Taxation of Non Residents with respect to capital gains including impact of indirect transfers The Chamber of Tax Consultants

Transcription

1 Taxation of Non Residents with respect to capital gains including impact of indirect transfers The Chamber of Tax Consultants CA. N.C. Hegde 20 th December

2 Discussion points Capital Gains taxation under domestic law Capital Gains taxation under the tax treaty Key recent developments Select treaty analysis in relation to capital gains taxation Case study Indirect Transfer Practical approach on TDS on indirect transfer Recent controversy on LTCG taxation 2

3 Capital Gains taxation under domestic law

4 Capital Gains - Domestic Law Capital Gains deemed to be Income Section 9(1)(i) read with sections 45(1) and 2(47) Any Profit or gains arising from transfer of a Capital Asset shall be chargeable to tax as Capital Gains and shall deemed to be income of the previous year in which transfer took place. The term transfer of capital assets include sale, exchange, relinquishment of any right or the compulsory acquisition thereof under any law. Capital assets include property of any kind whether fixed or circulating movable or immovable, tangible or intangible. Whether the term transfer would include indirect transfers was a matter of high profile debate 4

5 Capital Gains - Domestic Law Capital Gains for non resident Gains counted in same currency in which shares/debentures acquired and reconverted to INR No benefit of Indexation Computation of Gain Sale consideration, cost of acquisition & improvement taken on average conversion rate of the previous year from State Bank of India as per Rule 115A. All amounts would be converted into INR and the capital gain is Sale consideration (-) cost of acquisition (-) cost of improvement. 5

6 Capital Gains taxation under the tax treaty

7 Article 13 UN Model Treaty 1. [Immovable Property] 2. [Movable property forming part of the business property of a PE] 3. [Ship or aircraft] 4. Gains from the alienation of shares of the capital stock of a company, or of an interest in a partnership, trust or estate, the property of which consists directly or indirectly principally of immovable property situated in a Contracting State may be taxed in that State 5. Gains, other than those to which paragraph 4 applies, derived by a resident of a Contracting State from the alienation of shares of a company which is a resident of the other Contracting State, may be taxed in that other State if the alienator, at any time during the 12 month period preceding such alienation, held directly or indirectly at least _ per cent (the percentage is to be established through bilateral negotiations) of the capital of that company. 6. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3, 4 and 5 shall be taxable only in the Contracting State of which the alienator is a resident.

8 Capital Gains taxation tax treaty provisions Article 13 Article 13 applies to taxes levied by a Contracting State on capital gains. (While the heading of the articles refers to capital gains, the entire article uses the word gains ) It does not give definition of the expression capital gains. (In accordance with Article 3(2), the expression has to be interpreted as per the domestic law) Article 13 assigns either primary or exclusive taxing jurisdiction over capital gains to the State of residence (State R) or the State of source (State S). (However, such right to tax capital gains cannot be invoked in the absence of taxing powers under the domestic law E.g. section 10(38) of the Income-tax Act.) 8

9 Capital Gains taxation tax treaty provisions India has entered into DTAAs with a number of countries. The DTAAs provide the right of taxation, inter alia, in respect of capital gains arising in the source country. Many DTAAs (e.g. the US, UK) provide the right of taxation to a source country as per its domestic law. However, by amendment of domestic law, India has expanded its tax base unilaterally. In some cases, there would be treaty interpretation issues as the right of taxation to the source country is given in specific circumstances. For instance, on alienation of shares of a company, which is resident of a country, the country has the right of taxation of capital gains arising from such transfer. 9

10 Capital Gains taxation tax treaty provisions The DTAAs entered into by India with other countries have different formulations for taxation rights on capital gains. These may be divided, mainly, into four categories i. India has right of taxation of all capital gains as per its domestic law (e.g.us and UK); ii.india has right of taxation of capital gains arising on alienation of shares of an Indian company (in most treaties); iii.india has 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); iv.india does not have right of taxation of capital gains arising on transfer of shares of an Indian company (e.g. Mauritius, Singapore, Cyprus) 10

11 Interplay between domestic law vs. tax treaty Beneficial provisions of treaty given priority through incorporation into domestic tax law 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 Section 90(2A) of Income-tax Act, 1961 with effect from 1 April 2015 GAAR to override tax treaty? Notwithstanding anything contained in sub-section (2), the provisions of Chapter X-A of the Act shall apply to the assessee even if such provisions are not beneficial to him Does Article 51(c) of the Indian Constitution permit treaty override?

