Little Fairy Ltd. v. ACIT. IT (2024)

🏦 Little Fairy Ltd. v. ACIT (ITAT Delhi, 2024) – Beneficial Ownership & Taxation of Interest on Compulsorily Convertible Debentures under India–Cyprus DTAA

📘 Background

The concept of beneficial ownership plays a crucial role in determining eligibility for DTAA benefits under Article 11 (Interest).
In Little Fairy Ltd. v. ACIT (IT) [(2024) 207 ITD 284 (Delhi)(Trib.)], the Delhi Tribunal addressed a common cross-border issue:
Whether a Cyprus-based company earning interest income from Compulsorily Convertible Debentures (CCDs) issued by an Indian entity could avail the 10% concessional tax rate under Article 11(2) of the India–Cyprus Double Taxation Avoidance Agreement, or whether it should be taxed at the domestic rate of 40% on the ground that it was merely a conduit for its Mauritius parent company.

The Tribunal upheld the assessee’s claim, holding that the Cyprus entity was the beneficial owner of the interest income and thus entitled to DTAA relief.

⚙️ Facts of the Case

• Assessee: Little Fairy Ltd., a tax resident of Cyprus.
• Parent Entity: Wholly owned subsidiary of a Mauritius-based company.
• Investment:
  • The assessee invested in Compulsorily Convertible Debentures (CCDs) issued by an Indian company.
  • Interest was periodically received on these CCDs.
• Return of Income:
  • The assessee declared the interest income and applied Article 11(2) of the India–Cyprus DTAA, offering it to tax at 10% of the gross amount.
• Assessing Officer (AO)’s Findings:
  • Denied DTAA benefit.
  • Held that the Mauritius parent company was the real beneficial owner of the interest income.
  • Treated the assessee as a conduit company and applied domestic tax rate of 40%.
• Assessee’s Defence:
  • The investment in CCDs was made in its own name, through proper banking channels.
  • The assessee had absolute ownership and control over the funds and the interest income received.
  • The Cyprus company was not obliged to pass on any income to its Mauritius parent.

❓ Point of Dispute

Whether the assessee, a Cyprus-based company, was the beneficial owner of interest income earned on CCDs issued by an Indian company, and thus entitled to the 10% concessional tax rate under Article 11(2) of the India–Cyprus DTAA.

📑 Relevant Legal Provisions

🔹 Section 9(1)(v) – Interest Deemed to Accrue in India

Interest payable by a resident is deemed to accrue in India unless used for business or profession outside India.

🔹 Article 11(2) – India–Cyprus DTAA

“However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest.”

🔹 Concept of Beneficial Ownership

Beneficial ownership requires that the recipient:

• Has full control and right to use the income;
• Bears the risk and enjoys the reward of the investment;
• Is not a conduit or agent for another entity.

📑 Assessee’s Arguments

• Independent Investment:
  • The investment in CCDs was made independently by the Cyprus entity, not on behalf of its Mauritius parent.
• Ownership & Control:
  • The assessee had complete legal and beneficial ownership of the CCDs and the corresponding interest income.
  • The funds were received directly into its own bank account, with no contractual or legal obligation to remit the income to any other entity.
• DTAA Entitlement:
  • As the beneficial owner, the assessee was entitled to Article 11(2) benefits, limiting Indian tax to 10%.

📑 Revenue’s Arguments

• Conduit Company Theory:
  • The AO argued that the Mauritius holding company was the true owner of the funds invested.
  • The Cyprus entity was merely an intermediary created for tax advantage purposes.
• Denial of DTAA Relief:
  • Citing the OECD Commentary, the AO contended that treaty benefits are not available to entities lacking substance or economic ownership.

⚖️ Tribunal’s Analysis

1. Investment Made in Assessee’s Own Name:
   • The CCDs were subscribed in the name of the Cyprus entity.
   • All payments were routed through proper banking channels.
2. Control Over Funds & Income:
   • The assessee had full control and discretion over the interest income.
   • There was no contractual obligation to remit funds to the Mauritius parent.
3. No Evidence of Conduit Arrangement:
   • The Revenue failed to prove that the assessee was merely holding the investment on behalf of its parent.
   • There was no round-tripping, back-to-back funding, or income diversion established.
4. Beneficial Ownership Established:
   • The assessee enjoyed the income in its own right, satisfying the beneficial ownership test under Article 11(2).
   • Accordingly, the 10% treaty rate was applicable.
5. Application of DTAA Overrides Domestic Law:
   • By virtue of Section 90(2), the treaty provisions override the Income-tax Act, providing beneficial treatment to the assessee.

✅ Held

• The Cyprus-based assessee was the beneficial owner of the interest income on the CCDs.
• The Mauritius parent had no right or claim to the income.
• The assessee was entitled to DTAA benefit under Article 11(2).
• Interest income taxable in India at 10%, not at domestic rate of 40%.
• Addition deleted.

💡 Key Takeaways

1. Beneficial Ownership Test:
   • The right to receive and control income is decisive in determining beneficial ownership under DTAAs.
2. Cyprus DTAA Advantage:
   • Interest income earned by a resident of Cyprus is taxable in India at 10%, provided the recipient is the beneficial owner.
3. No Conduit Without Proof:
   • The Revenue must substantiate its claim of conduit arrangements with evidence; mere group ownership is insufficient.
4. Investment Substance Matters:
   • If investment is made in the assessee’s own name and funds, treaty benefits cannot be denied.
5. Treaty Override Confirmed:
   • Section 90(2) ensures that DTAA relief prevails over domestic tax provisions when beneficial.

🌐 Why This Case Matters

The ruling in Little Fairy Ltd. (2024) provides much-needed clarity on beneficial ownership in cross-border investments involving group entities. It assures legitimate foreign investors that treaty benefits cannot be denied merely on the basis of corporate ownership structures without evidence of tax avoidance.

The judgment aligns with global standards under the OECD Model Convention and India’s commitment to fair interpretation of DTAAs post-BEPS Action 6 (treaty abuse).

🔍 SEO Meta Details

• Meta Title: Little Fairy Ltd. vs. ACIT (ITAT Delhi, 2024) – Interest on CCDs Taxed at 10% under India–Cyprus DTAA
• Meta Description: ITAT Delhi rules that Cyprus-based Little Fairy Ltd. is the beneficial owner of interest on CCDs, entitled to 10% DTAA tax rate under Article 11(2) of India–Cyprus DTAA.
• Keywords: Little Fairy Ltd. ITAT Delhi 2024, India–Cyprus DTAA Article 11(2), beneficial ownership interest income, CCD interest taxation, Section 9(1)(v) India, cross-border investment tax India.