By Ritu Shaktawat, Partner & Milind Hasrajani, Associate, Khaitan & Co, Mumbai, India
The High Court of Bombay, in a landmark decision dated 28 October, has held that the income from debt securities earned by a Jersey trust settled by the Abu Dhabi Investment Authority (ADIA), and of which ADIA is the sole beneficiary, is exempt from tax in India, as any income earned by ADIA is not taxable in India under article 24 of the tax treaty between India the United Arab Emirates (UAE).
Facts of the case and issues involved
ADIA had set up a revocable trust in Jersey in 2013, of which it was the sole beneficiary, for the purpose of making investments into debt securities in India. The trust was registered with the securities regulator of India as a foreign portfolio investor under the applicable regulations. Under the India-UAE tax treaty, ADIA was recognised as a government institution and thus any income derived by it from India is exempt from tax in India as per article 24 of the treaty.
Accordingly, ADIA filed an application before the Indian Authority for Advance Rulings, a quasi-judicial body that rules on the taxation of non-residents, to seek clarity on whether the income earned by the Jersey trust, from the Indian debt securities, will be exempt from tax in India by virtue of the fact that the Jersey trust was a revocable trust and as such the income derived by it should be taxable in the same manner as if such income was derived by ADIA itself, being the sole beneficiary.
ADIA’s contentions before the Authority for Advance Rulings were broadly two-fold. Firstly, because the Jersey trust was a revocable trust, the capital contribution made by ADIA in the Jersey trust should be considered as a “revocable transfer” under the Indian income-tax law. Consequently, as per the Indian income-tax law, any income arising pursuant to such a revocable transfer should be taxed as the income of the transferor, i.e., ADIA, and thereby should be exempt as per article 24 of the India-UAE tax treaty. Secondly, under the Indian income-tax law, the income received by the Jersey trust is to be taxed in the hands of its trustee as the representative of the beneficiary of such trust in the like manner and to the same extent as it would have been taxed in the beneficiary’s hands and thereby exempt under the India-UAE tax treaty.
However, the authority denied ADIA’s claim and ruled that the income received by the Jersey trust should be taxable in India. The authority’s reasoning to deny ADIA’s claim was broadly four-fold. Firstly, the income from Indian debt securities was received by the Jersey trust, and in the absence of any tax treaty between India and Jersey, such income is taxable in India. Secondly, in the case of a trust, the settlor cannot itself be the sole beneficiary, as otherwise, the trust would serve no purpose. Thirdly, enforcing the provisions relating to a revocable transfer (which is an anti-abuse provision) may amount to prima facie tax avoidance by ADIA, which would bar the authority from ruling on the application at the threshold itself. And lastly, because the Jersey trust is a foreign trust, the provisions of Indian trust law are not applicable to it, and consequently such a foreign trust cannot avail the benefit of the provisions of the Indian income-tax law relating to a “revocable transfer” and taxation of the trustee as a representative of the beneficiary(ies). The authority also added that the taxation of foreign portfolio investors is governed by a specific code under the Indian tax law and therefore, the Jersey trust would be taxable as per those specific provisions.
Aggrieved, ADIA filed a petition before the High Court of Bombay challenging the order of the Authority for Advance Rulings.
Ruling of the Bombay High Court
The Bombay High Court quashed the order of the Authority for Advance Rulings and accepted the key contentions of ADIA, holding that the income arising to the Jersey trust will take the color of that of ADIA’s income. Thus, the benefit of the India-UAE tax treaty must be granted.
With respect to the reasoning of the authority that the settlor cannot be the sole beneficiary of a trust, the court held that there is no such requirement under the Indian tax laws or a bar under the Indian trust law. It placed reliance upon the decision of the High Court of Gujarat in the case Bhavna Nalinkant Nanavati, wherein the settlor was also the sole beneficiary of the trust.
The court noted that had ADIA directly made investments in India, its income would have been exempt, and it is only due to certain commercial reasons that ADIA had to set up the Jersey trust to make investment in India. Thus, the court observed that, by making investments through the Jersey trust, ADIA was not attempting to reduce any tax by using the trust structure.
Lastly, regarding the applicability of the provisions of the Indian income-tax law to a foreign trust, the court accepted ADIA’s contention that there is no such requirement under the Indian income-tax law that its provisions are applicable only to an Indian trust or a trust falling under the provisions of the Indian trust law. The court relied upon the case of Vikramsinghjit Gondal, wherein the Indian Supreme Court held that a trust set up outside of India was also a trust for the purposes of Indian income-tax law. Accordingly, ADIA’s contentions regarding revocable transfer and trustee paying taxes as a representative of the beneficiary were accepted. Thus, the court held that the income received by the Jersey trust should be taxed in the same manner as it would have been taxed in ADIA’s hands, i.e., being exempt under article 24 of the India-UAE tax treaty.
Comments
This decision is a first wherein treaty benefits are extended to a trust-based on the tax status of the beneficiary, and that too in a case where both the beneficiary and the trust are resident in different jurisdictions.
While the Bombay High Court has given a detailed and reasoned order, it remains to be seen whether the income-tax authorities will appeal the decision before the Supreme Court.
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