Global Tax Alert | 15 October 2013
India's Delhi High Court rules nonresident is entitled to 10% concessional tax rate on capital gains from sale of shares
This Tax Alert summarizes a recent ruling of the Delhi High Court (HC) in the case of Cairn UK Holdings Ltd. (Taxpayer)1 on the issue of whether a nonresident (NR) is taxable in India at the concessional rate of 10%, under proviso to Section 112 of the Income Tax Act (ITA), on long-term capital gains from the sale of shares of an Indian company in an off–market transaction. The HC overturned the ruling of the Authority for Advance Rulings (AAR)2 and held that the concessional rate of 10% applies to the NR Taxpayer. In doing so, the HC referred to earlier rulings of the AAR3 in favor of the concessional rate. The HC held that the benefit of the concessional rate of tax would be available to the NR with respect to capital gains which is determined in the currency in which the shares were initially acquired. In the HC's view, the benefit of the concessional rate was supported by the clear language of the provisions and was in lieu of the indexation benefit. As gain in the hands of the NR Taxpayer is calculated without grant of the indexation benefit, the Taxpayer can claim the benefit of concessional rate.
Section 112 provides for a concessional rate of tax on long-term capital gains to residents as well as NRs. The proviso to Section 112 states that tax on capital gains derived from the transfer of listed securities/units/zero coupon bonds should not exceed 10% of the capital gains computed without considering the benefit of indexation in terms of the second proviso to Section 48.
Section 48, as relevant to the present fact pattern, lays down the following computation mechanism of capital gains on the transfer of shares:
- • The first proviso to Section 48 (applicable only to NRs) provides for determining gain from the transfer of shares/debentures of an Indian company in the currency in which the shares/securities were initially acquired. This proviso grants exchange fluctuation protection to NRs.
- • The second proviso to Section 48 (applicable to only residents in the case of shares and debentures in an Indian company) grants benefit of indexation i.e., cost inflation index while determining capital gains arising from the transfer of a long-term asset.
The Taxpayer, a company incorporated in Scotland, acquired shares of Cairn India Ltd. (CIL), an Indian listed company. Subsequently, some shares of CIL were sold to another Indian company pursuant to a private deal and not through a recognized stock exchange. The shares transferred were held for a period exceeding 12 months and, consequently, were treated as a long-term capital asset. Gains on the sale of shares was calculated by adopting currency rates as were used for the initial acquisition.
The Taxpayer was of the view that gains arising on the sale of shares of CIL were eligible for the concessional rate of 10%. Accordingly, it filed an application before the Tax Authority, requesting a certificate for withholding tax at the rate of 10%. The Tax Authority rejected the Taxpayer's claim and passed an order for withholding tax at the rate of 20% by holding that benefit of the concessional rate is not available to an NR taxpayer which enjoys exchange fluctuation protection. The Taxpayer then filed an application before the AAR to determine the withholding tax rate. The AAR adopted a contextual or purposive principle of interpretation of applicable provisions and held that the concessional rate was in lieu of the benefit of inflation adjustment to cost which is available only to residents. According to the AAR, the NR which enjoys exchange fluctuation protection is not intended to have the benefit of an additional concessional rate.
The Taxpayer filed a Special Leave Petition before the Supreme Court (SC). The SC, by its order dated 30 July 2012,4 directed the Taxpayer to first approach the appropriate High Courts.
Before the HC, reliance was placed by the Taxpayer on an earlier ruling of the AAR in the case of Timken France5 wherein it was held that the concessional rate applies to all taxpayers, including residents as well as NRs, so long as capital gain is calculated without benefit of inflation adjustment to cost. The AAR further held that the double benefit/additional relief was not a taboo under the law and merely because the NRs were protected from foreign exchange fluctuation, it did not follow that they cannot avail of the benefit of the 10% rate which was available in terms of the clear provisions of the ITA. Accordingly, the issue before the HC was whether NRs (which avail exchange fluctuation benefit) can also avail the benefit of the concessional rate of 10%.
The HC, after taking note of the reasoning adopted by contrary AAR rulings, held that NRs can avail the benefit of the concessional rate of 10%, along with relief provided against adverse rupee volatility. The HC observed as follows:
- • The proviso to Section 112(1) does not state that a taxpayer which availed the benefit of the first proviso to Section 48 is not entitled to the benefit of the lower rate of tax. The said benefit cannot be denied because the second proviso to Section 48 is not applicable. If the Legislature intended to deny applicability of the proviso to a taxpayer taking advantage of the first proviso, specific language would have been incorporated to that effect.
- • The first proviso to Section 48 stipulates that, on the sale of the securities by an NR, the consideration received in INR should be reconverted into the same foreign currency. For an NR which has utilized foreign currency for the purchase of securities in INR, inflation in India is immaterial and inconsequential. The NR is most concerned with exchange rate fluctuation and its true and actual gain should take into account the exchange rate fluctuation. Therefore, the rationale for the first proviso is not the same as that for the second proviso to Section 48.
- • It is wrong to state that inflation alone contributes and is the determinative factor in exchange rate fluctuation. Inflation, by itself, cannot be the sole or even primary factor in exchange rate depreciation. There are several other complex factors and parameters which can affect exchange rate fluctuation.
- • The first and second provisos to Section 48 cannot be equated as granting the same relief or benefit. They operate independently and have different purposes and objectives.
- • The provisions of Section 112 cannot be read contextually with the two provisos of Section 48 merely because the Taxpayer, covered by the first proviso to Section 48, would also get the benefit of a reduced rate of tax.
- • The favorable ruling of the AAR in the case of Timken France was followed by the AAR in several cases over the last three to four years. In the interest of certainty and stability in interpretation of provisions, the AAR should follow its earlier view unless there are strong grounds and reasons to take a contrary view.
The question of availability of the concessional rate of 10% on capital gains to an NR which pays tax on capital gains by adopting the applicable exchange rate has been a contentious issue. The view emerging from the earlier rulings (which includes rulings of the AAR and the Income Tax Appelllate Tribunal) had largely been favorable to taxpayers. The AAR ruling in the case of Cairn UK unsettled this position by taking a divergent view from its earlier ruling in the case of Timken France (supra). This HC ruling is a positive decision which settles the controversy in favor of the Taxpayer.
2. Cairn UK Holdings Ltd., In Re [(2011) 337 ITR 131].
3. [(2007) 294 ITR 513 (AAR)].
4. [(2012) 346 ITR 161].
5. [(2007) 294 ITR 513 (AAR)].
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India), Mumbai
- • Sudhir Kapadia
+91 22 6192 0900
Ernst & Young LLP (India), Hyderabad
- • Jayesh Sanghvi
+91 40 6736 2078
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
- • Nachiket Deo
+44 20 778 30862
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
- • Gagan Malik
+65 6309 8524
Ernst & Young LLP, Indian Tax Desk, New York
- • Tejas Mody
+1 212 773 4496
EYG no. CM3879