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Tax Publishers ITO v. Scheme A1 of ARCIL CPS 002 XI Trust [ITA No. 2293/Mum/2018, dt. 10-9-2020] : 2020 TaxPub(DT) 3710 (Mum-Trib) Taxability of reversal of an impairment provision of an Asset Reconstruction Trust as income of an AOP citing an irrevocable trust existence with no definite share with pass thru mechanism under question by revenue *Facts:* Assessee trust was set up by Asset Reconstruction Company (India) Ltd. (ARCIL) in pursuance of SARFAESI Act, 2002 and RBI guidelines to acquire financial NPA (Non-performing Assets). As per the scheme the assessee was to set up the trust with the consortium partners. The consortium partners in the said Scheme A1 of ARCIL CPS 002 XI Trust were ARCIL 5%, ICICI Bank -- 95%. The Trust had accordingly taken over certain NPA's which would be securitized and then the Security Receipts (SR's) would be issued to the Qualified Institutional Buyers (QIB) who would subscribe to the SR's. Certain impairment provisions made on these NPA's were reversed by the Trust during the year. This was subjected to tax as claimed by the revenue. Assessee's plea against taxability were -- 1. That the Trust was only a pass thru mechanism so incomes are to be taxed in the hands of the Security Receipt holders which was not acceptable to the revenue. 2. The SR holder's contribution was revocable thus they cannot be taxed in the hands of the Trust/scheme as section 61 to 63 taxes the income of a revocable trust in the hands of the transferors, i.e., here the contributors or the Security Receipt holders. 3. Besides this there was no concerted effort by the SR's to join together to bring forth an adventure in the nature of trade to be called as an AOP either. 4. If the assessee were to be taxed it would tantamount to double taxation once in their hands and then in the hands of the SR's as well. The Revenue's contention in disagreeing to assessee's above grounds were -- 1. The SR's are not revocable thus taxable in the hands of the Trust scheme. 2. Since the Trust (ARCIL) was only acting as a Trustee and there being no Trust under the scheme as per the ITO they would be taxed as AOP as there was a concerted effort to pursue asset securitization of NPA's as a business activity. 3. The scheme of the trust was a colourable device to thwart taxes. On appeal the Commissioner (Appeals) held in favour of the assessee trust holding that the settlors and the beneficiaries can be one and the same there is nothing in the India Trust Act, 1882 against this -- "8.3 I have carefully considered the aforesaid arguments of the learned AR and find merit in it. Section 9 of the Indian Trust Act, 1882 defines beneficiary as -- "9. Who may be beneficiary Every person capable of holding property may be a beneficiary." Section 7 of the Indian Trust Act, states the person who can create trust as follows :-- "7. Who may create trusts A trust may be created -- (a) by every person competent to contract, and (b) with the permission of a principal civil court of original jurisdiction, by or on behalf of a minor, but subject in each case to the law for the time being in force as to the circumstances and extent in and to which the author of the trust may dispose of the trust property." 8.4 From the above, it is clear that there is no prohibition in the Trust Act on the settlor becoming beneficiary. Every person capable of holding property may be a beneficiary. A person who transfers the asset into trust is settlor and a person can become settlor if he is competent to contract. Hence, the assessing officer is wrong in holding that the appellant trust is not a valid trust since contributors and beneficiaries are the same." Besides the above the Commissioner (Appeals) also confirmed that there was no AOP formed as there was no effort to carry out any business or adventure in the nature of trade by the Security Receipt Holders. "Finance Act, 2002, with effect from 1-4-2002. As per the "Explanation" to section 2(31) of the Act, an AOP shall be deemed to be in existence, whether or not it was formed or established with the object of deriving income, profits or gains. However, in the case before us, we find, that the Commissioner (Appeals) had rightly observed that there is nothing on record which would suggest that the beneficiary had agreed to associate for any common objective". Aggrieved the revenue went in higher appeal to ITAT: Held in favour of the assessee against the revenue that -- (a) There was no AOP (a) The Trust could not be taxed (c) The trust was a revocable one as per the scheme with the security receipt holders thus the incomes can only be taxed in the hands of the beneficiary settlors (SR's). (d) The substantial income had risen only by reversal of an impairment provision made on the NPA which by itself did not bring in any real income. *Applied:* The DCIT v. India Advantage Fund (2014) 36 ITR (Trib) 304 (Bangalore) : 2014 TaxPub(DT) 4185 (Bang-Trib) also reiterated in ITO & Ors. v. M/s. India Advantage Fund-I & Ors. (2015) TaxPub(DT) 1486 (Bang-Trib) *Editorial Note:* Reference may also be made to the verdict of ING Bewaar Maatschappij I BV (INGBMBV) v. DCIT (International Taxation) [ITA No. 7119/Mum/2014, A.Y. 2007-08, dated 27-11-2019] : 2019 TaxPub(DT) 7949 (Mum-Trib) where similar pass thru mechanism was affirmed by the ITAT in cross border trust taxation (underlying principles being the same). ANOTHER OPINION Success by Passing Through in Cross Border Taxation 1. The Income Tax Act, 1961 (IT Act) contains provision to tax "any person". It is for this reason that the definition of any person is widely worded inclusively to cover even an AOP (Association of Persons) and a Body of Individuals. When two or more persons come together to pursue a business object with some or all being artificial/juridical persons, then the relationship assumes an AOP and in the event of all being individuals then it is termed BOI. 2. Most times there is a subtle difference as to whether the status of an entity needs to be taxed as an AOP or BOI or eventually in the hands of the end recipients, especially if the incomes accrue only to the end beneficiaries, rather than the AOP/BOI which might be only be a conduit structure loosely more called a pass through structure or more so like a trust. The IT Act does not define what an AOP is or a BOI is. To understand it, one may have to resort to legal decisions. The lead decision on this is CIT v. Indira Balakrishna (1960) 39 ITR 546 (SC) where the Apex court explained the term AOP as under :-- "It is enough for our purpose to refer to three decisions : In re B.N. Elias; Commissioner of Income Tax v. Laxmidas Devidas; and In re Dwarakanath Harischandra Pitale. In In re B. N. Elias Derbyshire, C.J., rightly pointed out that the word "associate" means, according to the Oxford Dictionary, "to join in common purpose, or to join in an action." Therefore, an association of persons must be one in which two or more persons join in a common purpose or common action, and as the words occur in a section which imposes a tax on income, the association must be one, the object of which is to produce income, profits or gains. This was the view expressed by Beaumont, C.J., in Commissioner of Income Tax v. Lakshmidas Devidas, at page 589 also in In re, Dwarakanath Harischandra Pitale. In In re B. N. Elias, Costello, J., put the test in more forceful language. He said : "It may well be that the intention of the Legislature was to hit combinations of individuals who were engaged together in some joint enterprise but did not in law constitute partnerships....When we find, ....that there is a combination of persons formed for the promotion of a joint enterprise.....then I think no difficulty arises whatever in the way of saying that.....these persons did constitute an association...." "In our opinion, what is required before an association of persons can be liable to tax is not that they should receive income but that they should earn or help to earn income by reason of their association, and if the case of the Department stops short of mere receipt of income then the Department must fail in bringing home the liability to tax of individuals as an association of persons." 3. The Finance Act, 2002 had inserted w.e.f. 1-4-2003 an Explanation to clarify that object of deriving income is not necessary for AOP, BOI, local authority or an artificial juridical person in order that such entity may come within the definition of "Person" in section 2(31). If income results, then they are liable to be taxed as AOP if the other conditions laid down by judicial decisions are satisfied. 4. Then comes the aspect of whether the end beneficiaries of the AOP/BOI are to be taxed or the AOP/BOI themselves, especially if the AOP/BOI takes a plea as to whether the income was a case of "diversion of income by overriding title" in the hands of the AOP/BOI in a definite/determined share/manner. The AOP/BOI thus only being a conduit mechanism performing only a trusteeship role. 5. Courts have repeatedly held that if the income is diverted before it reaches the hands of the AOP/BOI or the allocation of the share is determined prior to receipt of the income by the AOP/BOI, then it shall tantamount to diversion of income by overriding title. On the contrary if the apportionment happens post receipt of income then it is only an appropriation of income earned by the AOP/BOI thus the tax is to be fastened on the AOP/BOI. It has also been inferred by courts as to if the imputed investments/contributions/settlements made are revocable or otherwise as well. If revocable then they are taxed in the hands of the beneficiaries and if not revocable otherwise in the hands of the AOP/BOI as though a representative assessee (Sections 61 to 63 of the IT Act). It is again not necessary for the AOP/BOI to be a legally registered entity but can also be a loosely formed legal structure though proving a loose oral structure is difficult legally. 