A. Introduction
Recently, the Income Tax Appellate Tribunal, Mumbai (Tribunal) in the case of Legatum Ventures Limited (‘the Assessee/taxpayer’) [ITA No. 1627/2022], has said that the capital gains arising on the sale of unlisted shares by a non-resident has to be computed only by reference to the provisions of Section 112(1)(c)(iii) of the Income Tax Act, 1961 (‘the Act’) without cognizance to the provisions under Section 48 of the Act.
Following the ITAT Mumbai order stating that the forex neutrality provision would not be applicable to non-resident investors when calculating capital gains on the sale of assets, including shares or debentures, Private Equity (‘PE’) and Venture Capital (‘VC’) firms have contacted tax advisers to gauge the potential impact on their exits.
The investment plans and the tax consequences need to be examined by strategic and PE/VC investors before engaging in transactions involving shares or debentures as a result of the said decision.
In 2022, India had total outflows of $24 billion. Thus, the decision of the Tribunal has opened new doors for litigation and has put the PE and VC firms in a spot to bother.
B. Background
♦ The Assessee is a foreign company, incorporated in the UAE, primarily engaged in investment activities. During the Assessment Year 2018-19, the Assessee sold the shares of an unlisted Indian private limited company and computed the capital gains as per the first proviso to section 48 of the Act read with Rule 115A of the Income Tax Rules, 1962 (Rules) which resulted in a loss of INR 3,63,87,392.
♦ Accordingly, the Assessee filed a NIL return. The tax return filed by the Assessee was selected for audit wherein the learned Assessing Officer (‘learned AO’) claimed that capital gains on sale of unlisted shares must be computed only as per Section 112(1)(c)(iii) of ITA as per which the first proviso is to be ignored. Thus, the learned AO assessed the total income of the Assessee at INR 17,13,59,838.
♦ Looking at the relevant provisions, Section 48 only provides the mode of computation of income in the nature of capital gains, whereas Section 112 stipulates the tax rates applicable to long term capital gains.
♦ As per Section 48, income in the nature of capital gains shall be computed as follows:
Capital Gains =
Full Value of Consideration received or accruing as a result of the transfer of the capital asset
Less:
a) expenditure incurred wholly and exclusively in connection with such transfer;
b) the cost of acquisition of the asset and the cost of any improvement thereto
♦ Further, the first proviso to Section 48 of Act provides that incase of an Assessee, who is a non-resident, capital gains arising from the transfer of a capital asset being shares in, or debentures of, an Indian company shall be computed by converting the cost of acquisition, expenditure incurred wholly and exclusively in connection with such transfer and the full value of the consideration received or accruing as a result of the transfer of the capital asset into the same foreign currency as was initially utilized in the purchase of the shares or debentures, and the capital gains so computed in such foreign currency shall be reconverted into Indian currency.
This proviso essentially neutralizes the effect of foreign exchange fluctuations on income earned by non-residents.
♦ According to Section 112(1)(c)(iii), long term capital gain on transfer of unlisted securities or shares is taxable at 10% without giving effect to inter-alia foreign exchange fluctuation.
♦ Since the Assessee applied the method prescribed under section 48, the Assessee’s computation resulted in a long-term capital loss as against the long-term capital gain computed by the learned AO by applying the provisions of section 112(1)(c)(iii). The Assessee filed its objections before the Dispute Resolution Panel (‘DRP’) which were rejected and hence, the Assessee filed an appeal before the Mumbai Tribunal.
C. Assessee’s Contentions
♦ Section 112 applies only in the case, if the total income includes any income arising from transfer of a long-term capital asset which is chargeable under the head “capital gains” and where such income from transfer of a long-term capital asset forms part of the total income, Section 112 provides for the manner in which the tax payable by the Assessee on the total income shall be computed.
♦ Section 48 of the Act provides for the mode of computation of income chargeable under the head ‘Capital Gain’. In the Assessee’s case, since the computation as per Section 48 resulted in long-term capital loss, the provisions of Section 112(1)(c)(iii) are not relevant.
D. Tribunal’s Ruling
♦ The Tribunal upheld the order of the learned AO and DRP stating the following:
> Section 112 of the Act, forming part of Chapter XII- Determination of Tax in certain special cases, in the case of a non-resident or a foreign company, sub-clause (iii) of clause (c ) to sub-section (1) provides the mode of computation of capital gains.
> As per section 112(1)(c)(iii) of the Act, in case of a non-resident, capital gains arising from the transfer of a long-term capital asset, being unlisted securities or shares of a company in which public are not substantially interested, shall be computed without giving effect to 1st and 2nd proviso to section 48 of the Act. The aforesaid section further provides a tax rate of 10% on the capital gains so computed.
> Therefore, the Tribunal was of the considered opinion that section 112(1)(c)(iii) is a special provision for the computation of capital gains, in case of a non-resident, arising from the transfer of unlisted shares and securities. While, on the other hand, section 48 of the Act is a general provision, which deals with the mode of computation of capital gains in all the cases of transfer of capital assets.
> Further, the Tribunal also stated that section 112(1)(c)(iii) of the Act does not provide for “re-computation‟ of capital gains for levying tax rate of 10%. Since section 112(1)(c)(iii) is the specific provision, therefore, in case the ingredients of the said section, i.e.
(i) non-resident or foreign company;
(ii) long-term capital gains arise;
(iii) transfer of unlisted shares or securities of a company not being a company in which public are substantially interested,
are fulfilled, then capital gains is required to be computed as per the manner provided under the said section.
> The Tribunal highlighted the fact that it is a well-settled rule of interpretation that if a special provision is made respecting a certain matter, that matter is excluded from the general provision under the rule which is expressed by the maxim “Generallia specialibus non derogant”.
> Further, the Tribunal observed that a well-settled rule of construction that when, in an enactment, two provisions exist, which cannot be reconciled with each other, they should be so interpreted that, if possible, the effect should be given to both.
> Therefore, if the submission of the Assessee that in the present case the income chargeable under the head “capital gains” is to be computed only as per section 48 of the Act is accepted, then the same would render the computation mechanism provided in section 112(1)(c)(iii) of the Act completely otiose and redundant. The Tribunal, thus, found no merits in the claim of the Assessee to choose to be taxed under the provision which is more beneficial.
E. Concluding thoughts
Having regard to stated law, the Mumbai Tribunal has ruled in favour of the department. However, the ruling will result in higher tax payments with respect to capital gains arising on transfer of shares in unlisted companies though the non-resident taxpayer has incurred losses in dollar terms.
Further, the ruling also raises questions on interpretation of section 112 of the Act. As stated in the ruling, if only section 48 of the Act is accepted, section 112 of the Act becomes redundant. Therefore, the question is where one provision allows forex benefit to non-residents and results in a capital loss, should the provision prescribing tax rate and restricting availability of forex benefit.
The government may consider the merit in evaluating appropriateness of both the sections and removing ambiguity. Over the last few decades, the rupee has regularly fallen versus the dollar, such tendency may likely continue for the foreseeable future. It is understandable that non-residents measure their success in dollars rather than rupees, thus swift action may be necessary in order to resolve such dichotomy in provisions of the Act.
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Disclaimer: The content/information is only for general information of the user and shall not be construed as legal advice. The facts stated are based on information available in public domain. Views expressed above are personal.
Author Bio:
Author Name: Sumit Mahajan, Partner & Sonakshi Sood, Director – Tax | Organization: AccuWiz Consulting LLP | Location: Noida
