1

INTENSIVE WORKSHOP ON INTERNATIONAL TAXATION

ARTICLE 13 – CAPITAL GAINS

CA Prashanth K L

Bangalore Branch of SIRC

INTRODUCTION

• The main thrust of the presentation is Capital Gain as per the UN Model 2011.

• Additionally OECD model, some DTA’s and Income-tax Act,1961 provisions have also

been discussed.

• For explaining provisions, an example of a resident of UK, selling assets in India has

been considered.

2

2

WHAT IS CAPITAL GAIN?

o Article 13 does not define ‘capital gains’

o As per Indian Income Tax Act (IT Act)

Income assessable as ‘capital gains’ under section 45 - Gains arising on

“transfer” of a ‘capital asset’ not being ‘stock in trade’.

o As per basic principle of International Taxation, the country of residence

always has the right to tax.

o Country of source may be given full/partial or no right to tax.

3

CAPITAL GAIN- ITA

o Section 9(1)(i) read with sections 45(1) and 2(47) defines- “Capital Gain” as

• Any Profit or gains

• Arising from transfer of a Capital Asset

o Capital assets include property of any kind whether

• Fixed or circulating

• Movable or Immovable

• Tangible or Intangible.

4

3

OTHER RELEVANT DEFINITIONS

Capital Asset [Sec. 2(14)]: Property of any kind held by assessee, whether or not

connected with his business or profession. Exceptions are as below:

Assets not to be treated as ‘Capital Asset’

1 Stock-in-trade, consumables, stores or raw materials held for the purpose of

business or profession

2 Personal effects – movable property incl. wearing apparel & furniture held

for personal use by self/family member/dependent

3 Agricultural land in India provided not situated in any area, (i) within

territorial jurisdiction of municipality or cantonment board having

population of 10,000 or more or (ii) notified by Govt. outside the local

limits of above municipality (but within 8 kilometers)

4 Certain Gold Bonds issued by Central Government of India

5

Judgements:

Property of any kind is a capital asset: For the purpose of IT Act, property of

any kind is a capital asset, incl. movable, immovable, tangible/intangible assets,

incorporeal rights, and choosen in action. The term ‘property’ signifies every

possible interest which a person can clearly hold & enjoy – Ahmed G.H Ariff

V/s. CWT[1970]76ITR 471 (SC).

Personal effects – Must be intended for personal & household use: Gold &

silver coins & bars used for puja of deities as a matter of pride or ornamentation

and normally not intended for personal or household use are not personal

effects, therefore treated as capital assets – Maharaja Rana Hemant Singhji V/s.

CIT[1976] 103 ITR 61 (SC).

A property intended for personal or household use (may be for ceremonial

occasions only), is always a ‘personal effect’ – CIT V/s. H.H Maharani Usha

Devi.

6

4

Transfer includes

1 Sale 4 Conversion of Capital Asset into Stock-in-trade

2 Relinquishment 5 Redemption of Zero Coupon Bonds

3 Compulsory Acquisition

6 Giving possession of immovable property under part performance of contract

WHAT IS TRANSFER?

• Transfer of Capital Asset includes:

• The two main terms “Transfer” and “Capital Asset” are not defined in DTAA.

Instead, the DTAA uses the term “Alienation” for “Transfer”.

7

• The DTAAs entered into by India with other countries have different

formulations for taxation rights on capital gains. These may be divided into 4

main categories:

1. India has right of taxation of all capital gains as per its domestic law.

(e.g. US & UK)

2. India has the right of taxation of capital gains arising on alienation of

shares of an Indian company only if the transferee is a resident of India

e.g. Netherlands.

3. India has right of taxation of capital gains arising on alienation of shares of

an Indian company (in most treaties)

4. India does not have right of taxation of capital gains arising on transfer of

shares of an Indian company (e.g. Mauritius, Singapore, Cyprus)

8

CAPITAL GAINS TAXATION –DTAA

5

DOMESTIC LAW VS. DTAA

• Many DTAAs (e.g. the US, UK) provide the right of taxation to a source country

as per its domestic law.

• Beneficial provisions of treaty given priority through incorporation into ITA

• Section 90(2) of Income-tax Act, 1961- superior power of Treaty

• “Where the Central Government has entered into an agreement with the

Government of any country outside India or specified territory outside India,

as the case may be, under sub-section (1) for granting relief of tax, or as the

case may be, avoidance of double taxation, then, in relation to the assessee to

whom such agreement applies, the provisions of this Act shall apply to the

extent they are more beneficial to that assessee”

• **Sec 206AA& Tax Residence Certificate(TRC)?(Will be discussed Later)

• Sec 90(2A)- GAAR?.