6. The principle of diversion of income by overriding title assumes that what is not one's income cannot be taxed in his hands in the first place and under real income theory what is not one's earning but only a conduit of someone else cannot be taxed in the conducting hands. Same is the principle underlying trusteeship as well. 7. In cross-border taxation, this assumes key importance as there are countries where legal entities assume a conduit structure by virtue of law/legal formation. Sometimes they may be tax transparent entities as well. By tax transparency we mean only the end beneficiaries are taxed and not the conduit trust structure. 8. For instance in UK partnership firm is not taxed and is a tax transparent entity it is only the partners who are taxed for the income of the firm. When incomes accrued/arose from India to a UK partnership firm of solicitors/legal consultants the issue which was debated was as to whether the DTAA benefits could be conferred under article 15 read with article 7 (in the absence of a PE) for the UK firm in India, especially if the partnership firm was a tax transparent entity with only partners being taxed in UK. The Mumbai ITAT upheld the beneficial reading of DTAA exempting the firm from tax and so as well the partners enabling the pass-through principle under Indo-UK DTAA in Linklaters LLP v. ITO (International Taxation) (2011) 9 ITR (Trib) 217 (Mumbai) : 2010 TaxPub(DT) 2106 (Mum-Trib). The ITAT did also categorically observe that it is not necessary that the partners have to suffer tax to avail the DTAA benefit rather is enough if they are "liable/subject to tax" instead of the firm and "payment of tax" is not necessary to avail DTAA benefits. The ITAT opined this from the perspective what is the taxing right of one sovereign state cannot be questioned in the first place by another State to avail DTAA benefits. This to some extent is contrary to OECD principles which state that to avail DTAA there needs to be double taxation in the first place, otherwise the relevance of DTAA itself becomes otiose. 9. It was not the first time the aspect of "liable/subject to tax" vs. "payment of tax" distinction was discussed in the Indian tax regime, especially in reference to DTAA benefits. Reference be made to the decision of Mohsinally Ali Mohammed Rafik, In re (1995) 213 ITR 317 (AAR) : 1995 TaxPub(DT) 0915 (AAR), In re, Abdul Razak A Meman (2005) ITR 306 (AAR) : 2005 TaxPub(DT) 1596 (AAR), ADIT v. Green Emirate Shipping & Travels (2006) 99 TTJ (Mumbai) 988 : 2006 TaxPub(DT) 1050 (Mum-Trib) (though a contrary decision was also decided in the case of Cyril Eugene Pereira, In re (1999) 239 ITR 650 (AAR) : 1999 TaxPub(DT) 1308 (AAR) which also has been read by and large rendered as per incuriam). To cite some observations on this aspect -- "14. It is worthwhile to clarify that the expression 'liable to tax in a State' simply means that the net of the law of taxation of that State covers that person and not that he must pay the tax in that State. The following observation of the Hon'ble Supreme Court of India in Union of India & Anr. v. Azadi Bachao Andolan & Anr. (2003) 263 ITR 706 (SC) : 2003 TaxPub(DT) 1429 (SC) elucidates the point : In our view, the contention of the respondents proceeds on the fallacious premise that liability to taxation is the same as payment of tax. Liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of article 4 of the DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, the DTAC would not have used the words, 'liable to taxation', but would have used some appropriate words like 'pays tax'. The Hon'ble Supreme Court has also referred to the Commentary of Philip Baker to bring out the import of the phrase "liable to tax" employed in article 4(1) which reads as under: It seems clear that a person does not have to be actually paying tax to be 'liable to tax'-otherwise a person who had deductible losses or allowances, which reduced his tax bill to zero would find himself unable to enjoy the benefits of the Convention. It also seems clear that a person who would otherwise be subject to comprehensive taking but who enjoys a specific exemption from tax is nevertheless liable to tax, if the exemption were repealed, or the person no longer qualified for the exemption, the person would be liable to comprehensive taxation." (Emphasis, here italicized in print, supplied). It is thus clear that 'liable to tax' connotes that a person is subject to one of the taxes mentioned in article 2 in a Contracting State and it is immaterial whether the person actually pays the tax or not." 10. Given the above background, it is worthwhile to examine a recent decision in the case of ING Bewaar