EY ITS Course Session 10 Capital Gains

EY ITS Course Session 10
Capital Gains
Page 2 Capital Gains
Agenda
Basic
Capital gains ITA
Capital gains Treaty scenarios
Foreign investment - key considerations
Key judicial precedents
Basics
Capital Gains Basics
The capital asset must be transferred
There must be a capital asset situated in India
There must be profits and gains on such transfer i.e., capital gain
Such capital gain should not be exempt
Section 45 read with Section 9 Any profits and gains arising to a Non resident from
the transfer of capital asset situated in India effected in the previous year, shall be
chargeable to income-tax under the head Capital Gains and shall be deemed to be
income of the previous year in which the transfer took place unless such capital gain is
exempt
Essential conditions for taxing capital gains:
Capital gains - ITA
What is Capital Asset ?
Property of any kind held by an assessee (whether or not in connection with
his business or profession) but does not include the following:
Stock in trade, raw materials, consumable stores held for the purpose of business
or profession
Personal effects excluding jewellery, archaeological collections, drawings, paintings,
sculptures, any work of art
Agricultural land (subject to exceptions)
Gold bonds
Special bearer bonds
Gold deposit bonds
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Finance Act, 2012
It is clarified that property includes any rights in or in relation to an Indian company, including rights of
management or control or any other rights whatsoever
Short term / Long term capital asset
Short-term capital asset
A capital asset held by an assessee for not more than 36 months immediately
preceding the date of its transfer.
Exceptions- Following capital assets are considered short term if held for not more
than 12 months:
Shares of a company or any other security listed in a recognized stock exchange
in India
Units of UTI,
Units of a mutual fund,
Zero coupon bond
Short-term capital gain: Gain on transfer of short-term capital asset
Long-term capital asset
Any capital asset, which is not a short-term capital asset
Long-term capital gain: Gain on transfer of long-term capital asset
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What is Transfer ?
Transfer includes:
Sale, exchange or relinquishment of the capital asset
Extinguishment of any rights in the capital asset
Compulsory acquisition of capital asset under any law
Conversion of the capital asset into stock in trade
Maturity or redemption of a zero-coupon bond
Any transaction involving the allowing of the possession of any immovable property
to be taken or retained in part performance of a contract
Any transaction which has the effect of transferring or enabling the enjoyment of
any immovable property
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Finance Act, 2012
Additionally transfer has been defined to include
Disposing of or parting with a capital asset or interest therein.
Creating any interest in any capital asset.
Whether directly or indirectly.
Whether absolutely or conditionally
Whether voluntarily or involuntarily
Whether by agreement or otherwise
This is notwithstanding that transfer of capital asset is characterized as effected or dependent upon or flowing
from transfer of a share / shares of a foreign company
Capital gains tax rate shares / securities
Particulars Non-resident company*
Stock Exchange transaction** Long-term
Exempt
Short-term 15%
Outside Stock Exchange transaction
(i.e. sale of listed shares through private deal)
Long-term 10%
***
/ 20%
Short-term 40%
Sale of unlisted shares Long-term 10% (without foreign
exchange rate adjustment)
Short-term 40%
* Tax rates are applicable to non-residents (for shares purchased in foreign currency) after making prescribed foreign exchange
adjustment for computing capital gains chargeable to tax. Further, no indexation benefit is available to non-residents with respect
to gains arising from sale of securities (purchased in foreign currency)
In case sale of shares by non-resident, the taxation would be subject to provisions of applicable tax treaty
** Transfer of shares on a recognised stock exchange would attract Securities Transaction Tax on the value of transaction
***There are conflicting judicial precedents on the availability of lower rate of 10%
Finance Act, 2012
Unlisted equity shares sold under offer for sale to public included in an IPO, prior to listing on a
recognized stock exchange, it would now be subject to STT
Consequently, resultant capital gains would be tax as follows
Tax on short term gains 15%
Tax on long term gains Exempt
Applicability of 10% beneficial rate to NR
Compagnie Financiere
Hamon
1
Four Star Oil and Gas Co
2
Burmah Castrol Plc
3
Benefit of the proviso to section 112(1) of the Income-tax Act (Act) could not
be denied to non-residents even if they were entitled to a different relief under
the first proviso to section 48 of the Act
Cairn UK Holdings Ltd
4
BASF Aktiengesellschaft
5
Also, for application of proviso to section 112 of the Act, the asset must be one qualified
for indexation benefit under second proviso to section 48 of the Act. If proviso to section
112 of the Act was supposed to apply to first proviso to section 48 of the Act which
gives benefit of exchange fluctuation protection to NR, specific provisions to that effect
would have been made.
