Concessional tax of 10% on capital gains to an NRI is debatable

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Economic Times
6 September 2011, by

Anand Dhelia and Ajit Kamdar
Senior Tax Professionals

Are you a non-resident and have sold listed shares of an Indian company in an off market deal? In that case, Long term capital gains on sale of such shares could be taxable at the rate of 20%. This is as per the recent pronouncement by the Authority for Advance Ruling ('AAR') in the case of Cairn UK Holding Ltd where the AAR concluded that non-resident taxpayers are not entitled to claim the concessional rate of 10% for taxation of long term capital gains on sale of shares. Though the ruling of AAR is binding only on the applicant and on the Tax Authority in relation to the transaction it is sought, the ruling does have a persuasive value for others.

As per the current provisions of the Income Tax Act, gains arising from sale of equity shares held for more than twelve months are categorised as 'long term capital gains' and are subject to tax inter-alia in the following manner:

Long Term Capital Gains on equity shares Tax Rate

Listed equity shares subject to securities transaction tax (stock exchange transaction) Exempt Listed equity shares - Off market sale Taxpayer has an option to offer such capital gains to tax at 20.6 percent after indexation* or, at 10.3 percent without indexation, whichever is beneficial (Refer to the example given below)

*Indexation is an adjustment to cover inflation over the years

Example: Consider 10,000 shares of an Indian Company bought in May 2005 @ Rs. 30 per share are sold through an off market deal in March 2011 @ 200 per share. The computation of Long term capital gain under the two options would be as under:–

Option 1

(With Indexation) Amount (Rs) Option 2

(Without Indexation) Amount (Rs) Sale Consideration 20,00,000 Sale Consideration 20,00,000 Less: Indexed Cost of Acquisition – (3,00,000*711/497)* 4,29,175 Less: Cost of Acquisition 3,00,000 Long Term Capital Gain 15,70,825 Long Term Capital Gain 17,00,000 Tax liability@20.6% (including cess) 3,23,590 Tax liability@10.3% (including cess) 175,100 *Cost Inflation Index (CII) for the tax years 2010-11 and 2005-06

As can be inferred from above, option 2 for the concessional rate is beneficial for the tax payer.

The option of 20% or 10% long term capital gain tax rate is applicable to all the taxpayer irrespective of their residential status, other than the non-resident taxpayer who has acquired the shares by utilising foreign currency. In case of non-resident taxpayer, who has acquired shares utilising foreign currency, the mechanism for computing capital gains is different. In such cases, non-residents have been given protection against the exchange rate fluctuations, while arriving at the capital gains from sale of shares of an Indian company and are denied the indexation benefits.

Having regard to the above, the issue before the AAR was whether these non-residents for whom the indexation benefit does not apply (i.e. where shares have not been purchased in foreign currency) were also eligible to claim the beneficial rate of 10%. The ruling was pronounced in respect of the Scotland based applicant, Cairn UK Holdings Ltd ('herein after referred to as Cairn UK' or 'company'). Cairn UK had sold shares of its Indian subsidiary, Cairn India Ltd, to Petronas Corporation International Limited (sale done off-market i.e. not through the stock exchange) and was seeking a certificate from the tax department for lower deduction of tax rate of 10% which was turned down by the department. Hence, the Company sought an advance ruling from the AAR.

Company (Non-resident) contended that the concessional tax rate of 10% was applicable on long term capital gains arising on the sale of shares of an Indian company (in an off-market transaction) in case the benefit of indexation was not availed. Company contended that the concessional tax rate benefit is available to both non-residents and residents and that if the legislature intended to restrict the option of concessional benefit to residents only, specific language would have been incorporated to that effect. The Company further contended that merely because a resident can have only one benefit (either indexation or 10% rate), non-residents cannot be denied benefit of the concessional rate on the grounds that protection against exchange rate fluctuation is available to them.

Availability of exchange rate fluctuation could be a justification to deny the indexation benefit, but the same cannot be said to apply for denying the lower rate of 10%. Reliance was placed on an earlier pronouncement of the AAR in the case of Timken France, where it was held that the benefit of concessional rate of 10% should be allowed to non-residents.