9

Applicability of DTA Provisions

o Even if gain is taxable under DTA, it needs to be taxable under ITA. Only then

tax is payable in India.

o Article 13 applies to all capital gains

o Whether Short Term or Long Term

o Whether at normal rates or special rates

10

6

CONCEPT OF ALIENATION!?

o ‘Alienation’ not defined in Article/Treaty or IT Act

o Protocol to India-Canada DTAA: term ‘alienation’ includes ‘transfer’ within the

meaning of Income-tax Act, 1961

o India – Mauritius DTAA: term “alienation” means:

Sale

Exchange

Transfer, or relinquishment of the property or

Extinguishment of any rights therein or

Compulsory acquisition thereof under any law in force in the respective

Contracting States

11

CONT…

• Article 13 does not cover capital appreciation or revaluation of assets as there is

no alienation

• Commentary on OECD Model Convention (OECD commentary) provides that

article applies if such appreciation taxed under domestic laws (will be discussed

later)

12

7

Appreciation & Immigration Tax

• As a general Rule, Appreciation of an asset is not taxable as capital gain

• However, some countries tax the appreciation, as if there is a transfer.

• E.g. Australia, Canada and recently USA

• On the date of immigration, it is deemed that assets are sold at market price and

Capital Gains are taxed.

• Tax on capital appreciation is covered in the DTA.

• Appreciation of asset is also covered in this article.

ISSUES WITH IMMIGRATION TAX

• Suppose a US resident emigrates to India. At the time of emigration, tax will be

payable in USA.

• Now assume, after 5 years, he sells the capital asset situated in USA. Capital gains

should be taxed in India as he is a resident of India.

• Further, as per DTAA, Only India can tax the gain.

• Now, the concern is, Can he get the credit for the tax he paid in USA earlier?

• Assume, sale took place after several years, Will the credit for tax paid in US be

given?

• Again, on immigration, a “Deemed Sale” is considered.

• In India, cost of the asset will be considered as the original cost, and not the

deemed sale value.

14

8

15

CONVERSION OF CAPITAL ASSET INTO STOCK IN TRADE

Conversion of capital asset into stock in trade is considered as transfer in the

Income Tax Act, 1961.

So, this transfer will result in deemed capital gain.

However, it is important to bear in mind that taxing rights of capital gains is

covered by the DTA. Moreover manner of taxation is left to the domestic law.

Further the liability to pay capital gain tax is deferred till the date of sale and

Any subsequent appreciation in the value of stock in trade ( from the date of

conversion to the date of sale) to be taxed as business Income & this can be taxed

in India if there is a PE in India.``

WHAT DOES ARTICLE-13 COVERS?

• Article 13(1) – Immovable Properties

• Article 13(2) – Movable Properties

• Article 13(3) – Ships, Aircrafts or Boats

• Article 13(4) – Shares/ Interest in partnership/trust, property of which consists

principally of Immovable property in COS

• Article 13(5) – Shares exceeding certain percentage of investee company

• Article 13(6) – Other property

16

9

Article 13(1) – Immovable Properties

• The term “immovable property” means property as explained in article 6. Apart

from immovable property as generally understood in Income-tax Act, article 6

also considers:

Property accessory as immovable property

Rights to which provisions of general law respecting landed property apply.

Livestock& Equipment used in agriculture and forestry

Usufruct of immovable property

Several other rights and assets associated with immovable property,

agricultural property and even rights of mining are considered as immovable

property

17

Cont.....

• Shares of a Co-operative society or company, which gives the right of

occupation of property when sold, will be considered as immovable property.

• The following are immaterial for the country of Source for levying tax on

alienation of immovable property:

Whether the property is commercial or residential.

Whether the property is a capital asset or stock-in trade.

18

10

• Article 6 clarifies that ships, boats and aircrafts shall not be regarded as

immovable property

• Right to Tax is granted to country of source

• Country of source decides whether such capital gains are taxable

• Whether such income is treated as Capital Gains or business income or other

income, depends on domestic law.

19

Cont.....

IN INDIA

• Capital Gains If Capital Asset

• Business Income If stock in trade

There can be Capital Gains, if the tax payer gives possession of the property

for the part performance of the contract, as alienation includes “Partial

Alienation”

20

11

ILLUSTRATION

• If a resident of Malaysia, gives possession of his land in part performance of a

contract (Joint Development Agreement). Does it amount to Alienation?

• Can it be taxed as per Article 13(1)?

• ITA- As per Sec2(42)(v), It is considered as a transfer.

• Capital gain is taxed under ITA.

• Even under a DTA, it will be taxed in India.

21

ARTICLE 13(2) – MOVABLE PROPERTY OF PE/ FIXED BASE

• Applicable in case of:

• Alienation of Movable property forming part of the business assets of

Permanent Establishment/ Fixed Base in country of source

• Sale of such Permanent Establishment or Fixed Base itself in India

Accordingly, the following can be taxed in India:

Slump sale of undertaking;

Sale of branch of a foreign bank situated in India.

• Right to Tax is granted to country of source.