Accordingly, benefit of proviso to section 112(1) Act should not be avaialble to non-
residents
1. 310 ITR 1
4. A.A.R. No.950 of 2010 2. 312 ITR 104
3. 307 ITR 324 5. 293 ITR 1
Particulars Rate of taxation
(excluding surcharge and education cess)
Capital gains tax
- Long -term* [where assets (other than shares) are held for
more than 36 months before the date of sale]
- Short -term [where assets (other than shares) are held for
36 months or less before the date of sale]
Foreign company - 20%
Other Non residents 20%
Foreign company - 40%
Other Non residents 30%
*Indexation benefit available with respect to long-term capital gains arising to non-residents (other than gains arising from sale of securities in
hands of non-residents)
Capital gains tax rate Other than shares /
securities
Special provisions for computation of capital
gains for non-residents in certain cases
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All non-residents;
Shares or debentures of an Indian Company;
Purchased in foreign currency;
No indexation even if long term capital gains;
Not applicable to unlisted long term securities
Particulars Remarks Amount
Gross sales consideration in Indian currency
to be converted into foreign currency
Average of State Bank of India ('SBI') TT buying and
selling rate to be taken as at the date of transfer
XXX
Less cost of acquisition^ in Indian currency
to be converted into foreign currency
Average of the SBI TT buying and selling rate to be
taken as at the date of acquisition
XX
Less incidental expenses of transfer in
Indian currency to be converted into
foreign currency
Average of the SBI TT buying and selling rate to be
taken as at the date of transfer
X
Capital Gains in foreign currency to be
reconverted into Indian currency
TT buying rate on date of transfer to be taken XXX
*As per Proviso 1 of Section 48 of the IT Act read with Rule 115A of the Income tax Rules, 1962
^ No indexation benefit available
Certain Exemptions Non resident specific
Sec 47
Amalgamation/ demerger
(Section 47(via) / Section 47(vic))
Transfer of shares of an Indian company
pursuant to merger/ demerger of foreign
companies not taxable provided:
at least twenty-five per cent of the
shareholders of Amalgamating
company/ Demerged Company
continue to remain shareholders of
Amalgamated company/ Resulting
Company, and
such transfer does not attract tax on
capital gains in the country in which
Amalgamating Company/ Demerged
Company is incorporated
Transfer of bond/ GDR/ ADR
Transfer of a capital asset being,
bonds/ GDR/ ADR between non
resident is not taxable
Transfer from holding company to
subsidiary company and vice versa
Transfer of a capital asset by a
holding company to its wholly-
owned Indian subsidiary and vice
versa, provided recipient is Indian
company
Capital gains - Treaty scenario
Tax under treaty
Capital gains tax dealt with Article 13/14.
Capital gain or alienation or property not defined under DTAA
Alienation defined (E.g., Mauritius, Tanzania, Sri Lanka, Bangladesh) to mean sale, exchange, transfer,
relinquishment, extinguishment, compulsory acquisition.
Sale, exchange or transfer, as defined in domestic law covered E.g. Bangladesh.