Maatschappij I BV (INGBMBV) v. DCIT (International Taxation) ITA No. 7119/Mum/2014, AY 2007-08, dated 27th November, 2019 : 2019 TaxPub(DT) 7949 (Mum-Trib) the facts of which is as under: 11. One ING BMBV (the assessee) was a trustee investor of a tax transparent entity Netherlands resident called ING EMEF (ING Emerging Markets Fund) who was also a sub-account holder/participant of ING Assets Management BV (a SEBI registered FII -- Foreign institutional investor). This ING EMEF was a Netherlands entity with corpus from three different investor beneficiaries all based out of the Netherlands in a specified determined shares as under -- -- ING IEMEF -- ING Institutional Emerging Equity Market Fund -- 53.86% -- NNLNV -- Nationale-Nederlanden Leversverzekering Maatschappij NV -- 19.66% -- INGBPNV -- ING Belgeggingfondsen Paraplu NV -- 26.48% 12. The Trustee/representative assessee INGBMBV invested in India on behalf of the tax transparent entity ING EMEF in Indian equity markets using the monies contributed by the above 3 beneficiaries in ING EMEF by availing professional services of ING Asset Management BV thus bringing forth both long-term and short-term capital gains relevant to assessment year 2007-08. 13. Long-term capital gains stood exempted by virtue of section 10(38) as these were listed securities. The tax officer and the first appellate authority taxed the assessee as an AOP at the maximum marginal rate on the short-term capital gains holding that the beneficial shareholding was indeterminate and there was the role of the assessee being a representative assessee for the assessee as well with two in between layers as well thus ignoring the aspect of tax transparency conduit claim of the assessee. 14. It was the plea of the assessee that the assessee was only a trustee representative investor for the tax transparent investor and since the tax transparent assessee investor and the end beneficiaries were all resident entities of the Netherlands they ought to enjoy the benefits of article 13(5) of the Indo-Netherlands DTAA which empower taxing of capital gains only in the place of residency, i.e., in the Netherlands and not in India. 15. Because of the shares of the end-beneficiary entities were also clear and determined beforehand, only end beneficiaries hence be taxed and since the end beneficiaries also did not have a presence in India due to their Netherlands residency; vide article 13(5) of the Indo-Netherlands DTAA they all be exempt from capital gains tax in India. This did not impress the ITO or by the first appellate authority. Aggrieved, assessee went in appeal and won the case at the ITAT. 16. The ITAT while granting the beneficial reading of the DTAA article 13(5) discussed the following :-- (i) "Subject to tax" and "actual payment of tax" are different terms to avail DTAA benefits subject to tax is enough and there is no reason to call for actual payment of tax. (ii) The aspect of pass through principle of tax transparency has to be given an empowered reading under the DTAA applying the decision of Linklaters LLP v. ITO (International Taxation) (2011) 9 ITR (Trib) 217 (Mumbai) : 2010 TaxPub(DT) 2106 (Mum-Trib). (iii) Documents produced by the Dutch tax office of the assessee, etc., manifested the pass through status of the assessee being a tax transparent entity and thus, the residency of the end beneficiaries also stood manifested factually. (iv) Since the relevant assessment year was 2007-08 aspects of TRC, etc., was not called for. 17. It is also relevant to note a resident investment entity adopting a near analogous structure of the above cross-border investment was also granted the same pass thru reading that the investment manager/settlor should not be read as an AOP and taxed at maximum marginal rate and it is only the end beneficiaries who may be taxed as the determinate shares of the end beneficiaries were also specified besides the fact that there was no agreement inter se between the beneficiaries as well to bring forth an AOP. All the beneficiaries were residents in the said case so the aspect of DTAA benefit did not arise. Reference be made to the DCIT v. India Advantage Fund (2014) 36 ITR (Trib) 304 (Bangalore) : 2014 TaxPub(DT) 4185 (Bang-Trib) also reiterated in ITO & Ors. v. M/s. India Advantage Fund-I & Ors. (2015) TaxPub(DT) 1486 (Bang-Trib) for a detailed discussion - a worthy good read on the same subject/structure. 18. The aspect of pass through is a vexed topic with lower Indian tax authorities not buying the said concept in the first place when it comes to domestic or international tax domain. It emerges even more importance as OECD has supported the aspect of granting treaty benefits in case of pass through entities. Given the BEPS project these are areas where better clarity may need to emerge, especially when there is tax protectionism as well being attempted to in the global diaspora.