22

12

Cont.…

o The term “movable property” is not defined

• Generally understood to include property which does not qualify as

‘immovable property’ (E.g. Equipments, computers, furniture, etc.,)

• Certain specific exclusions (Eg: ships) provided by Article 13(3)

o Does not apply to:

• Stock-in- trade (considered under article 7)

• If PE used for preparatory & auxiliary activities

• If the movable property does not form part of PE/Fixed Base.

23

24

The UK resident has a Permanent Establishment in India for sale of electronic items. He also has a machine which is leased out to an Indian resident, but does not form a part of any PE. The UK resident sells such machine in India. Can it be considered as Alienation? Is it taxable as per Article 13(2)?

This clause{13(2)} does not apply to sale of machine, since it is not part of PE Sale of such a machine will be governed by article 13(6)

ILLUSTRATION

13

ARTICLE 13(3)- SHIPS, AIRCRAFTS OR BOATS

o Applicable in case of Alienation of

• Ships or Aircraft operated in International Traffic.

• Boats engaged in inland waterway transport

• Movable property pertaining to such operations

o Right to Tax is granted to country in which Place of Effective

Management(POEM) is situated.

o Only one country is given the right to tax.

o Place of Effective Management is not defined in the Article.

25

Cont.…

• If the place of effective management is on the ship itself, the place of effective

management is deemed to be where the ship's home harbor is situated.

• If there is no home harbor, then place of effective management will be in the

country where the operator of the ship is resident.

• Any movable property relating to operation of ships & aircrafts in international

traffic, can be taxed only where the place of effective management is situated.

• It is immaterial whether there is PE or not; or whether the asset forms part of PE

or not

• However, immovable property pertaining to operation of ships or aircrafts

should be taxed under article 13(1) in source country.

26

14

ILLUSTRATION

A resident of UK earns capital gains from the sale of ships in India pertaining to the operation of ships

2) Between India and South Africa

1) In the inland waterways of

India

I. Where can the capital gains be taxed, if he operates his business from USA? II. In situation-2, If the home harbor of the ship is India, Where Capital gains are taxed?

1) May be taxed in India, as the criteria of International Traffic is not satisfied

2) Should be Taxed only in USA(POEM) In the situation mentioned in II above, it should be Taxed only in USA(POEM)

ARTICLE13(4)

o Applicable in case of alienation of :

• Shares of Company

• Interest in Partnership/trust or

• Estate

o Property of which consists principally(50% as per UN Model) of immovable

property (directly or indirectly) situated in country of source.

o Right to tax is granted to Country of Source, where the property is situated

28

15

CONT.…

o Applicable on entire value on alienation of shares, etc even if part of the value

is derived from assets other than immovable property

o Applicable irrespective of

• Types of shares (equity, preference or otherwise)

• % of holding

• Listing status of shares

• Mode of alienation

• Status of residence of Investee (company, firm or trust)

29

Cont.…

o This paragraph shall not apply if the immovable property is used by such

entity in its business activities.

o UN Model expressly applies to interest in Partnership, trust or estate where

property consists ‘principally’ of immovable property situated in Country of

Source.

o UN Model excludes entities using immovable property in their business

activities (exclusion not applicable to property management company)

o Does not apply to debentures, bonds or other assets

o Intended to prevent tax avoidance in situations where capital gains on

alienation of immovable property is sought to be evaded through creation of

structures.

30

16

Situation Taxability of Article 13(4)

UK resident has invested in ABC India Property Pvt. Ltd. ABC has a flat in Mumbai. That is only major asset.

On sale of shares of ABC, Capital gains can be taxed in India and UK.

In the above example, the immovable property is used for ABC’s own business.

On sale of shares of ABC, Capital gains will be taxed according to other clauses.

ABC is in the business of management of immovable property.

On sale of shares of ABC, capital gains can be taxed in India and UK.

Resident of UK selling assets situated in India under the following situations:

Extent of holding by the Non Resident in the Indian Company is not relevant

Illustration

31

ILLUSTRATION

• Let us consider a situation where the immovable property in India is held through 2 vertically held companies. The UK resident holds shares in Company 1. Company 1 holds share in Company 2. Company 2 holds principally of immovable property.

UK Resident

Company 1

Company 2

Immovable Property

If the UK resident sells shares of Company 1 , will capital gain be taxable in India under article 13(4)

Immovable property is indirectly of Company 1. Hence gain on sale of shares of Company 1 will be taxable in India under Article 13(4)

17

Consider the following balance sheet of the company

Liabilities Amount Assets Amount Share capital 10,000 Land 3,000

Less: Losses (6,000) Machinery 4,000

Net worth 4,000 Debtors and bank 3,000

Loans 6,000

Total 10,000 Total 10,000

Should gross value be considered where the value of land is less than 50% of the total assets; or should the loss be set off against machinery and other assets and then the value of land be considered (then land value will be more than 50%)?

