Under the tax treaty between India and Country X, capital gains from the sale of shares of Red Chilies Ltd., an Indian company, are taxable only in…

CA Final · Direct Tax Laws and International Taxation · MTP · May 2025
Under the tax treaty between India and Country X, capital gains from the sale of shares of Red Chilies Ltd., an Indian company, are taxable only in Country X, provided the transferor is a resident of Country X, except when the transferor holds more than 10% equity in Red Chilies Ltd. X Ltd., a resident of Country X, invests in Red Chilies Ltd. through its two wholly owned subsidiaries, Lalit Ltd. and Mohan Ltd., both incorporated in Country X. Each subsidiary individually holds 9.95% shares, resulting in a combined holding of 19.9% in Red Chilies Ltd. The subsidiaries sell the shares of Red Chilies Ltd and claim exemption as each is holding less than 10% equity shares in the Indian company. Examine whether GAAR be invoked to deny treaty benefit?

Suggested Answer and Working Notes:

The above arrangement of splitting the investment through two subsidiaries appears to be with the intention of obtaining tax benefit under the treaty. Further, there appears to be no commercial substance in creating two subsidiaries as they do not change the economic condition of investor X Ltd. in any manner (i.e. on business risks or cash flow), and reveals a tainted element of abuse of tax laws. Hence, the arrangement can be treated as an impermissible avoidance arrangement by invoking GAAR. Consequently, treaty benefit would be denied by ignoring Lalit Ltd. and Mohan Ltd., the two subsidiaries, or by treating Lalit Ltd. and Mohan Ltd. as one and the same company for tax computation purposes.

Topics: Provisions to Counteract Unethical Tax Practices

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