Tax Publishers

ITO v. Scheme A1 of ARCIL CPS 002 XI Trust [ITA No. 2293/Mum/2018, dt. 10-9-2020] : 2020 TaxPub(DT) 3710 (Mum-Trib)

Taxability of reversal of an impairment provision of an Asset Reconstruction Trust as income of an AOP citing an irrevocable trust existence with no definite share with pass thru mechanism under question by revenue

Facts:

Assessee trust was set up by Asset Reconstruction Company (India) Ltd. (ARCIL) in pursuance of SARFAESI Act, 2002 and RBI guidelines to acquire financial NPA (Non-performing Assets). As per the scheme the assessee was to set up the trust with the consortium partners. The consortium partners in the said Scheme A1 of ARCIL CPS 002 XI Trust were ARCIL 5%, ICICI Bank -- 95%. The Trust had accordingly taken over certain NPA's which would be securitized and then the Security Receipts (SR's) would be issued to the Qualified Institutional Buyers (QIB) who would subscribe to the SR's. Certain impairment provisions made on these NPA's were reversed by the Trust during the year. This was subjected to tax as claimed by the revenue.

Assessee's plea against taxability were --

1. That the Trust was only a pass thru mechanism so incomes are to be taxed in the hands of the Security Receipt holders which was not acceptable to the revenue.

2. The SR holder's contribution was revocable thus they cannot be taxed in the hands of the Trust/scheme as section 61 to 63 taxes the income of a revocable trust in the hands of the transferors, i.e., here the contributors or the Security Receipt holders.

3. Besides this there was no concerted effort by the SR's to join together to bring forth an adventure in the nature of trade to be called as an AOP either.

4. If the assessee were to be taxed it would tantamount to double taxation once in their hands and then in the hands of the SR's as well.

The Revenue's contention in disagreeing to assessee's above grounds were --

1. The SR's are not revocable thus taxable in the hands of the Trust scheme.

2. Since the Trust (ARCIL) was only acting as a Trustee and there being no Trust under the scheme as per the ITO they would be taxed as AOP as there was a concerted effort to pursue asset securitization of NPA's as a business activity.

3. The scheme of the trust was a colourable device to thwart taxes.

On appeal the Commissioner (Appeals) held in favour of the assessee trust holding that the settlors and the beneficiaries can be one and the same there is nothing in the India Trust Act, 1882 against this --

"8.3 I have carefully considered the aforesaid arguments of the learned AR and find merit in it. Section 9 of the Indian Trust Act, 1882 defines beneficiary as --

"9. Who may be beneficiary

Every person capable of holding property may be a beneficiary."

Section 7 of the Indian Trust Act, states the person who can create trust as follows :--

"7. Who may create trusts

A trust may be created --

(a) by every person competent to contract, and

(b) with the permission of a principal civil court of original jurisdiction, by or on behalf of a minor, but subject in each case to the law for the time being in force as to the circumstances and extent in and to which the author of the trust may dispose of the trust property."

8.4 From the above, it is clear that there is no prohibition in the Trust Act on the settlor becoming beneficiary. Every person capable of holding property may be a beneficiary. A person who transfers the asset into trust is settlor and a person can become settlor if he is competent to contract. Hence, the assessing officer is wrong in holding that the appellant trust is not a valid trust since contributors and beneficiaries are the same."

Besides the above the Commissioner (Appeals) also confirmed that there was no AOP formed as there was no effort to carry out any business or adventure in the nature of trade by the Security Receipt Holders.

"Finance Act, 2002, with effect from 1-4-2002. As per the "Explanation" to section 2(31) of the Act, an AOP shall be deemed to be in existence, whether or not it was formed or established with the object of deriving income, profits or gains. However, in the case before us, we find, that the Commissioner (Appeals) had rightly observed that there is nothing on record which would suggest that the beneficiary had agreed to associate for any common objective".

Aggrieved the revenue went in higher appeal to ITAT:

Held in favour of the assessee against the revenue that --

(a) There was no AOP

(a) The Trust could not be taxed

(c) The trust was a revocable one as per the scheme with the security receipt holders thus the incomes can only be taxed in the hands of the beneficiary settlors (SR's).

(d) The substantial income had risen only by reversal of an impairment provision made on the NPA which by itself did not bring in any real income.