The DTA does not provide the answer. The OECD model however states in para 28.4 that the value will be determined considering the value of all assets, without considering debts or other liabilities. Even if the debt is secured by mortgage on the relevant immovable property, it should be ignored.

This clause is not there in some of the DTAs entered into by India.

18

ARTICLE 13(5)

o Applicable in Alienation of

• shares not covered in 13(4)

• representing a participation of certain percentage

• in a Investee company which is resident in contacting state

o Percentage will be established through bilateral negotiations

• may be taxed in Country of source.

35

ILLUSTRATION

• A resident of Netherlands owns 20% of the Indian company's shares. The

shareholding prescribed in the DTAA with India is 10%.

• If he sells shares equal to 5%, will the same be taxed in India?

• The words used are “Gains …. representing a participation of 10% ….”. Shares

being sold, represent only 5% (less than 10%). Therefore can the source

country tax the capital gains?

• The answer is Yes. Wondering why?? Then read on..

• The UN model of 2011 states that if “at any time during the 12 month period preceding such alienation, if the alienator directly or indirectly held at least ____% of the shares”, then the same will be taxable in India.

36

19

CONT…

• Suppose, he sells shares equal to 15%, will the same be taxed in source

country?

• The answer is Yes, because he is selling 15%, which exceeds 10% holding in

the company at the time of sale.

• And assume, he sold the remaining 5% after a

1) 11 months

2) 13 months

• What will be the tax implication of capital gains arose in the above situations.

37

1) The answer is Yes. Because, he was holding 20% of the shares of the co. in the

preceding 12 months.

2) No, as the condition of 10% in the DTA is not satisfied.

INDIRECT ALIENATION

38 DIRECT TAX

X Co.

Y Co.

I Co.

• X holds shares of Y which in turn holds shares of I, an Indian Company. If X sells shares of Y co, can the capital gains be taxable in India?

Sale Overseas

jurisdiction 1

Overseas

jurisdiction 2

• Taxable as indirect transfer of a capital asset situated in India subject to % of holding in Indian co(I) as per Article 13(5)

20

CASE STUDY

Vodafone Group Plc. vs. Indian tax authorities

OVERVIEW

• In 2007 Vodafone International purchased the Indian mobile telephony assets of

Hong Kong-based Hutchison Whampoa Ltd.. The Indian Tax court issued that

Vodafone withhold a $2.2 billion liability for capital gains tax to the Indian tax

authorities.

• Hong Kong-based Hutchison sold its 66.98% shares in the Indian Telecom

Company Hutch Essar ltd through a holding company based in an offshore

destination for $11.2 billion to Vodafone.

• Hutchison controlled its Indian telecom subsidiary through a Cayman Island

company called CGP. CGP’s shares were sold to Vodafone, which consequently

became majority owner of the Indian telecom firm.

21

VODAFONE’S ARGUMENT

India does not have jurisdiction to tax the Hutchison deal because it was

structured as a transaction.

INDIAN TAX AUTHORITY’S ARGUMENTS

Although Vodafone and Hutchison had conducted their transaction offshore,

the deal involved Indian assets and was hence liable for capital gains tax in

India.

Under Indian Laws, Vodafone was responsible for withholding tax on the

transaction and paying it to the Indian authorities.

SUPREME COURT DECISION

• The Supreme Court ruled in favour of Vodafone in the $2 billion tax case saying

Indian tax authorities have no jurisdiction over Vodafone’s 2007 purchase of the

Indian mobile telephone assets of Hong Kong-based Hutchison Whampoa Ltd.

when neither company is based in India.

22

IMPLICATIONS

• The verdict has implications for cross border M&A activity and similar pending

cases before various courts.

• The Vodafone tax case threw an interesting question on the taxability of a non

resident company acquiring shares of a resident company through an indirect

route. This is a landmark case, as it is for the first time that the tax departments

had sought to tax a company through a mechanism of tracing the source of

acquisition.

ARTICLE 13(6) OTHER PROPERTY

• Applicable in case of Alienation of property

• Other than those mentioned paras 13(1) to 13(5)

• May be taxed in the contracting state

• India cannot tax the same

44

23

ILLUSTRATION

• If a non-resident owns know-how which is sold to an Indian resident , will it give

rise to taxation in India?

Outright sale of Know-how will not be considered as as royalty u/s. 9(1)(vi)

Hence, it may be considered as Business Income/ Capital Gain based on the facts.

More likely it may be sale of capital asset.

The asset sold does not fall under articles 13(1) to 13(5)

Hence, the gain will be taxable only in the State R.

Section 5 does not include incomes outside India. Even under section 9(1), the

capital asset is situated outside India. Therefore capital gain cannot be said to be

deemed to accrue in India.

Sale of Trademarks& Brands -Foster’s- A brand name

• If a Multinational company like Foster’s enters into Brand License agreement with resident of India(Foster’s India), will it be taxed in India?