12 Select treaty analysis in relation to capital gains taxation

13 India US tax treaty A Ltd. Sale of shares of Transaction: Sale of shares of B B Ltd. A Ltd. to E Ltd. E Ltd. USA Domestic Tax Law: Taxable Ltd. by 100% B Ltd. Tax treaty: Applicable tax treaty: US tax treaty As per Article 13: Capital gains India 100% Except as provided in Article 8 (Shipping and C Ltd. Air Transport) of this Convention, each Contracting State may tax capital gains in accordance with the provisions of its domestic 100% Mauritius* law. D Ltd. India No benefit available under the India-US tax treaty. * Capital gains are exempt from tax in Mauritius

14 India UAE tax treaty The India UAE DTAA had a beneficial clause for taxation of shares. If the UAE resident earned capital gain on sale of shares, it was not taxable in India. However 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. Gains other than shares( units of a mutual fund) not taxable 14

15 India Singapore tax treaty Singapore DTAA has 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. This benefit was brought about by Article 1 of the Protocol signed between India and Singapore on 29 June It is with effect from 1 August There is however a Limitation of Benefits Clause (LOB) which was also brought about with effect from 1 August 2005 (Article 3 of the Protocol) and is very limited in application as it applies only to Article 1 of the Protocol. 15

16 India - Singapore The LOB clause provides for below two tests: The benefit of exemption of tax in India 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. (clause 3(1)) Thus this article considers the affairs of the person. Affairs has not been defined. Generally it can be considered as transactions and arrangements of the person. Clause(2) of Article 2 of the Protocol provides that a shell/conduit company which claims to be a resident of Singapore, will not be entitled to the benefits of Capital Gain relief. 16

17 India Singapore tax treaty A shell/conduit company (shell company) is any legal entity with negligible or nil business operations or with no real and continuous business activities carried out in that Contracting State. This test applies to any legal entity and not just a company. There are tests for determining whether a company is a shell company or not. These are given in clauses (3) and (4) of Article 3 of the Protocol. Clause (3) provides for a positive test. The entity will be a shell company if its total annual expenditure on operations in Singapore is less than $200,000 in Singapore. (The test for an Indian company is Rs.50 lakhs for operations in India.) Thus if the company is to be considered as a bona fide company for this clause, it must spend at least $ 2,00,000 per year on its operations in Singapore. 17

18 Key recent developments in Indian tax landscape effected vide Finance Act, 2012 including taxation of indirect transfers

19 Retrospective amendments taxing Indirect transfer Scope of taxation in India for non residents Income received or deemed to be received in India Income accrues or arises in India Income deemed to accrue or arises in India (section 9) Finance Act 2012 amended provisions of section 9(1)(i) w.r.e.f to include indirect transfer of capital assets situate in India 19

20 Retrospective amendments taxing Indirect Transfers As per the provisions of Section 9(1)(i) of the Income Tax Act, 1961 ( the Act ) the following income shall be deemed to accrue or arise in India :- All income accruing or arising, whether directly or indirectly, - through or from any business connection in India, or - through or from any property in India, or - through or from any asset or source of income in India, or - through the transfer of a capital asset situated in India Are explanations 4 and 5 to section 9(1)(i) merely clarificatory in nature and whether the retrospectivity attached thereto tenable in law? 20

21 Explanation of the term Property Section 2(14) of the Act defines the term capital asset as a property of any kind The term property used in section 2(14) of the Act has been explained as under: Explanation. For the removal of doubts, it is hereby clarified that property includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever It is an approach whereby the right of management or control or any other rights in a company may be treated as a separate property than the shares being property. This is intended to cover situations where some assets such as right to control/management in a company are being transferred separately from the transfer of shares of the company. 21