Applied: The DCIT v. India Advantage Fund (2014) 36 ITR (Trib) 304 (Bangalore) : 2014 TaxPub(DT) 4185 (Bang-Trib) also reiterated in ITO & Ors. v. M/s. India Advantage Fund-I & Ors. (2015) TaxPub(DT) 1486 (Bang-Trib)

Editorial Note: Reference may also be made to the verdict of ING Bewaar Maatschappij I BV (INGBMBV) v. DCIT (International Taxation) [ITA No. 7119/Mum/2014, A.Y. 2007-08, dated 27-11-2019] : 2019 TaxPub(DT) 7949 (Mum-Trib) where similar pass thru mechanism was affirmed by the ITAT in cross border trust taxation (underlying principles being the same).

ANOTHER OPINION

Success by Passing Through in Cross Border Taxation

1. The Income Tax Act, 1961 (IT Act) contains provision to tax "any person". It is for this reason that the definition of any person is widely worded inclusively to cover even an AOP (Association of Persons) and a Body of Individuals. When two or more persons come together to pursue a business object with some or all being artificial/juridical persons, then the relationship assumes an AOP and in the event of all being individuals then it is termed BOI.

2. Most times there is a subtle difference as to whether the status of an entity needs to be taxed as an AOP or BOI or eventually in the hands of the end recipients, especially if the incomes accrue only to the end beneficiaries, rather than the AOP/BOI which might be only be a conduit structure loosely more called a pass through structure or more so like a trust. The IT Act does not define what an AOP is or a BOI is. To understand it, one may have to resort to legal decisions. The lead decision on this is CIT v. Indira Balakrishna (1960) 39 ITR 546 (SC) where the Apex court explained the term AOP as under :--

"It is enough for our purpose to refer to three decisions : In re B.N. Elias; Commissioner of Income Tax v. Laxmidas Devidas; and In re Dwarakanath Harischandra Pitale. In In re B. N. Elias Derbyshire, C.J., rightly pointed out that the word "associate" means, according to the Oxford Dictionary, "to join in common purpose, or to join in an action." Therefore, an association of persons must be one in which two or more persons join in a common purpose or common action, and as the words occur in a section which imposes a tax on income, the association must be one, the object of which is to produce income, profits or gains. This was the view expressed by Beaumont, C.J., in Commissioner of Income Tax v. Lakshmidas Devidas, at page 589 also in In re, Dwarakanath Harischandra Pitale. In In re B. N. Elias, Costello, J., put the test in more forceful language. He said : "It may well be that the intention of the Legislature was to hit combinations of individuals who were engaged together in some joint enterprise but did not in law constitute partnerships....When we find, ....that there is a combination of persons formed for the promotion of a joint enterprise.....then I think no difficulty arises whatever in the way of saying that.....these persons did constitute an association...."

"In our opinion, what is required before an association of persons can be liable to tax is not that they should receive income but that they should earn or help to earn income by reason of their association, and if the case of the Department stops short of mere receipt of income then the Department must fail in bringing home the liability to tax of individuals as an association of persons."

3. The Finance Act, 2002 had inserted w.e.f. 1-4-2003 an Explanation to clarify that object of deriving income is not necessary for AOP, BOI, local authority or an artificial juridical person in order that such entity may come within the definition of "Person" in section 2(31). If income results, then they are liable to be taxed as AOP if the other conditions laid down by judicial decisions are satisfied.

4. Then comes the aspect of whether the end beneficiaries of the AOP/BOI are to be taxed or the AOP/BOI themselves, especially if the AOP/BOI takes a plea as to whether the income was a case of "diversion of income by overriding title" in the hands of the AOP/BOI in a definite/determined share/manner. The AOP/BOI thus only being a conduit mechanism performing only a trusteeship role.

5. Courts have repeatedly held that if the income is diverted before it reaches the hands of the AOP/BOI or the allocation of the share is determined prior to receipt of the income by the AOP/BOI, then it shall tantamount to diversion of income by overriding title. On the contrary if the apportionment happens post receipt of income then it is only an appropriation of income earned by the AOP/BOI thus the tax is to be fastened on the AOP/BOI. It has also been inferred by courts as to if the imputed investments/contributions/settlements made are revocable or otherwise as well. If revocable then they are taxed in the hands of the beneficiaries and if not revocable otherwise in the hands of the AOP/BOI as though a representative assessee (Sections 61 to 63 of the IT Act). It is again not necessary for the AOP/BOI to be a legally registered entity but can also be a loosely formed legal structure though proving a loose oral structure is difficult legally.