Article 13/14 does not cover the following:
Consideration for use of property
Gain on redemption of debentures/bonds
Distribution on liquidation/capital reduction to the extent of accumulated reserves
Tax under treaty
Capital assets Taxability
Immovable property
(including shares
representing immovable
property)
Taxable in the country where the immovable is situated
Movable property forming
part of PE.
Taxable in the country in which PE exist
Ships, aircraft, boat Taxable in the country of Place of Effective Management
Other shares
Generally taxable in source country (where company whose share are transferred is
resident). However, certain treaties provide exception such as
Mauritius, Cyprus, Korea etc. provide taxation in country of residence of transferor
Singapore, Netherland etc. provide taxation in country of residence of transferor
subject to fulfillment of certain conditions
France, Belgium etc. provide for taxation in country of residence of transferor subject
to threshold participation
Any other property
Taxability varies from treaty to treaty
Article 13/14 Immovable property
Immovable property defined in Article 6.
Meaning as per domestic law.
Includes property accessory to immovable property, livestock and equipment used in agriculture
and forestry, usufruct of immovable property, etc.
Excludes ships, boats, aircraft.
Gains derived by a resident of a Contracting State from the alienation of immovable property
referred to in Article 6 and situated in the other Contracting State may be taxed in that other
State. [Generally followed in treaties and Corresponds to Article 6.]
Applies to immovable property, whether business or private property.
Supplement Gains from alienation of shares deriving principal value from immovable property
(defined in certain treaties to mean 50%) is situated in a State, taxable in that State.
Applicable to principally immovable property owning entities.
Article 13/14 Movable property of PE
Movable property All property other than immovable property defined in Art. 6.
Includes incorporeal property, e.g., goodwill, license, etc.
Economic ownership of property should be allocable to PE as per attribution principles.
Gains from alienation of :
i) Movable property forming part of the business property of a PE/fixed base or ;
ii) PE/FB
May be taxed in that other State in which the movable property of the PE/FB is situated.
[Generally followed in treaties]
Gains from movable property not forming part of PE not covered.
E.g., gains from sale of private property.
Article 13/14 Ships, aircrafts, boats
Gains from the alienation of:
ships or aircraft operated in international traffic,
boats engaged in inland waterways transport or
movable property pertaining to the operation of such ships, aircraft or boats
shall be taxable only in the Contracting State in which the POEM of the enterprise
is situated
India reserves the right not to extend Article 8 to cover inland waterways transportation.
[Generally
followed in
treaties, subject to
deviations]
Article 13/14 Shares
Gains arising from transfer of shares are generally taxable in source
country (where company whose share are transferred is resident).
However, certain treaties provide exception such as
Mauritius, Cyprus, Korea etc. provide taxation in country of residence of
transferor
Singapore, Netherland etc. provide taxation in country of residence of
transferor subject to fulfillment of certain conditions
France, Belgium etc. provide for taxation in country of residence of
transferor subject to threshold participation
Article 13/14 Any other property
Gains from the alienation of any property, other than those discussed
earlier, shall be taxable only in the Contracting State of which the alienator
is a resident. (Generally followed in treaties, with or without threshold)
Essentially covers capital gains from movable private property or capital
gains in State of residence or third States (E.g. land forming part of PE in India,
situated in 3rd State).