• The brand name is linked with the place where business is done.

• The brand name of Foster’s was developed due to Indian business.

• Therefore the situs of brand name was in India also

• Just because the documents pertaining to the brand name were handed outside India, does not mean that the asset was transferred outside India.

• Hence, capital gains arise in the above situation may be taxed in India.

46

24

47

Whether the gain can be apportioned between India and other country?

The Authority denied that and held that once the asset is located in India there

is no legal basis for apportioning the income.

SOURCE/ SITUS RULES

Article 13 only states what kind of capital gains can be taxed in the source country and the residence country.

Therefore source/ situs rules have to be considered as per domestic law.

EXCEPTION TO THE SITUS RULE

• There are considerable variations in the Domestic Law regarding taxation of Capital gains in each country.

• In case of US residents, even if the shares are held outside US, the source of capital gain for shares is US.

• If US residents sell any shares in India, it is not considered as Indian sourced income.

• Capital Gain Article as per India-US DTA gives rights to both in India. However tax credit is given by US as per its own domestic rules. Since, US considers such gain as being sourced in USA, tax credit for tax paid in India is denied.

25

REASONS FOR ISSUES

• The DTAA does not deal with the taxability of capital gains and leaves it to the

domestic law of each contracting state.

• A comparison of tax laws of OECD member countries shows considerable

variation in the taxation of Capital gains.

• In some countries, capital gains are not deemed to be taxable income

• Ex- Belgium, Malaysia, New Zealand

• In other countries, capital gains made by individual outside his trade/business

are not taxed.

• E.g. Netherlands, Thailand

49

CONT…

o Even where capital gains made by individual outside his trade/business are

taxed, they are taxable only in specified cases, like sale of immovable property

or speculative gains.

o E.g: Russia

o Once the gains are determined to be taxable in India, computation of such gains

would be as per the provisions of the ITA.

o Section 48 provides the mechanism to compute capital gains earned in India.

o Full value of consideration is to be reduced by the expenditure on transfer and

the cost of acquisition or improvement.

50

26

51

APPLICABLE TAX RATES FOR CAPITAL GAINS UNDER THE ACT

• Tax liability in the hands of non-residents on capital gains is determined by

• Section 111A

• Section 112

• Rates in force

• Short-term gains are taxable in like manner for residents and non-residents.

52

27

Type of asset Rate of tax Legal provisions

Equity Shares or units of an equity-oriented fund, on which STT is paid

15% Section 111A

Capital assets other than those mentioned above including off-market sale of listed equity shares and units of equity- oriented fund

a. Slab rates for individual & HUF

b. 40% for foreign companies

c. 30% for those not covered above

Rates in force' as per Part I to the First Schedule of the relevant assessment year's Finance Act

Below table summarizes the rates for STCG

CONT.…

53

LONG-TERM CAPITAL GAINS - TAXATION

• Section 112(1)(c) read with proviso to Section 112(1) and Section 10(38) provide the tax rates applicable for long-term gains

• Tax rates are as follows

Type of asset Applicable tax rates

Unlisted Securities 10% (No benefits of proviso to sec 48)

Listed securities on which STT is not paid on transfer (Lower rate of tax as per Proviso to Section 112(1))

Lower of : 10% tax before availing 'indexation' benefit(or) 20% tax after availing 'indexation' benefit.

Listed securities on which STT is paid on transfer

Exempt from tax as per Section 10(38)

54

o However, there are certain adjustments required by provisions to section 48

28

FOREIGN EXCHANGE FLUCTUATION ADJUSTMENT

• The first proviso to Section 48 provides for adjustment of foreign exchange

fluctuations.

• This provision is applicable to capital gains

• short-term or long-term

• arising on transfer by a non-resident

• of shares or debentures of an Indian company

• purchased out of foreign currency

• Gains shall be computed by converting the amount of sale consideration into the

same foreign currency used at the time of purchase.

• The main objective of this provision is to protect non-residents from the

devaluation of rupee.

55

ILLUSTRATION

10

Sr. Particulars In In

No. Rupees USD

a. Cost (at Rs. 45 per USD) 45,000 1,000

b. Sale consideration (at Rs. 60 per USD) 60,000 1,000

c. Gain in respective currency ( b – a ) 15,000 Nil

d. Taxable gain on account of application of FFA Nil

On appreciation of Rupee, Adjustment may not be required

29

ADJUSTMENT FOR INFLATION

• This proviso to Sec48 provides protection from inflation in India

• Enables to compute gains after increasing the costs by prescribed indexation

factors.

• Provisions of 'indexation benefit' and 'foreign exchange fluctuation adjustment'

are mutually exclusive.

• Therefore, indexation applies only for capital assets other than those for which

foreign exchange fluctuation adjustment applies.

• Benefit is restricted only to long-term capital gains.