6. The principle of diversion of income by overriding title assumes that what is not one's income cannot be taxed in his hands in the first place and under real income theory what is not one's earning but only a conduit of someone else cannot be taxed in the conducting hands. Same is the principle underlying trusteeship as well.

7. In cross-border taxation, this assumes key importance as there are countries where legal entities assume a conduit structure by virtue of law/legal formation. Sometimes they may be tax transparent entities as well. By tax transparency we mean only the end beneficiaries are taxed and not the conduit trust structure.

8. For instance in UK partnership firm is not taxed and is a tax transparent entity it is only the partners who are taxed for the income of the firm. When incomes accrued/arose from India to a UK partnership firm of solicitors/legal consultants the issue which was debated was as to whether the DTAA benefits could be conferred under article 15 read with article 7 (in the absence of a PE) for the UK firm in India, especially if the partnership firm was a tax transparent entity with only partners being taxed in UK. The Mumbai ITAT upheld the beneficial reading of DTAA exempting the firm from tax and so as well the partners enabling the pass-through principle under Indo-UK DTAA in Linklaters LLP v. ITO (International Taxation) (2011) 9 ITR (Trib) 217 (Mumbai) : 2010 TaxPub(DT) 2106 (Mum-Trib). The ITAT did also categorically observe that it is not necessary that the partners have to suffer tax to avail the DTAA benefit rather is enough if they are "liable/subject to tax" instead of the firm and "payment of tax" is not necessary to avail DTAA benefits. The ITAT opined this from the perspective what is the taxing right of one sovereign state cannot be questioned in the first place by another State to avail DTAA benefits. This to some extent is contrary to OECD principles which state that to avail DTAA there needs to be double taxation in the first place, otherwise the relevance of DTAA itself becomes otiose.

9. It was not the first time the aspect of "liable/subject to tax" vs. "payment of tax" distinction was discussed in the Indian tax regime, especially in reference to DTAA benefits. Reference be made to the decision of Mohsinally Ali Mohammed Rafik, In re (1995) 213 ITR 317 (AAR) : 1995 TaxPub(DT) 0915 (AAR), In re, Abdul Razak A Meman (2005) ITR 306 (AAR) : 2005 TaxPub(DT) 1596 (AAR), ADIT v. Green Emirate Shipping & Travels (2006) 99 TTJ (Mumbai) 988 : 2006 TaxPub(DT) 1050 (Mum-Trib) (though a contrary decision was also decided in the case of Cyril Eugene Pereira, In re (1999) 239 ITR 650 (AAR) : 1999 TaxPub(DT) 1308 (AAR) which also has been read by and large rendered as per incuriam). To cite some observations on this aspect --

"14. It is worthwhile to clarify that the expression 'liable to tax in a State' simply means that the net of the law of taxation of that State covers that person and not that he must pay the tax in that State. The following observation of the Hon'ble Supreme Court of India in Union of India & Anr. v. Azadi Bachao Andolan & Anr. (2003) 263 ITR 706 (SC) : 2003 TaxPub(DT) 1429 (SC) elucidates the point :

In our view, the contention of the respondents proceeds on the fallacious premise that liability to taxation is the same as payment of tax. Liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of article 4 of the DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, the DTAC would not have used the words, 'liable to taxation', but would have used some appropriate words like 'pays tax'.

The Hon'ble Supreme Court has also referred to the Commentary of Philip Baker to bring out the import of the phrase "liable to tax" employed in article 4(1) which reads as under:

It seems clear that a person does not have to be actually paying tax to be 'liable to tax'-otherwise a person who had deductible losses or allowances, which reduced his tax bill to zero would find himself unable to enjoy the benefits of the Convention. It also seems clear that a person who would otherwise be subject to comprehensive taking but who enjoys a specific exemption from tax is nevertheless liable to tax, if the exemption were repealed, or the person no longer qualified for the exemption, the person would be liable to comprehensive taxation." (Emphasis, here italicized in print, supplied). It is thus clear that 'liable to tax' connotes that a person is subject to one of the taxes mentioned in article 2 in a Contracting State and it is immaterial whether the person actually pays the tax or not."