Foreign investment - key considerations
Key Holding company Jurisdictions
H Co H Co
IHC
I Co I Co
India
Overseas
Transfer of shares of Indian company (I Co) by
non resident (H Co) may be taxable in India
Key jurisdictions considered to mitigate capital
gains taxability on transfer of shares in India are as
follows:
Mauritius
Singapore
Cyprus
Netherlands
As per DTAA, right to tax capital gains on sale of
shares of Indian company has been given to
above mentioned countries (IHC)
Capital gains tax rate in above mentioned
jurisdictions is Nil (Subject to fulfillment of certain conditions)
Recently tax department has been questioning investments through the preferred
jurisdictions made in the preceding slide
Lack of commercial substance has been the main concern of the tax authorities
In various cases, AAR* has held that the gains arising to the applicant Mauritius Company
from sale of shares of an Indian Company will not be taxable in India under the India
Mauritius placing reliance on
Supreme Court in the case of UOI vs Azadi Bachao Andolan (supra); and
CBDT Circular no. 789
Benefits under the India-Singapore treaty would be available subject to the fulfillment of
LOB conditions
Benefits under India-Netherlands is available only in prescribed situations
* AARs include the ruling in the case of E*Trade Mauritius Limited, Praxair Pacific Limited etc
Key Holding company Jurisdictions
As per SEBI regulations, FII can invest not more than 10% in a listed company
Controversy around the erstwhile investment structures, new structures for investing
in India has become imperative
Capital Gains Article of Indian tax treaties with Spain, Denmark, Belgium and France
(European Countries) have the following clause:
Gains for the alienation of shares of the capital stock of a company forming part of a
participation of at least 10 per cent in a company which is a resident of a Contracting
State may be taxed in that Contracting State
Based on the above, one may take a view that capital gains arising on transfer of
less than 10% shares of Indian companies to tax resident of abovementioned
European Countries may be not be taxable in India
Tax implications in respective European Countries to be factored
FIIs investment - Europe Gateway
Indirect transfers taxability
Finance Act, 2012, subject to availability of treaty benefits, proposes to tax indirect
transfers ie situations where shares of a foreign company are transferred with
substantial underlying assets in India
Clarificatory amendments
proposed with retrospective
effect
Source rule: Expression through to include by means of or
in consequence of or by reason of transfer of capital asset
in India
Any share or interest in a company or entity outside India
deemed to be situated in India if shares or interest derives its
value directly or indirectly substantially from assets located
in India
Property to include rights of management or control or any
other rights whatsoever
Wide meaning of transfer
Tax will have to be withheld by buyer (whether resident or non
resident) on such indirect transfers
Computation for indirect transfer
HoldCo
FCo1
ICo
Hold Co transfers shares of FCo1 and triggers tax in India
Assumptions
Purchase cost $ 100 (INR rate 20)
Sale price $ 500 (INR rate 50)
First proviso to S. 48(1) does not apply as transfer is not of
ICo shares
Second proviso to S. 48(2) permits indexation.
View 1 : Assuming indexation multiple is 3, capital gain is
$ 200 (i.e. $ 500- $ 300) capital gains tax therefore needs to
on income of $ 200 X 50 = 10,000
View 2 : Capital gain computation
Sale price ($ 500 x 50) 25000
Indexed Cost ($100 X 3 X 20) 6000
Gain 19,000
Liquidation of Foreign Companies
Facts
F Co1 holds shares of F Co2 which in turn holds shares in I
Co
F Co2 is to be liquidated, pursuant to which shares of ICo to
be transferred to FCo1
Tax implications
Tax implications on transfer of shares of I Co may be as
follows:
View 1 - Not taxable in India
View 2 - Taxable in India (Subject to DTAA)
Though the issue is litigious, View 2 meets the MLTNTS
comfort since the shares of I Co would be considered to be
received by F Co1 in India
Prior to distribution, the asset was located in India. After
the distribution, it will continue to be an asset located in
India
The common law understanding is that a share of a
company is located where the company is located
The consideration, to this extent, can, therefore, be
regarded as received where the asset is located
FCo1
FCo2
ICo
100%
100%
Outside
India
Distribution of
ICo shares on
liquidation
India
FCo1
ICo
100%
Outside
India
India
Liquidation of FCo2
Post Liquidation
Capital gains outbound scenario
