Capital Gains from Listed Securities: No beneficial 10% tax rate for Non-residents
The Indian Authority of Advance Rulings (“AAR”) recently held, in the case of Cairn U.K. Holdings Ltd (“CUHL”),1 that a non-resident investor would not be entitled to the beneficial 10% tax rate on long term capital gains from the sale of listed securities. Ordinarily, long term capital gains are taxable at 20% (exclusive of applicable surcharge and education cess).
The applicant CUHL is a private limited company registered in Scotland. CUHL sold its 2.29% stake in an Indian listed company, Cairns India Ltd. (“CIL”) for a consideration of USD 241,426,378. This transfer took place off-market and the AAR was required to determine whether such gains were entitled to the benefit of the proviso to Section 112(1) of the Income Tax Act, 1961 (“Act”).
Arguments and Ruling
The arguments were primarily based on an interpretation of the proviso to Section 112(1) which states as follows:
“Provided that where the tax payable in respect of any income arising from the transfer of a long-term capital asset, being listed securities or unit or zero coupon bond, exceeds ten per cent of the amount of capital gains before giving effect to the provisions of the second proviso to section 48, then, such excess shall be ignored for the purpose of computing the tax payable by the assessee.” [Emphasis Supplied]
The second proviso to s. 48 confers indexation benefits (which offset the effect of inflation) to Indian residents with respect to long term capital gains from sale of shares. The issue in this case was whether the reference to this proviso restricted the benefits of s.112(1) to Indian residents, or whether this reference merely specified the conditions to be satisfied by residents if they wished to claim the benefit of s. 112.
Applicant’s Arguments: a) The proviso makes no reference to the assessee being a resident or a non-resident, provided that the income is any income arising from the transfer of specified assets, namely, listed securities or units or zero coupon bond. It was argued that the reference to the second proviso was only to ensure that the 10% rate was applied before giving effect to the s.112 benefit; b) The reference to zero coupon bonds makes it evident that the s.112 benefit is not restricted to the situations contemplated in the second proviso, since the third proviso to section 48 expressly excludes bonds from the purview of the second proviso. Similarly it was argued that s.112 applied to “listed securities” including listed debentures which are expressly excluded from indexation benefits under the third proviso. Therefore, the scope contemplated by the proviso to s.112 should be wider than the scope contemplated by the second proviso to s.48; c) Reference to other provisions of the Act, namely, Sections 88 and 155BB(1), demonstrates that the terms “before giving effect to” and “without giving effect to” intend to specify the chronology of computation and not to restrict the scope of the said provision; d) Additionally, if non-residents are being allowed a double benefit in terms of exchange rate benefits and benefits under s.112, it would not be a ground enough to read down s.112. Reliance was placed on sections 115BBA and 115E of the income tax legislation under which double benefits have been provided to non-residents; e) Finally, as the provision is ambiguous in relation to its applicability to non-residents, this should be read in favour of the taxpayer.
Revenue’s arguments: a) Non-residents cannot claim double benefit of exchange rate fluctuation and a beneficial rate under s.112 b) The term “before giving effect to” in the proviso to s.112 pre-supposes that the said proviso is restricted to entities contemplated in the second proviso to s.48 i.e. residents availing of indexation benefits; c) Zero coupon bonds do not fall within the ambit of “bonds” and therefore are not excluded from the second proviso to s.48. Further, with respect to listed debentures, only debentures held by non-residents are out of the purview of the second proviso. Therefore, the inclusion of these two categories in the proviso to s.112 should not take away from the argument that the said proviso is limited by the second proviso to s.48; d) Sections 115AB and 115AD (which prohibit application of the first and second provisos to s.48 and apply beneficial treatment to the class of persons covered under both), demonstrate that beneficial treatment is accorded only to the class of persons to whom a provision specifically makes a reference (which according to the Revenue is the class of persons covered under the second proviso to s.48).
AAR Ruling: The AAR upheld the arguments put forth by the Revenue holding that s.48, which confers indexation benefits, is a provision which governs the mode of computation of income. s.112(1) specifies the rates that govern the taxability of such income. Therefore, the AAR held that the beneficial 10% taxation (of non-indexed capital gains) under the proviso to s.112(1) comes into picture only with respect to capital assets to which the second proviso to s.48 apply. Further, as the proviso to s.112 does not make a mention of the first proviso to s.48, the class of persons covered by the latter are not entitled to the benefit of the former.
On the question of applicability of the proviso to s.112(1) to zero coupon bonds, the two-judge bench of the AAR came up different interpretations, though leading to the same conclusion. V.K. Shridhar, the member, emphasized on the difference between a bond and a zero coupon bond, observing that in the case of the latter, among others, no benefits were to be received before maturity or redemption of the bonds. Thus, he held that zero coupon bonds were not removed from the second proviso to s.48 by virtue of the third proviso to the same section and were therefore, entitled to the benefit of the proviso to s.112(1). On the other hand, Justice P.K.Balasubramanyan, the Chairman, held that the proviso to s.112(1) was applicable to the ambit of circumstances covered by the second proviso to s.48 without taking into account the third proviso to the same section and that therefore zero coupon bonds were entitled to the benefit of s.112.
From a non-resident investor perspective, it would be relevant to keep in mind that off-the-floor transfers of listed securities held for a long term may, as per this ruling, attract the same tax rate as gains from the transfers of unlisted securities held for a long term, unless they are sold on the stock exchange.
Though in line with an earlier ITAT ruling2, the AAR in Cairn has categorically deviated from the stand taken by it in its previous rulings such as Timken France SAS3, where it specifically examined and deviated from the ITAT’s decision, to hold that the benefit conferred by the proviso to s.112(1) is in addition to the benefit applicable under the first proviso to s.48. It was also held that the second proviso to s.48 being only a mode of computation of capital gains, could not be a sine qua non for applying the beneficial rate of 10% under the proviso to s.112(1).
While AAR rulings are binding only on the parties involved, it is reasonable to expect that the AAR should come to similar conclusions on cases involving similar facts and questions of law, which leads us to question whether there is a sound basis for the difference of opinion in Timken and Cairn.
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