Recently, the Mumbai bench of the Tribunal in the case of Renu T Tharani (“the assessee”) [TS-6762-ITAT-2020(Mumbai)-O], held the peak credits appearing in the HSBC bank account of one GWU Investments Ltd, a Cayman Islands Company, shares of which were held by the family trust of the assessee, as taxable in the hands of the assessee (Indian beneficiary). It was held that non-signing of 'consent waiver' disproved the assessee’s 'conduct'. In this backdrop, Bharath Janarthanan (Advocate, KB Legal Chambers) discusses the observations of the Tribunal in the context of “Identification of beneficial ownership”. The author states that the requirement of providing the details of “beneficial owner”, to identify the “natural persons” (and not intermediary legal persons) who ultimately owns or controls the entity or on whose behalf the transactions are being conducted, are purely to collate information and documents and carry out customer due diligence from the anti-money laundering regulations perspective. The author accordingly opines that it does not automatically imply that the funds lying in such bank accounts automatically belong to such identified beneficial owners available at their disposal and representing their undisclosed income / asset. The author signs off concluding that “Not co-operating with the investigation in India has its own consequences but that by itself cannot be sufficient enough to draw an adverse inference qua the taxability of the sum under the Act…”

“Beneficial Ownership” of a Family Trust's foreign bank deposits

Recently, the Mumbai bench of the Tribunal in the case of Renu T Tharani (“the assessee”): [TS-6762-ITAT-2020(MUMBAI)-O], held the peak credits appearing in the HSBC bank account of one GWU Investments Ltd (“GWU”), a Cayman Islands Company, shares of which were held by the family trust of the assessee, as taxable in the hands of the assessee. Though many factual and legal issues arise when one reads the decision in detail, this article only briefly discusses a couple of issues that are purely legal without much discussion / deliberations on facts which are contentious. The issues discussed are as under:

Validity of reassessment proceedings – Reopening and assessment on merits cannot survive together:

The first issue dealt with by the Tribunal was regarding the validity of the re-assessment proceedings. The applicable assessment year was AY 2006-07. Therefore, under normal circumstances, the time limit to initiate the re-assessment by issuing notice under section 148 of the Income-tax Act, 1961 (“the Act”) is 6 years from the end of the relevant assessment year under section 149(1)(b) provided, the required conditions are satisfied. The extended time limit of 16 years under section 149(1)(c) will apply in a scenario where the income, in relation to any asset located outside India, chargeable to tax has escaped assessment.

In the case of the assessee, the reassessment proceedings were initiated by issuance of notice under section 148 dated 31.10.2014 (beyond a period of 6 years) and therefore, the extended time limit of 16 years was invoked for issuance of notice. As the assessee’s original return of income disclosed her status as resident in India, which was no different when also filed in response to notice under section 148, one can presume that the extended time period was invoked as the HSBC Geneva account was not disclosed by her in the returns filed in India (assuming there was an obligation on her to disclose the bank account belonging to GWU!!). It appears like, during the proceedings, the assessee furnished proofs with regard to her actual residential status as being a non-resident, which was also accepted by the Assessing Officer and assessed the assessee in the status of “non-resident”. On merits, it was held that the peak credit in the HSBC bank account for that year represented undisclosed income earned by her in India and was therefore, taxable in India, which was also upheld by both the appellate authorities.  

It is submitted that once the residential status of the assessee was accepted as non-resident, then the very basis of chargeability would undergo a change as per section 5 of the Act. The scope of taxability varies between a resident vis-à-vis a non-resident. While a resident is taxable on global income earned by him / her, which also includes income in relation to an asset located outside India (subject to DTAA provisions), a non-resident can only be taxed if such income is received or deemed to be received or accrued or deemed to be accrued in India as per section 5(2) of the Act. Therefore, it follows that the extended time limit of 16 years will not apply in the case of non-residents as the income in relation to an asset found outside India will not be taxable in India as such income accrues outside India.

Therefore, in the instant case, once the assessee’s status was accepted as non-resident, then automatically, the proceedings ought to have been dropped as the item, which was a subject matter of reopening, was beyond the scope of chargeability under the provisions of the Act. Though this argument was taken, the Tribunal appears to have not considered it by holding that the initiation was valid as it was based on the materials and details available on record at the time of issuance of notice. However, what appears to have been lost sight of is that while initiation may be valid based on the records / information that was then in the possession of Assessing Officer, subsequently during the proceedings, once the status was accepted as non-resident, the Assessing Officer ought not have proceeded further and concluded the assessment and made the addition which was beyond the scope of the charging provisions.