• **CBDT has been clear in its view that as protection is already provided for forex fluctuation under the first proviso which takes into account inflation, further relief will not be available.(Case Law)

57

CASE LAW

• Proviso to Section 112(1) states that where long-term gains are earned on sale of

listed securities or units, the tax rate applicable would be restricted to 10%.

• Applicable on gains computed “before giving effect to the provisions of the

second proviso to Section 48”, i.e., on gains earned before taking ‘indexation

benefit’.

• Lower rate of 10% applies only to gains eligible for ‘indexation benefit’. As gains

adjusted for forex fluctuation are not eligible for ‘indexation benefit’ no relief of

lower rate available.

• Dual benefit of Foreign Fluctuation Adjustment and 10% tax rate available?

• As held in BASF Aktiengesselschaftvs. DDIT (293 ITR 1)

58

30

BASF AKTIENGESSELSCHAFT VS. DDIT - MUM ITAT

59

Indexation benefit is not availed on gains on

which Forex Fluctuation

Adjustment is applied.

Hence lower tax rate of 10% is available.

Lower rate of 10% applies only to gains

eligible for ‘indexation benefit’. As gains adjusted for forex fluctuation are

not eligible for ‘indexation benefit’ no

relief of lower rate available.

ASSESSEE‘S STAND REVENUE’S STAND

• It is held that he proviso to Section 112(1)

of the Act does not apply to the case of

assesse(not applicable for foreign currency

securities to which the indexation benefit

is not available.) and consequer the rate of

tax on long term capital gain computed

under the first proviso Section 48 would

be 20%.

• Bench: K Singhal, A Garodia

OTHER KINDS OF CAPITAL GAINS TYPICAL TO INDIAN ITA.

Any amount is received from an insurer on account of damage to capital asset gives

rise to capital gain U/s 45(1A).

Whether the such destruction will be considered as “alienation”?

Although the meaning as per the DTA is very wide, still a “destruction” cannot be

considered as alienation. Alienation means giving away.

E.g. Exit tax & gift tax on capital gain can be considered for the purpose of DTA. In case of

exit taxes, there is neither a transfer, nor destruction, nor any change to the asset. Still it

can be considered as alienation for this article.

31

• capital asset introduced by a partner in a firm will be considered as capital gain as

per Sec 45(3).

• Does it amounts to Alienation?

• It depends on the clause of the Article.

• Suppose, If an NRI transfers his bullion lying in India, in the Indian firm and he

does not have a PE in India, then under article 13(6), there can be no capital

gains taxable in India.

CONT…

• Value of the immovable property has to be considered as per the stamp duty

authority(Subject to conditions) as per Sec 50(C).

• Does DTAA allows the same?

• The manner of taxation is left to the respective countries.

• DTA cannot prevent application of section 50C.

62

CONT…

32

• If the consideration for transfer cannot be determined , fair market value of the asset

shall be considered as the consideration Under section 50D.

• This is also permitted under a DTA.

CONT…

ISSUES IN INCOME TAX ACT, 1961

33

TDS

• As per Section 195, TDS has to be deducted before making the payment to a non-

resident.

• Deduction has to be only on “sum chargeable to tax”.

• Therefore, where the payment does not include any income chargeable to tax, no

deduction of tax at source is required.

• However, there are some issues on computation of TDS in relation to capital

gains.

• Deduction of tax on capital gain or gross consideration?

• Can the payer himself determine the amount of tax to be deducted at source?

65

DEDUCTION OF TAX ON CAPITAL GAIN OR GROSS CONSIDERATION?

• Does the TDS has to e applied on Capital Gains or the whole consideration paid to

the Non- Resident?

• The Supreme Court in case of GE India Technology Cen. (P.) Ltd. has corrected this

ruling and held that

The obligation to deduct tax at source is, however, limited to the appropriate

proportion of income chargeable under the Act forming part of the gross sum of

money payable to the non- resident.

(GE India Technology Cen. (P.) Ltd. vs. CIT [2010])

66

34

• However, there are certain instances where the above ruling was ignored and

held that deduction of tax at source was required on each remittance on the

gross sum payable.

• The Karnataka High Court- CIT (International Taxation) vs. Samsung

Electronics Co. Ltd. [2009]

• Syed Aslam Hashmi vs. ITO [2013]

67

CAN THE PAYER HIMSELF DETERMINE THE AMOUNT OF TAX TO BE DEDUCTED AT SOURCE?

• Determination of TDS can be difficult in certain cases, especially where capital

gains are earned.

• If proper details are available, payer can compute the gain and deduct the taxes

on his own.

• Approaching the tax officer for an order u/s. 195(2) is not required in every case.

68

35

• Can a CA issue certificate in cases of capital gains?

• especially where sale of properties are concerned

• As an extension of the above principle, a CA can also issue a certificate in Form

15CB determining the TDS.