10. Given the above background, it is worthwhile to examine a recent decision in the case of ING Bewaar Maatschappij I BV (INGBMBV) v. DCIT (International Taxation) ITA No. 7119/Mum/2014, AY 2007-08, dated 27th November, 2019 : 2019 TaxPub(DT) 7949 (Mum-Trib) the facts of which is as under:

11. One ING BMBV (the assessee) was a trustee investor of a tax transparent entity Netherlands resident called ING EMEF (ING Emerging Markets Fund) who was also a sub-account holder/participant of ING Assets Management BV (a SEBI registered FII -- Foreign institutional investor). This ING EMEF was a Netherlands entity with corpus from three different investor beneficiaries all based out of the Netherlands in a specified determined shares as under --

-- ING IEMEF -- ING Institutional Emerging Equity Market Fund -- 53.86%

-- NNLNV -- Nationale-Nederlanden Leversverzekering Maatschappij NV -- 19.66%

-- INGBPNV -- ING Belgeggingfondsen Paraplu NV -- 26.48%

12. The Trustee/representative assessee INGBMBV invested in India on behalf of the tax transparent entity ING EMEF in Indian equity markets using the monies contributed by the above 3 beneficiaries in ING EMEF by availing professional services of ING Asset Management BV thus bringing forth both long-term and short-term capital gains relevant to assessment year 2007-08.

13. Long-term capital gains stood exempted by virtue of section 10(38) as these were listed securities. The tax officer and the first appellate authority taxed the assessee as an AOP at the maximum marginal rate on the short-term capital gains holding that the beneficial shareholding was indeterminate and there was the role of the assessee being a representative assessee for the assessee as well with two in between layers as well thus ignoring the aspect of tax transparency conduit claim of the assessee.

14. It was the plea of the assessee that the assessee was only a trustee representative investor for the tax transparent investor and since the tax transparent assessee investor and the end beneficiaries were all resident entities of the Netherlands they ought to enjoy the benefits of article 13(5) of the Indo-Netherlands DTAA which empower taxing of capital gains only in the place of residency, i.e., in the Netherlands and not in India.

15. Because of the shares of the end-beneficiary entities were also clear and determined beforehand, only end beneficiaries hence be taxed and since the end beneficiaries also did not have a presence in India due to their Netherlands residency; vide article 13(5) of the Indo-Netherlands DTAA they all be exempt from capital gains tax in India. This did not impress the ITO or by the first appellate authority. Aggrieved, assessee went in appeal and won the case at the ITAT.

16. The ITAT while granting the beneficial reading of the DTAA article 13(5) discussed the following :--

(i) "Subject to tax" and "actual payment of tax" are different terms to avail DTAA benefits subject to tax is enough and there is no reason to call for actual payment of tax.

(ii) The aspect of pass through principle of tax transparency has to be given an empowered reading under the DTAA applying the decision of Linklaters LLP v. ITO (International Taxation) (2011) 9 ITR (Trib) 217 (Mumbai) : 2010 TaxPub(DT) 2106 (Mum-Trib).

(iii) Documents produced by the Dutch tax office of the assessee, etc., manifested the pass through status of the assessee being a tax transparent entity and thus, the residency of the end beneficiaries also stood manifested factually.

(iv) Since the relevant assessment year was 2007-08 aspects of TRC, etc., was not called for.

17. It is also relevant to note a resident investment entity adopting a near analogous structure of the above cross-border investment was also granted the same pass thru reading that the investment manager/settlor should not be read as an AOP and taxed at maximum marginal rate and it is only the end beneficiaries who may be taxed as the determinate shares of the end beneficiaries were also specified besides the fact that there was no agreement inter se between the beneficiaries as well to bring forth an AOP. All the beneficiaries were residents in the said case so the aspect of DTAA benefit did not arise. Reference be made to the DCIT v. India Advantage Fund (2014) 36 ITR (Trib) 304 (Bangalore) : 2014 TaxPub(DT) 4185 (Bang-Trib) also reiterated in ITO & Ors. v. M/s. India Advantage Fund-I & Ors. (2015) TaxPub(DT) 1486 (Bang-Trib) for a detailed discussion - a worthy good read on the same subject/structure.

18. The aspect of pass through is a vexed topic with lower Indian tax authorities not buying the said concept in the first place when it comes to domestic or international tax domain. It emerges even more importance as OECD has supported the aspect of granting treaty benefits in case of pass through entities. Given the BEPS project these are areas where better clarity may need to emerge, especially when there is tax protectionism as well being attempted to in the global diaspora.