ratio of decision apply to India? The court giving the term “beneficial owner” a common law definition ignored the civil law definition under English, French and Dutch versions of the Treaty.

The Canadian Court’s interpretation had captured the essence of the concept of ‘beneficial owner’ and is in accordance with the views expressed in the OECD Commentary. Further, observations on what constitutes a conduit should be subject to the principle that a conduit should have “absolutely no discretion on use or application of funds”.

Lifting corporate veil in India:
Legal personality of a corporate body is well accepted under the English and Indian laws and the doctrine of piercing the corporate veil is an exception to the rule. It follows that merely because an otherwise legal action is taken because of a tax-saving motive, that in itself is not enough to lift the corporate veil and ignore the intermediate entity, ostensibly created for a tax-saving purpose.

A intermediary company, otherwise qualified, cannot be disregarded as a facade merely because it was purposely created and operated to avail legitimate tax benefits; the aforesaid principles have been upheld by the Supreme Court in Azadi Bachao Andolan case in relation to India-Mauritius treaty.

The doctrine of looking at the substance and not the form of the transaction applies when there is a colourable or illegal transaction. When the transaction itself is plain and admits of no ambiguity, there is no case for looking at the substance of the form, ignoring the transaction. This has been made explicitly clear by the Indian Supreme Court while clarifying the decision of the Constitution Bench in McDowells case; a tool used to allege tax evasion. In an earlier decision, in the Meenakshi mills case, the Supreme Court has held that the corporate veil could be lifted when it was being used to evade tax or circumvent tax obligations.

The settled law is consistent with views substantiated by the Courts in Canada. It would be interesting to see how the Indian tax administration and Courts reconcile the ratio of the decision in the pending high profile cases like those of Vodafone, GE and AT&T.

The Prévost case is a welcome reaffirmation that legally effective transactions will not be ignored by the Courts.

Nonetheless, the analysis in the decision and developments concerning conduit companies generally mean that care and caution should be exercised by multinationals establishing offshore holding companies, intra-group financing structures or licensing intellectual property to other companies in the group.

In addition to "beneficial owner" concerns, changes to the foreign affiliate rules, GAAR and limitation on benefits provisions in tax treaties must be considered.

Given that Canada is a common law jurisdiction (the province of Quebec is civil law), the said decisions could have persuasive imp-act on Indian cases. Whereas one needs to see if and how it would influence the views of Indian judiciary, I am sure it would certainly set thinking in the minds of policy makers to legislate an Indian version of GAAR!

The author is a Partner with BMR & Associates and views expressed are personal. With inputs from Dale Hill, Gowlings. BMR and Gowlings who are Tax and member firms in Canada and India. Views expressed are personal