• However, as a practice, and to avoid unnecessary risk of incorrect computation of

tax payable, deductors tend to approach the income-tax department.

69

TAX RESIDENCY CERTIFICATE

• As per Sec 90(4) & 90(5), Tax payer must obtain a TRC of the country of which it

is resident to take benefit of a DTAA

• The TRC is required to be obtained at the time of availing the benefit of the

DTAA.

• TRC needs to contain the prescribed particulars, failing which the details need to

be submitted under a self-declaration in Form 10F

• In case no benefit of the DTAA is adopted, a TRC is not required.

36

SEC 206AA

• Section 206AA provides for deduction of TDS at higher rates in case PAN is not

available.

• In case a non-resident earning income from India does not provide a valid PAN, the

tax rate applicable would the rates as per the Act, the DTAA or 20%, whichever is

higher.

• This provision supersedes all other provisions under the Act.

• Therefore, even if tax is required to be deducted at a lower rate under any of the

beneficial provisions of a DTAA, it may be deducted at a rate of 20%

71

72

ILLUSTRATIONS

37

• US Co holds 50% shares of Mauritius Co

• Mauritius Co holds 100% shares of Indian Co

• Mauritius Co has no other significant assets or business operations

• US Co wants an exit from its investment in Indian Co. For this purpose the US Co transfer its shares in Mauritius Co to a French Co

• Shares of Mauritius Co will be deemed to be situated in India

• Capital gains arising to US Co on transfer of shares of Mauritius Co may be taxable in India

What are Tax Implications?

73

74

PQR is liquidated

Shareholder X receives shares in QR

on liquidation Substantial value in QR’s shares due

to investment in R Shares of Co. QR deemed to be in

India

Does it qualify as Transfer?

No transfer u/s. 45 Section 46(2) applies

38

• A Inc. holds 100% shares of B Ltd and

in turn B Ltd holds 100% shares of Indian Company, C Ltd.

• A Inc. transfers share of B Ltd.

What are Tax Implications?

75

• A GmbH holds 100% shares of B Co

Ltd and in turn B Co Ltd holds 100% shares of C Ltd

• B Co Ltd has no assets other than

shares of C Ltd

• A GmbH transfers shares of B Co Ltd

What are Tax Implications?

76

39

• A is US Citizen and returned to India

upon retirement

• Since he spends more than 182 days in India he is Ordinary Resident in India

• Since he continues to be US Citizen, he is resident of US as well

• He has huge investments in US made out of income earned in US

• Taxability of gains from sale of shares in US

• Taxability of gains from sale of share in India What are Tax Implications?

77

SOME ISSUES IN INDIAN DTAA

40

NO ARTICLE FOR CAPITAL GAINS

• The DTAA which India has signed with Malaysia in 2001 does not contain any Article on Capital Gain.

• In such a case, Article 21 (Other Income) should be considered.

• As per Article 21,only COR has the right to tax.

79

MAURITIUS DTAA

• India's DTAA with Mauritius has led to several controversies

• As per Article 13(4) of the DTAA, the right to tax capital gains derived by a resident of Mauritius is only with Mauritius.

• Capital gains are not taxable in Mauritius as per its domestic tax laws

• Mauritius tax resident earning capital gains in India does not have to pay tax in either country.

80

41

INDIA-MAURITIUS TAX TREATY

81 DIRECT TAX

Hold Co.

I Co.

Transaction Sale of shares of the Indian company by Hold Co. As per domestic Law of India - Taxable As per India – Mauritius Tax treaty – Article 13 – Gains derived by a resident of a Contracting State from the alienation of any property shall be taxable only in that State. As per Mauritius domestic law – No capital gains tax

MAURITIUS

INDIA

Sale

SINGAPORE DTAA

• Singapore DTAA has a favorable clause for gain on sale of shares.

• If a resident of Singapore sells shares of an Indian company, the gain is not

taxable in India.

• However, Limitation of Benefits clause was also brought about at the same time

• LOB clause applies to sale of other assets (which include shares) not covered in

Articles 13(1) to 13(3)

• As per clause (1) of the LOB clause, the benefit of exemption of tax of Capital

Gain will not be available if the affairs of the Singapore resident are “arranged

with the primary purpose to take advantage of the benefits in Article 1 of this

Protocol.”

82

42

83

Test-1 Affairs’ of Singapore

resident are arranged

with the primary

purpose to take

advantage of treaty

The case of entities not having bona fide business

shall be covered by clause (1)

or

83

Shell/Conduit Co. - any legal entity with negligible or nil

business operations or with no real and continuous business

activities carried out in Singapore

Deemed to be a Shell/Conduit

Co. if its op expenses are

< 2L SGD p.y. in last 24 months

Deemed not to be a Shell/Conduit Co. if it is

listed in Singapore; and if its op expenses are

>= 2L SGD p.y. in last 24 months

Test-2

NETHERLANDS DTAA

• Gains from shares taxable only in Netherlands.

