No capital gains on intra-group transfer of shares

No capital gains on intra-group transfer of shares in an Indian company for no consideration

- AAR

Authority for Advance Rulings (AAR) [2010-TIOL-07- ARA-IT] in the case of Amiantit International Holding Ltd. (Applicant) on the issue of whether the transfer of shares held by the Applicant in an Indian company, to its Cyprus-based 100% subsidiary under a re-organization scheme, is taxable as per the provisions of the Indian Tax Law (ITL) held that the transfer of shares did not result in any consideration and, therefore, it could not be taxed as capital gains under the provisions of the ITL. The AAR also held that even though the transfer was an international transaction between Associated Enterprises (AEs), as there was no income arising as per the charging provisions of the ITL, the transfer pricing (TP) provisions could not be applied to determine taxable gain based on arm’s length principles.

Background and facts of the case

1. The Applicant, an investment company incorporated in Bahrain, had investments in Europe, Asia, North Africa and Latin America. The Applicant was wholly owned by South Arabian Amiantit Company (SAAC) which was a listed entity in Saudi Arabia. The Applicant held 70% equity shares in an Indian company which was engaged in the production of glass-reinforced polyester pipes, storage tanks etc. The Applicant also held 100% shares in another investment company incorporated in Cyprus (Cyprus subsidiary) which held shares of various group entities.
2. The Applicant proposed to reorganize its group and thereby split itself into two companies, one owning the business in Europe and the other owning businesses in Asia, North Africa and Latin America. As part of the reorganization scheme, the Applicant proposed to hold all international investments relating to pipe manufacturing through its Cyprus subsidiary for certain commercial reasons.
3. The Applicant, therefore, proposed to contribute the shares of the Indian company without any consideration, along with the other non-European investments, to its Cyprus subsidiary under a ‘Contribution agreement’ which was executed outside India. Such a contribution, akin to a gift, was permissible under Bahrain legislation. Furthermore, such shares transferred to its Cyprus subsidiary would not be re-transferred to the Applicant.

Contentions of the Applicant

1. Since no consideration, which can be evaluated in terms of money, is received or receivable from its Cyprus subsidiary, no profit or gain accrues or arises on account of the transfer of shares under the scheme of reorganization and, therefore, no capital gains tax can be levied under the ITL.
2. The transfer of shares to its Cyprus subsidiary under the reorganization scheme can also be considered as a ‘gift’ which is not regarded as a taxable transaction under the provisions of the ITL and, therefore, the charging provisions of the ITL stand excluded.

Contentions of the Tax Authority

1. The transfer of shares under the reorganization scheme is based on business considerations aimed at deriving certain financial advantages and, therefore, such a transfer cannot be considered as without consideration. Further, the benefits and advantages of the reorganization represent the valuable consideration for the transfer.
2. The transfer of shares under the guise of ‘gift’ would, in substance, not be a gift since the Applicant would not be poorer to the extent of assets parted with and, therefore, cannot be exempted under the provisions of the ITL.
3. Once the transfer of shares is admitted to be an international transaction between AEs, there is some scope for manipulation of consideration and, therefore, the TP provisions would be applied for computing the income, having regard to the arm’s length price.

Ruling of the AAP

1. The relevant questions which need to be answered for resolving the controversy are:

• Did any profit or gain arise from the transfer of capital asset (in the form of shares of the Indian company)?
• Is it possible to identify or quantify the value of the consideration received or accrued to the Applicant as a result of the transfer?

2. It is a settled law that the charging provisions must be read harmoniously with the computation mechanism under the ITL. If the computation provision cannot be given effect to for any reason, the charge fails. This interplay and relative scope of the two provisions have been explained earlier by the Supreme Court (SC) in the case of B C Srinivasa Setty [128 ITR 294].

3. The charging provisions for capital gains state that any profits or gains arising from the transfer of a capital asset would be chargeable to tax when such an asset is transferred.

4. The term ‘arising’ as used in the charging provisions for capital gains refers to ‘a right to  receive profits’. When the right to receive income becomes vested in the taxpayer, it is said to accrue or arise. Thus, in this context, the expression ‘arising’, employed in the charging provisions refers to actual receipt of income as well as a right to receive income.

5. If consideration is incapable of being valued in definite terms or it remains unascertainable on the date of the transfer of shares, the charging provisions and the computation mechanism cannot be applied. As there is nothing concrete or definite which the transferee (Cyprus subsidiary) gives or makes over to the transferor (Applicant) as a quid pro quo for the receipt of shares, there cannot be a consideration as contemplated in the charging provisions for capital gains.

6. The TP provisions under the ITL can be applied only when there is income chargeable to tax that arises from an international transaction. Reliance was placed on an earlier ruling of the AAR in the case of Dana Corporation [2009- TIOL-29-ARA-ITI^rnwhich held that TP provisions are not independent charging provisions and the expression ‘income arising’ postulates that the income has already arisen under the charging provisions of the ITL. Therefore, the application of TP provisions was ruled out in a case where the income is not chargeable to tax by the application of the charging provisions for capital gains.

7. As there is no income chargeable to tax, the question of withholding the tax does not arise. Therefore, there can be no obligation on the Cyprus subsidiary to withhold any taxes under the ITL.

Comments

The AAR ruling has applied the legal propositions laid down by various decisions of the SC in interpreting the terms ‘profits or gains’ and ‘arising’ used in the capital gains provisions of the ITL. Furthermore, the charging and computation provisions must be read together to tax profits, arising from transfer of capital assets, as capital gains. The AAR also held that unless the transferor (Applicant) acquires a right to receive an identifiable and monetarily convertible benefit from the transferee (Cyprus Subsidiary) as a quid pro quo, there cannot be any consideration as contemplated in the capital gains provisions.

In addition, the AAR has reiterated the proposition it had earlier laid down in its decision in the case of Dana Corporation (supra) that TP provisions of the ITL cannot be applied when there is no income that is otherwise chargeable to tax.

The AAR also held that withholding tax obligation arises under the ITL only when an income is chargeable to tax in India.

A ruling by the AAR is binding only on the Applicant, in respect of transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the Applicant and the said transaction. However, it does have persuasive value and the Indian Courts, the tax authority and the appellate authorities do recognize the principles and ratios laid down by the AAR, while deciding similar cases. Other taxpayers who would like to achieve certainty on their transactions could consider approaching the AAR for a ruling, after evaluating the facts of their respective cases