Authority for Advance Rulings (Income-tax) (“AAR”) has rendered an important ruling in the case of Trans world Garnet Company Ltd. [2011-TII- 02-ARA-INTL] dealing with the issue of whether or not the non-availability of the indexation benefit under the provisions Second proviso to section 48 of the Income-tax Act, 1961 (the “Act”) to non-residents amounts to discrimination under the India-Canada Double Tax Avoidance Agreement (the “tax treaty”). After considering the various provisions of the Act and Article 24 of the tax treaty, the AAR held that the denial of indexation benefits to the applicant does not amount to discriminatory treatment under the tax treaty.
Facts :- The applicant is a Canadian registered company engaged in the business of mining, processing and supply of industrial garnet. It holds a 74% equity share capital in Transworld Garnet India Private Limited which is proposed to be transferred to VV Minerals, an Indian partnership firm, pursuant to the share purchase agreement with VV Minerals. As these shares were held for more than 12 months, they are considered as long-term capital assets and the gains arising upon their transfer would be taxable as long-term capital gains. As the applicant is a Canadian tax resident, in this case it would be taxed in India on the long-term capital gains it has earned, as per the tax treaty.
Provisions of the Act
Section 48 of the Act deals with the computation of capital gains. The relevant provisos to the said section are described below:
• The first proviso to section 48 of the Act protects a non-resident from foreign exchange fluctuation risks by allowing them to compute capital gains in the foreign currency which was utilised in the purchase of capital assets
• the second proviso to section 48 of the Act allows the benefit of indexation, i.e. an inflated tax base wherein the cost of acquisition is adjusted for inflation on the long term capital gains arising from the transfer of capital assets other than capital gains arising to non-residents as per the first proviso of section 48 of the Act.
In light of the above facts, the following questions were raised before the AAR:
• The second proviso to section 48 states that no indexation benefit is available to non-residents in the computation of long-term capital gains arising from the transfer of shares in an Indian company. Will not the denial of indexation benefits tantamount to discriminatory tax treatment under Article 24 of the India-Canada Double Taxation Avoidance Agreement?
• Whether in computing the capital gains, deduction is admissible under section 48 of the Act for the following expenses incurred in connection with the transfer of shares?
– Fees for valuation of business, professional fees for advice in connection with transfer, legal expenses, fees for escrow account, travel and hotel charges incurred in connection with transfer.
As far as issue no. 2 is concerned, there was an extraordinary hike in expenditure claimed by the applicant vis-à-vis the estimated amount which required further verification by the Revenue and hence the AAR chose not to comment on the question raised in issue 2. We have accordingly not discussed this matter in our analysis.
• As per the provisions of the Section 90(2) of the Act , the assessee is entitled to be governed by the beneficial provisions of the tax treaty vis-à-vis the provisions of the Act
• The applicant is prevented from availing of the benefit of indexation while computing its long term capital gains
• Consequently, long-term capital gains computed by the applicant under the normal of First proviso to section 48 of the Act of the Act are much higher (approx. INR 140 million) vis-à-vis the long term capital gains which would have been had the benefit of indexation given to the applicant (approx. INR 72 million)
• This resulted in discriminatory treatment of a Canadian national compared with an Indian national
• Reliance was placed on the decisions in the cases of Metchem Canada Inc. v. DCIT 284 ITR (AT) 196, Daimlerchrysler India Private Ltd v. DCIT  29 SOT 202 (PUN), and SMS Demag Pvt. Ltd vs. Deputy Commissioner of Income Tax, New Delhi  038 SOT 496 (DEL] which dealt with the non-discrimination issue as per the applicable tax treaties
• The ruling of the Universities Superannuation Scheme Ltd. In re  275 ITR 434 ( AAR), in which a similar issue of denial of indexation benefits in the case of a Foreign Institutional Investor (“FII”) was analyzed may not be applicable to the applicant as FIIs are special entities which are given special benefits under the Act and are specifically prohibited from availing of indexation benefits.
• Though the first proviso to section 48 of the Act states that the benefit of indexation is not available to non-residents, non-residents are protected from vagaries of fluctuation in currency rates as per other provisions of the Act
• As per the Article 24(4)(b) of the India-Canada Double Tax Avoidance Agreement , a company which is resident in Canada may be subject to a higher rate of tax than the Indian company provided such difference does not exceed 15%. In the present case, there is no difference in the rate of capital gains taxation between the resident and the non-resident applicant.
Ruling by the AAR
• Article 24(1) of the tax treaty with Canada aims at ensuring equality of treatment to nationals of the Contracting State so that they are not subjected to taxation requirements which are more burdensome than the nationals of another state
• Discrimination is understood to be unequal treatment in an identical situation. Different treatment does not constitute discrimination unless it is arbitrary
• A comparison cannot be made between a resident and national of a state and a national of another State to contend that they must be taxed in the same way. The State is not obliged to extend the same privileges accorded to its own residents to the ones who are not. Therefore, discrimination on account of nationality other than residence is prohibited
• The terms ‘taxation’ and ‘tax’ are not interchangeable. The object clause of every agreement uses the expression ‘taxation’ and ‘tax’ where the purpose is stated to be “avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and wealth”. Avoidance of discrimination is the object of the former and avoidance of double taxation is the object of the latter
• Article 24(1) of the tax treaty uses the word ‘taxation’. Discrimination against taxation therefore means the procedures by which tax is imposed. The term ‘tax’ means the levy of tax itself, whereas the term `taxation’ means the procedures by which tax is imposed and includes formalities relating to returns payment, prescribed times, etc
• The terminology used in Article 24(1) and Article 24(2) of the tax treaty is different because discrimination under Article 24(1) is based on nationality and discrimination under Article 24(2) is based on the situs of the enterprise
• Furthermore, the Act expressly permits (under Explanation to section 90(2) of the Act) taxing a foreign company at a rate higher than the Indian company and states that this shall not be regarded as discrimination under the relevant tax treaty
• Reliance is placed on the ruling of the Universities Superannuation Scheme (supra) in which it was held that different tax treatment based on residential status and not on nationality does not amount to discrimination
• Reliance placed by the applicant on the case of Metachem Canada Inc (supra), Daimler Chrysler India (P) Ltd (supra) and SMS Demag Pvt. Ltd (supra) may not be of much assistance as the facts of the case in question are different
• In light of the above arguments, the denial of indexation benefits to a non-resident applicant while computing long-term capital gains would not amount to discriminatory treatment in terms of Article 24 of the tax treaty.
Conclusion :- The AAR in this case has not specifically ruled on the issue of whether or not, as per the provisions of the Act, a non-resident is entitled to indexation benefits. In a nutshell, the AAR has reiterated the fact that the State is not obliged to extend the same privileges offered to its own residents to non-residents and that mere differentiation in tax treatment because of the residential status of the assessee would not amount to discrimination, as set out in the tax treaty.