• If Dutch company holds at least 10% of Indian Co. gains may be taxable in India

• Only if sale happens to Indian Resident

• If sale happens to NR, then gain taxable only in Netherlands

• Gain taxable only in Netherlands if realized in course of corporate organization,

reorganization, amalgamation, division, etc. and buyer or seller owns at least

10% of the other co.’s capital

84

43

85

Transferor holds more than 10% in Indian Co.

yes No

Whether the transferee is Resident of

India

**Taxable only in Netherlands

No` **Taxable only in

Netherlands Yes

Sale took place in context of

amalgamation, Reorganization..

Etc..,?

Yes

**Taxable only in Netherlands

No **May be taxable in

India

**Netherlands has participation exemption relief If a Dutch co. holds at least 5% of the shares of Indian operating company, then gains are not taxable in Netherlands.

SWITZERLAND DTAA

This DTAA between India and Switzerland has a peculiar feature.

In the case of a Swiss resident who earns gains from sale of shares of an Indian company, is not taxable in

India. But if the holding in the Indian Company exceeds 10% or sale is to a Indian resident ,The gains are

taxable in India.

Even if an Indian resident holds shares in a Swiss company, the gains are taxable only in India. Switzerland

doesn’t get any right to tax these gains

India( COS) is required to give a tax credit instead of the normal scenario where the Switzerland( COR) gives the

right to tax.

44

CYPRUS DTAA

87

The India-Cyprus DTAA also provides for similar benefits on capital gains as the India- Mauritius DTAA.

Therefore, no tax is payable in India on sale of shares in an Indian company by a tax resident of Cyprus.

However, recently, the CBDT has notified Cyprus as a “Notified Jurisdictional Area”

In other words, Cyprus has been listed as a non-co-operative jurisdiction and the applicable anti-tax

avoidance provisions come into effect from 1st November, 2013 on all transactions with Cyprus.

CONT…

• Any payment on which TDS applicable will be liable to deduction as per rates

under the Act or 30% whichever is higher.

• However, it does not deny the benefits available under the DTAA. As mentioned

earlier, capital gains earned in India will not be taxable in India as per the DTAA

with Cyprus.

88

45

89

Revenue concludes arguments before Madras HC on challenge to Cyprus

notification, distinguishes petitioner's reliance on apex court judgments in Azadi

Bachao & GE India Technology; Defending validity of Sec 94A:

Revenue counsel Mr. Chopda elucidates that for better implementation of DTAA

as also for effective enforcement of Exchange of Information (‘EOI’), the said

section was enacted,

further draws attention to the G20 summit pursuant to such

sections/legislations were introduced in 15 countries

Clarifies that CBDT press release not the basis for Sec 201 orders on petitioners,

but only meant to simplify Sec 94A interpretation, consequently Sec 94A(5) is

simplified to mean – ‘any payment’ against the phrase ‘any sum or income or

amount on which tax is deductible under chapter XVII-B...’ contained therein;

Arguments on Cyprus Notification in Madras High Court

90

Revenue counsel argues that since no comma placed after ‘amount’ in Sec.

94A(5), only for ‘amount’ reference has to be made to Chapter XVII-B and not

for ‘sum’ or ‘income’;

Intervener in the case refutes Revenue’s case of displaced comma, contends that

these three expressions have to be read conjoint with the phrase ‘on which tax

is deductible under Chapter XVII-B’;

Court reserves judgement.

46

UAE DTAA

The India-UAE DTAA had a beneficial clause for taxation of shares. If the

UAE resident earned capital gain on sale of shares of Indian company, it

was not taxable in India.

In March 2007, the DTAA has been amended by a protocol. As per the

protocol, capital gain earned on sale of shares will be taxable in India.

INDIA-UK TAX TREATY

92 DIRECT TAX

Hold Co.

I Co.

UK

Transaction Sale of shares of the Indian company by Hold Co. As per domestic Law of India - Taxable As per India – UK Tax treaty – Article 13 – Except as provided in Article 8 (Air transport) and 9 (Shipping) of this Convention each Contracting State may tax capital gains in accordance with the provisions of its domestic law. NO BENEFIT UNDER TAX TREATY

INDIA

Sale

47

ILLUSTRATION

• If a UK company owns shares in a Mauritius company , and the value of Mauritian

company is derived substantially from shares it holds in Indian company,

• Then the shares of Mauritius company shall be deemed to be situated in India.

• If the UK company sells the shares of Mauritius company to say a French

company, Will it be considered as transfer of capital asset “situated in India”?

Exp 5 to sec 9(1)(i)- Indirect Transfer. May be taxable in India

94

REFERENCES

INTERNATIONAL TAXATION COMPENDIUM (CHAPTER 45) - NARESH AJWANI KLAUS VOGEL ON DOUBLE TAXATION CONVENTIONS - DR. KLAUS VOGEL