On the contrary, having accepted the status as non-resident, it appears that the Assessing Officer proceeded to complete the assessment on the footing that the deposits in the HSBC bank account represented income sourced from India and therefore, was chargeable to tax in India. This basis of making the addition was also upheld by both the appellate authorities. Without getting into whether the reasons for upholding the addition is correct or not, it is submitted that this finding or the basis of addition runs completely contrary to the reasons for which the proceeding under section 147 was initiated and thereby, invoking the extended time limit. In other words, while the extended time limit can be invoked only when income in relation to an asset located outside India chargeable to tax has escaped assessment, which was so done in this case, however, for the purpose of making the addition on merits, a contrary view was taken and it was held that the income was from a source in India and accrued in India and therefore, was taxable in India after having accepted that the assessee was a non-resident for that year. In such a scenario, the time limit for the purpose of completing the assessment expired at the end of 6 years and the extended time limit could not have been invoked to tax an income which has its source in India. These palpable contradictions go to the very root of the matter itself and therefore, the other cannot exist while one survives.

It needs to also be mentioned that the Tribunal, while upholding the validity of the reassessment, was also of the view that, “it was wholly unrealistic to assume that the money at her disposal in the Swiss Bank account reflected income earned outside India in such a short period of one year.” Therefore, if it was the Tribunal’s view that money at her disposal in the Swiss Bank account represented income earned within India which was sought to be taxed, then the extended time period could not have been invoked for the reasons discussed above. If it was Tribunal’s view that the assessee could not have earned the money allegedly lying at her disposal in the swiss bank accounts within the year under consideration, then the entire sum of Rs.196.47 crore (subject to relief given for duplication of entries) could not have been taxed in the year under consideration.

2. Identification of beneficial ownership – Source of the dispute is the KYC norms in Switzerland!:

The genesis of the entire saga lies in the assessee, a natural person, being identified as a beneficial owner in the base note obtained from the French Government. While the base note indicated GWU as the account holder, however, addition was confirmed without any discussion on (a) How can the assessee be taxed in respect of the funds in the HSBC account when GWU was identified as the account holder? (b) whether the mere identification of a natural person as a “beneficial owner” is enough for the revenue to tax the amount lying in the bank account by entirely ignoring the legal structure?  (c) The test of “ownership” for the purpose of taxability under the Act, moreso for the purposes of section 69A; (d) If section 68 was invoked, then whether the required conditions under section 68 were satisfied? (e) Whether merely because a person is identified as a “beneficial owner”, can a presumption be held against him that the money lying in the bank account is out of his undisclosed income which has its source in India? (f) Whether merely because a person is identified as a “beneficial owner”, can he be said to be the “actual owner” of the funds which was available at his disposal?

It may be noted that Switzerland, in its fight against money laundering and terrorist financing, prescribes the banks’ code of conduct regarding the exercise of due diligence (“CDB”) while transacting with its customers. The CDB is one of the Swiss financial centre’s most important self-regulatory agreements. Since 1977, it has governed the duties of the banks for the treatment of assets entrusted to them and the requirements for client identification. In order to conform with changing circumstances and international standards, for example the recommendations of the Financial Action Task Force (“FATF”), CDB is regularly amended.[1]

In this context, the requirement of identification of “beneficial owner” first arises while entering into a banking relationship with the banks in Switzerland because the banks must seek a declaration from its customers with regards to the identification of “beneficial owner” in order comply with the regulations concerning the fight against money laundering and the financing of terrorism.[2] In this regard, it may be pertinent to refer to the preamble of the “Agreement on the Swiss banks’ code of conduct with regard to the exercise of due diligence” entered into in 2008 (“CDB 08”)[3] which states as under:

“Art.1 Preamble
a) With a view to preserving the good name of the Swiss banking community, nationally and internationally,

b) with a view to laying down rules ensuing business conduct that is beyond reproach when establishing business relationships and in the area of banking confidentiality, and
c) with a view to making an effective contribution to combating money laundering and terrorist financing,

the banks hereby contract with the SBA in its capacity as the professional organisation charged with safeguarding the interests and reputation of Swiss banking

a) to verify the identity of their contracting partners and, in cases of doubt, to obtain from their contracting partners a declaration as to the identity of the beneficial owner of the assets;

b) not to provide any active assistance in the flight of capital;

c) not to provide any active assistance in tax evasion and similar acts by providing incomplete or misleading attestations.” [Emphasis supplied]

