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
Contentions of the Applicant
Contentions of the Tax Authority
Ruling of the AAP
1. The relevant questions which need to be answered for resolving the controversy are:
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-ITIrnwhich 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.
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.