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

Page 4 Capital Gains

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

Page 6 Capital Gains

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

Sect

ion

2(14

)C

apita

l Ass

et

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

Page 7 Capital Gains

Short term / Long term capital asset

Short-term capital assetA 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 assetAny capital asset, which is not a short-term capital asset

Long-term capital gain: Gain on transfer of long-term capital asset

Cap

ital A

sset

Shor

t-Ter

m/ L

ong-

Term

2(

42A)

/ 2(

29A)

Page 8 Capital Gains

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

Sect

ion

2(47

)Tr

ansf

er

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

Page 9 Capital Gains

Capital gains tax rate shares / securitiesParticulars 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 exchangeadjustment 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

Page 10 Capital Gains

Applicability of 10% beneficial rate to NR

Compagnie FinanciereHamon1 Four Star Oil and Gas Co

2 Burmah Castrol Plc3

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 Ltd4 BASF Aktiengesellschaft5

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 20102. 312 ITR 104 3. 307 ITR 324 5. 293 ITR 1

Page 11 Capital Gains

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

Page 12 Capital Gains

Special provisions for computation of capital gains for non-residents in certain cases

App

licab

ility 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 currencyto 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 currencyto 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

Page 13 Capital Gains

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

Page 15 Capital Gains

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

Page 16 Capital Gains

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 transferorSingapore, Netherland etc. provide taxation in country of residence of transferor

subject to fulfillment of certain conditionsFrance, Belgium etc. provide for taxation in country of residence of transferor subject

to threshold participation

Any other property Taxability varies from treaty to treaty

Page 17 Capital Gains

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.

Page 18 Capital Gains

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.

Page 19 Capital Gains

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 boatsshall 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]

Page 20 Capital Gains

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

Page 21 Capital Gains

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

Page 23 Capital Gains

Key Holding company Jurisdictions

H CoH Co

IHC

I CoI 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)

Page 24 Capital Gains

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

Page 25 Capital Gains

As per SEBI regulations, FII can invest not more than 10% in a listed company

Controversy around the erstwhile investment structures, new structures for investingin 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 aparticipation of at least 10 per cent in a company which is a resident of a ContractingState may be taxed in that Contracting State

Based on the above, one may take a view that capital gains arising on transfer ofless than 10% shares of Indian companies to tax resident of abovementionedEuropean Countries may be not be taxable in India

Tax implications in respective European Countries to be factored

FIIs investment - Europe Gateway

Page 26 Capital Gains

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

Page 27 Capital Gains

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) 25000Indexed Cost ($100 X 3 X 20) 6000Gain 19,000

Page 28 Capital Gains

Liquidation of Foreign CompaniesFacts 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

Page 29 Capital Gains

Capital gains outbound scenario

I CoI Co

IHC

F CoF 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

Page 31 Capital Gains

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

Page 32 Capital Gains

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

Page 33 Capital Gains

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 VAAR 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?

Page 34 Capital Gains

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)

Page 35 Capital Gains

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

Thank You