Art 3 of CDB 08, which prescribes the procedure relating to identification of beneficial owner, states that if the contracting partner (i.e the account holder) and the beneficial owner are not one and the same, then the banks are under an obligation to obtain a declaration regarding identification of beneficial owner through Form A, which requires an account holder to identify the beneficial owner. It is also stated that, in the process of obtaining documentation, the banks are to obtain the first name, last name, date of birth, nationality, country of domicile etc of such beneficial owner. It is further stated that in the case of collective investment vehicles or investment companies which has 20 or few investors, such investors must be identified as beneficial owners. Rules regarding identification of beneficial owner are also laid down in the case of “domiciliary companies” which include all legal entities, companies, establishments, foundations, trusts/fiduciary companies or similar associations, either Swiss or foreign, that do not engage in any commercial or manufacturing business or any other form of commercial operation and such domiciliary companies are also required to provide a declaration in Form A identifying the beneficial owner.

Though an obligation is cast on the Swiss banks to obtain details regarding the “beneficial owner” from its customers / account holders, the guidance as to who has to be identified as such “beneficial owners” apart from what is mentioned above in CDB can be found in the recommendations made by FATF on money laundering. FATF makes recommendations from time to time which Switzerland has been adopting through CDB. The term “beneficial owner” was defined by FATF as under[4]:   

“Beneficial owner” refers to the natural person(s) who ultimately owns or controls a customer and/or the person on whose behalf a transaction is being conducted. It also incorporates those persons who exercise ultimate effective control over a legal person or arrangement. [Emphasis supplied]

Thus, when read together, it appears like, the requirement of providing the details of “beneficial owner”, who are defined to mean “natural persons” who ultimately owns or controls the entity or on whose behalf the transactions are being conducted, are purely to collate information and documents and carry out customer due diligence from the anti-money laundering regulations perspective. The obligation appears to be to identify the natural persons (and not intermediary legal persons).

However, in my view, it does not automatically imply that the funds lying in such bank accounts automatically belong to such identified beneficial owners available at their disposal and representing their undisclosed income / asset. The existence of legal and corporate structures ought to be recognised even in the cases involving Swiss Bank accounts unless of course it is proved that the entire structure is a sham and entered into for the purpose of avoidance of tax. One cannot cry foul and tax an assessee merely based on being identified as beneficial owner which was done only to comply with the anti-money laundering regulations in Switzerland. Of course, the obligation to prove the existence of the structure and as to why the assessee’s name is identified as beneficial owner is on the assessee, however, mere identification would not empower the Revenue to treat the amount lying in such accounts as undisclosed income / asset of such assessees unless the test of chargeability under the Act is satisfied. It is, at best, a starting point to inquire into whether at all, there is any income / asset that is left untaxed in India in the hands of the assessee within the parameters laid down under the Act. If the Reserve Bank of India prescribes an obligation on the banks to collect details from its customers regarding the ultimate shareholders / beneficiaries / partners etc and identify them as “beneficial owners” to satisfy a requirement under anti-money laundering regulations in India, it will be absurd to say that such shareholders / beneficiaries / partners etc ought to have disclosed the details of bank balances belonging to the underlying entity as belonging to them because they are identified as “beneficial owners” while complying with the banking requirements. Conclusion can be no different when it involves foreign companies and bank accounts.

Conclusion:

It goes without saying that each case will have to be determined based on its own set of facts. Therefore, when one is faced with such issues, one will have to find out the circumstances under which the name of the assessee is identified as the beneficial owner based upon the applicable facts, law, disclosure and compliance requirements in Switzerland at the time when such accounts were opened or at the time when the respective compliances were carried out. Not co-operating with the investigation in India has its own consequences but that by itself cannot be sufficient enough to draw an adverse inference qua the taxability of the sum under the Act merely on the basis of a base note when read in the context in which such beneficial owners are identified in Switzerland and such information was generated and handed over to the Indian tax department.

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[1]   https://www.swissbanking.org/en/media/positions-and-press-releases/amended-agreement-on-the-banks2019-code-of-conduct-with-regard-to-the-exercise-of-due-diligence-cdb-as-of-2016

[2] Oliver Arter, Trusts and Banking Relationships – Who is a Beneficial Owner?, Trust Law International, Vol.26,No.1, 2012, 3seq., Bloomsbury Professional, West Sussex, England

[3] The author was able to lay hands upon 2008 agreement and onwards and hence, reliance is placed upon 2008 agreement for the purpose of this article. The agreement / code of conduct applicable for the relevant assessment year / period (even for period prior to 2008) ought to be considered and applied accordingly.

[4] The Forty Recommendations by Financial Anti Task Force on Money laundering – 20 June 2003.