Taxability of transfer of shares of an Indian company from one non-resident to another non-resident for no consideration in the course of group reorganisation

Recently, the Authority for Advance Ruling (AAR) in the case of M/s Amiantit International Holding Ltd. [2010-TIOL-07-ARA-IT] held that the capital gains is taxable only when the applicant derive any profit or gain in the form of money or money’s worth or which is capable of being turned into money has accrued or arisen to the applicant.

The charging section [section 45 of the Income Tax Act, 1961 (the Act)] relating to capital gains and the computation provisions (section 48 of the Act) must be read harmoniously. When there is a case for which the computation provision cannot be applied, the charging section fails.

Further the AAR, reiterating the principle laid down in Dana Corporation [2009-TIOL-ARA-IT] , held that the transfer pricing provisions in an international transaction can be applied only when income is chargeable to tax in India and since in the present case income was not chargeable to tax in India the question of withholding tax under section 195 of the Act does not arise.

 Facts of the case

• The taxpayer, an investment company, is a company incorporated in the Kingdom of Bahrain. The applicant is having investments in various Asian, European as well as Latin American companies. The taxpayer was wholly owned by South Arabian Amiantit Company which is a listed company in Saudi Arabia.
• The applicant holds 70 percent of the equity shares in physical form in an Indian company who is engaged in the production of glass reinforced polyester pipes, storage tanks, etc. The applicant also holds 100 percent shares in an investment company incorporated in Cyprus which held shares of various group entities.
• The applicant proposes to restructure the group and thereby split itself into two companies, one owning the business carried on in Europe and the other owning business carried on in Asia, North Africa and Latin America. As a part of the restructuring process, the applicant proposes to hold all international investments relating to pipe manufacturing through Cyprus company due to some commercial reasons.
• Thus, the applicant proposes to contribute the shares of the Indian company without any consideration along with non-European investments to its Cyprus subsidiary under a ‘Contribution Agreement’ which was executed outside India. Such a contribution akin to a gift is permissible under the Bahrain legislation. Further, such shares transferred to its Cyprus subsidiary would not be re-transferred to the applicant.

Taxpayer’s contentions

• Since no consideration which can be evaluated in terms of money is received or receivable by the applicant, no profit or gain has accrued or arisen to the applicant on account of transfer of shares. Hence, the liability to pay capital gains tax does not arise under section 45 read with section 48 of the Act.
• Further, the transfer or contribution of shares in the course of reorganisation to the Cyprus company is in the nature of ‘gift’ and as per section 47(iii) of the Act such transfer cannot be considered as taxable transfer

Tax department’s contentions

• The tax department contended that charge under section 45 of the Act is squarely attracted and the mere fact that money consideration has not passed would not put the transfer out of the domain of section 45 of the Act. The purported transfer is not without consideration.
• The transfer is based on business considerations aimed at deriving certain financial advantages as a part of reorganisation process. Though the proposed contribution of shares has been given the form of gift, in substance there is no gift because the donor will not be poorer to the extent of assets he parted with. Therefore, such transfer cannot be exempted under the provisions of the Act.
• Since the transfer of shares of an Indian company by the applicant to a Cyprus company is an international transaction under section 92B(1) of the Act, the transfer pricing provisions would be applicable for computation of income having regard to the “arm’s length price”. There is scope for manipulation of consideration in the transfer of shares and accordingly the value of the consideration has to be determined in accordance with the transfer pricing provisions.
• The tax department relied on the decision of the AAR in the case of Canoro Resources Limited, In re [2009] 313 ITR 2 (AAR) where it was held that the transfer pricing provisions contained in Chapter X of the Act will override the capital gains provisions in case of an international transaction.

Issues before the AAR

• Whether the applicant is liable to tax in India in relation to the proposed contribution of shares of an Indian company?
• Whether the proposed contribution of shares by the applicant to the Cyprus company attracts the transfer pricing provisions of section 92 to 92F of the Act?
• Whether the Cyprus company, is required to withhold tax in
  accordance with the provisions of section 195 of the Act?

AAR’s ruling

On taxability under the head capital gains

• The AAR observed that it is a settled law that the charging section relating to capital gains and the computation provisions must be read harmoniously under the provisions of the Act. When the computation provision cannot be applied, the charging provision fails. The Supreme Court in the case of CIT Vs. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC) had explained the scope of both the above provisions.
• As per sections 45 of the Act any profit or a gain arising from the transfer of a capital asset is chargeable to tax when such asset is transferred. The expression ‘arising’ used in section 45 of the Act may very well comprehend actual receipt of income. At the same time, the primary meaning of these words as connoting a ‘right to receive’ still holds good.
• The AAR observed that it is not possible to perceive as to how any profit or gain has accrued or arisen to the applicant by virtue of the transfer of shares to its subsidiary company. Further, it is not possible to identify or pinpoint anything which has the characteristic of profit or gain or any consideration which is capable of being valued in praesenti. The income in the sense of profit and gain should be real but not hypothetical income.
• The possibility of the applicant improving its overall business by virtue of re-organisation and the mere possibility or chance of the applicant making better returns in the near or distant future as a consequence of reorganisation can hardly be regarded as a consideration accruing or arising to the transferor when he has no right to receive a definite or an ascertainable amount or benefit from the transferee.
• Accordingly, the AAR held that the since applicant did not derive any profit or gain in the form of money or money’s worth or nothing capable of being turned into money has accrued or arisen to the applicant on the date of transfer, the applicant was not liable to tax in India.

On the applicability of transfer pricing provisions

• The AAR relied upon its earlier ruling in the case of Dana Corporation where it was held that transfer pricing provisions contained in Chapter X of the Act cannot be invoked in a case where the income is not chargeable to tax at all. Section 92 of the Act is not an independent charging provision but a provision providing computational methodology. Accordingly, only when income arises under the substantive charging provisions of the Act, the computation aspect relating thereto is taken care of by section 92 and other related provisions of Chapter X of the Act.
• Accordingly, the AAR held that if income is not chargeable under section 45 read with section 48 of the Act the transfer pricing provisions under section 92 of the Act are not applicable.
• Further, in respect of the reliance placed by the tax department on Canoro Resources Limited’s case, the same was refuted by the AAR on the grounds that the facts and circumstances of that case were different from the applicant’s case and therefore the same cannot be applied.

On withholding tax

• The applicant is not liable to withhold tax under section 195 of the Act since income is not chargeable to tax in the present case.

Our Comments

The AAR, in the present case has reiterated some important principles. The AAR held that the charging section relating to capital gains and the computation provisions must be read harmoniously under the provisions of the Act. When the computation provision cannot be applied, the charging provision fails. Further, the capital gains is taxable only when the applicant derive any profit or gain in the form of money or money’s worth or which is capable of being turned into money has accrued or arisen to the applicant.

The AAR after upholding the principle laid down in Dana Corporation held that the transfer pricing provisions in an international transaction can be applied only when income is chargeable to tax in India and since in the present case income was not chargeable to tax in India the question of withholding of any tax under section 195 of the Act does not arise.

It is important to note that the Finance Bill 2010 has proposed to amend section 56 of the Act. As per the amendment which may comes into effect from 1 June 2010, the transfer of shares for a no consideration or a consideration less than the fair market value of shares will be taxable in the hands of recipient as Income from Other Sources.

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