I Co I Co
IHC
F Co F Co
India
Overseas
Divestment of foreign company shares
Transfer of shares of Foreign company (F Co) by
Indian company (I Co) taxable in India
Tax implications in India can be deferred if initial
investment and subsequent divestment made
through IHC
Controlled Foreign Corporation (CFC)
Direct Tax Code proposes to introduce CFC
provisions. As per proposal if IHC is considered as
CFC capital gains arising on transfer of shares of
F Co may be taxable in India
Foreign company reorganization
IT Act does not provide any exemption in the
hands of Indian shareholder of a foreign company
which is undergoing a restructuring exercise, even
if such a restructuring is tax neutral in the overseas
jurisdiction
Key judicial precedents
Brief facts
German company held 100% share capital of the Indian company
Indian company proposes to buy-back equity shares from German company
Applicant (German Company) contended that the proposed buy-back would be taxable
u/s 45 (charging section) of the Income tax Act,1961 (Act) but the same should be
exempt u/s 47(iv) of the Act
AAR Ruling
S.46A of the Act was specifically introduced to subject capital gains arising on buy-back
to income tax
Exemption u/s 47 not available for buy-back as the gains are taxable u/s 46A, exemption
available for gains u/s 45
Proposed buy-back should be taxable in the hands of the German company
Buy-back by wholly owned subsidiary from
foreign parent not exempt*
No exemption can be claimed on buy-back of shares by wholly owned subsidiary from foreign
parent
* A.A.R. No.1067 of 2011 dated February 27, 2012
Recent case law: Buy-back scheme held as
'colorable device' for avoiding payment of DDT*
Brief facts
Indian company made a buy-back of its own shares from its Mauritian shareholder
Indian company stopped distributing dividend since 2003
AAR ruling
Buy-back, in that case, was held to be a tax avoidance scheme
Buy-back was a 'colorable device' for avoiding payment of DDT Board did not
record reasons for non declaration of dividend
Colorable transactions are to be ignored for the purposes of the Indian tax laws
Such distribution would be treated as distribution of profits by the company
Attracts obligation to withhold tax in the hands of the company
* A.A.R. No. P of 2010 dated March 22, 2012
Brief facts
V, an Indian entity; Z, a Mauritius-based company; and S, an Indian subsidiary of V
Z had invested in S by purchasing equity and interest free CCDs
Z sold interest free CCDs to V
AAR Ruling
Gains arising to Mauritius company on sale of CCDs to an Indian company was held as
interest income
Method laid down in the shareholder agreement between Z, V and S was found to be
similar to the manner in which interest on any investment is calculated
AAR concluded that V and S are parent and subsidiary only on paper. In reality, they are
one and the same entity.
Hence appreciation in the value of debentures is payment of interest from V to Z
* A.A.R. No.1048 of 2011 dated March 21, 2012
Gains arising on sale of CCDs held as interest
income *
Gains arising on transfer of CCDs whether always considered as interest?
Gains arising on transfer of IP*
Facts
Foster Australia and Dismin Mauritius
sold shares and IPR to SAB Miller UK
for USD 120 M.
There was termination of user license of
Foster India in favour of Foster Australia
for no consideration.
Foster Australia executed deed of
assignment in favour of SKOL India
(company nominated by SAB Miller UK)
for grant of India related license with
right to sublicense for consideration of
USD 100.
Transaction structure
* Fosters Australia Ltd In re (302 ITR 289) (AAR)
Issue
Whether receipt from transfer of brand IP, trademark and exclusive licence of brewing
manual IP was transfer of capital asset situate outside India, being the situs of domicile
of the owner ?
Judgment
Transfer of capital asset situated in India attracts charge under 9(1)(i).
No legal principle that situs of intangible asset goes with ownership. An intangible asset
can have more than one situs.
IP comprising of Foster trademark and brand IP were located in India where business
was carried on. Goodwill generated in India did not shift its location on extinguishment
of license.
Receipt arising from transfer of brand and trademark IPR was taxable in India.
As regards, brewing technology manual, it was held that upon severing of ties of Ausco
with ICO, the situs of asset shifted outside India and hence the receipt is not taxable in
India.
Gains arising on transfer of IP
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EY ITS Course Session 10 Capital Gains

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