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March 3, 2010 Gift of shares of Indian company between non-residents not taxable in India – Is this still the case after the Budget? The Authority for Advance Ruling (“AAR”) in a recent ruling1 has held that gift of shares of an Indian company between two non-resident companies as part of a group reorganization is not taxable in India. These types of intra-group transactions are not uncommon and this ruling is quite helpful to determine the taxability of such transactions in India. However, in light of the recent Budget proposals announced by the Finance Minister on February 26, 2010, it is unclear whether such transactions will be taxable in India. We have discussed the Budget implications on such transactions below in our analysis. Facts: M/s Amiantit International Holding Ltd. (“Applicant”), a company incorporated in Kingdom of Bahrain is an investment holding company with investments in Asia, Europe and Latin America. The Applicant is owned 99% by South Arabian Amiantit Company (“SAAC”). Applicant in its application has disclosed that it holds 70% equity capital of Amiantit Fiberglass Industries (India) Private Limited (“AFIIL”). Applicant also has a wholly owned subsidiary in Cyprus, Amitech Cyprus Holding Limited (“ACHL”). The Applicant proposes to restructure the group with a view to split its business into two – one owning business in Europe and the other owning business in Asia, North Africa and Latin America. With this intention, the Applicant proposes to contribute shares of AFIIL along with non-European investments to ACHL for nil consideration. This contribution which is akin to a gift is permissible under Bahrain legislation and the contribution agreement is proposed to be executed outside India. The question raised by the Applicant was whether capital gains tax is liable to be paid in relation to the transfer of shares held by the Applicant to ACHL as part of reorganization of business of the group and whether transfer pricing provisions would get attracted for the proposed transfer. Arguments The Applicant contended that pursuant to the proposed transaction, no profit or gain will accrue or arise to the Applicant as no consideration can be evaluated in terms of money as a result of the proposed transfer of shares. Therefore, the liability to pay capital gains tax does not arise. Further, the Applicant also stated that a transfer of an asset by way of gift is exempt from capital gains tax under Section 47(iii) of the Income Tax Act, 1961 (“ITA”). Since the proposed transaction is in the nature of gift and hence this transaction should not be subject to capital gains tax. The Revenue contended that the charging provision for capital gains is Section 45 which is squarely attracted in the present case. The mere fact that money consideration has not passed would not put the transfer out of the domain of Section 45. The proposed transfer is based on business considerations aimed at deriving certain financial advantages as a part of reorganization process. Further, the Revenue contended that there is in substance no gift because the donor will not be poorer to the extent of assets he parted with. Ruling The AAR analysed the provisions relating to capital gains under the ITA and stated that the charging section relating to capital gains and the computation provisions together constitute an integrated code. Therefore, as per the observations of the Supreme Court in CIT vs. B.C. Srinivasa Shetty2 when there is a case to which the computation provision cannot be applied at all, it is not intended to fall within the charging section. Further, the AAR held that the Revenue’s contention that the Applicant would improve its overall business and the mere possibility of the Applicant making better returns in the future as a consequence of the reorganization cannot be regarded as consideration accruing or arising to the Applicant. Capital gains cannot arise on the basis of uncertain and indefinite future contingencies or hypothetical and imaginary estimations. Thus, the AAR held that by the proposed transfer of shares, the Applicant will derive no profit and make no gain and nothing in the form of money or money’s worth will accrue or arise to the Applicant. Further, since it is not possible to determine the consideration in the present case, following the ratio laid down in Srinivasa Shetty’s case, the AAR held that the transaction will not be taxable in India. With respect to the applicability of transfer pricing provisions to the proposed transaction, the AAR relied on the ruling given in Dana Corporation3 wherein the application of transfer pricing provisions was ruled out in a case where the income is not chargeable to tax in the first place. Analysis In this case, the AAR has not really dealt with the fact whether the proposed transaction would be exempt from capital gains by virtue of the exemption provided in Section 47(iii). In fact, interestingly, the AAR first sought to examine whether there is a capital gain accruing or arising to the Applicant. Since there was no capital gain, the question of applicability of the exemption provisions for capital gains does not arise. In cases where there is a capital gain accruing or arising, a transfer of a capital asset by way of gift is still exempt from capital gains tax in view of Section 47(iii). However, as per the Budget 2010 proposals transactions such as gift of shares or transfer of shares for a consideration less than the fair market value of shares undertaken by a company may now be taxable with effect from June 2010 under the proposed amendment to Section 56 of the ITA as Income from Other Sources. Thus, if we were to look at this transaction in light of the Budget proposals, while it may still be argued that the transaction should not be subject to capital gains tax as the consideration cannot be determined, it may be taxable under the head Income from Other Sources. Further, while capital gains tax is levied on the transferor i.e. company transferring the shares, tax levied on Income from Other Sources is levied on the transferee i.e. company receiving the shares, Thus, there may also be situations where both the transferor as well as the transferee may end up paying taxes, albeit under different heads of income. While we can rely on B.C Srinivasa Shetty’s case where there is a gift of shares of a company, it is relevant only in the case of capital gains tax and not for other heads of income. However there is no clarity on how these proposed provisions would apply in the event the consideration is not determinable, although the principle laid down B.C Srinivasa Shetty’s case should still be followed. Thus, it is important that we revisit any such proposed reorganizations and restructurings in light of the impact of the Budget proposals. For our detailed discussion on the implications of the Budget proposals, please visit India Budget Insights (2010-11).
1 AAR No. 817/2009 2 (1981) 128 ITR 294 3 227 CTR 441/
You may direct your comments to Ramya Krishnan-AniL +91 900465 0363 |
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