22 Explanation of term through In the first three limbs of section 9(1)(i) of the ITA, both words through and from have been used whereas fourth limb uses word through. This would imply that the word through is different than from The legislation has explained word through to mean By means of In consequence of By reason of Thus, the word through is wider in interpretation than from 22

23 Explanation of phrase transfer Definition of the term transfer in 2(47) has been explained as under It includes in its ambit a. disposing or parting with an asset, b. disposing or parting with an interest in an asset, c. creating any interest in an asset, The above activity may be carried out in any manner whatsoever including a. directly or indirectly b. absolutely or conditionally, c. voluntarily or involuntarily, or d. by way of an agreement (whether entered into in India or outside India) or otherwise Further it is irrelevant whether such transfer of rights has been characterized as being affected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India. 23

24 Explanation of phrase capital asset situated in India Explanation 5 to section 9(1)(i) of the Act is not restricted to capital asset but extends to other assets as well For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India The fourth limb of section 9(1)(i) subjects transfer of capital asset situated in India and not all assets. The word asset may widen the scope of section 9(1)(i) and lead to ambiguity in interpretation. 24

25 Indirect transfer of shares Situation 1 Taxable Situation 1: direct share transfer Situation 2 Taxable, conditional on the shares in Z Co deriving their value substantially from assets located in India ( Explanation 5 to section 9(1)(i)) Term substantially not defined Withholding obligation on buyer Situation 2: indirect share transfer Situation 3 Taxable, conditional on the shares in Z Co deriving their value substantially from assets located in India ( Explanation 5 to section 9(1)(i)) Term substantially not defined Withholding obligation on buyer Situation 3: indirect transfer of assets Offshore S X Co Y Co Sale X Co Z Co Sale Offshore X Co Z Co Sale Offshore S Y Co S Assets 25

26 Shome Committee s key recommendations on indirect transfers The phrase, an asset or seems to be juxtaposed with capital asset to buttress the concept of capital assets. Since the objective is taxation of capital assets alone, the phrase an asset or should be omitted The phrase, the share or interest in a company or entity registered or incorporated outside India, should mean and include only such share or interest which results in participation in ownership, capital, control or management. Mere economic interest should not be contemplated within the ambit of Explanation 5 to section 9(1)(i) The word Value should refer to fair market value of both tangible and intangible assets as may be prescribed. The value is to be determined at the time of the last balance sheet date of the foreign company with appropriate adjustments made for significant disposal/acquisition, if any, between the last balance sheet date and the date of transfer The phrase directly or indirectly may be clarified to represent a look through approach whereby all intermediaries between the foreign company and assets in India may be ignored. 26

27 Shome Committee s key recommendations on indirect transfers The word substantially used in Explanation 5 should be defined as a threshold of 50% The taxation of capital gains on indirect transfer should be restricted only to capital gains attributable to assets located in India. Thus capital gains should be taxed on a basis of proportionality between fair market value of the Indian assets and global assets of the foreign company, as proposed in DTC Bill Exemption may be provided to a foreign company which is listed on a recognized stock exchange and whose shares are frequently traded therein. Transfer of shares or interest in a foreign company or entity under intra group restructuring may be exempted from taxation subject to the condition that such transfers are not taxable in the jurisdiction where such company is resident. 27

28 Shome Committee s key recommendations on indirect transfers Where capital gains arising to a non-resident on account of transfer of shares or interest in a foreign company or entity are taxable under section 9(1)(i) of the Act and there is a DTAA with country of residence of the non-resident, then such capital gains shall not be taxable in India unless- (i) the DTAA provides a right of taxation of capital gains to India based on its domestic law; or (ii) the DTAA specifically provides right of taxation to India on transfer of shares or interest of a foreign company or entity. There should be prospective application of amendments to Sec 9 on indirect transfers; If retrospective amendments are carried through no penalty / interest should be levied in respect of the income brought to tax on application of retrospective amendments; 28 Retrospective application of tax law should occur in exceptional or rarest of rare cases; But if Government decides to proceed with retrospective amendments, no burden ought to be fixed on the payer for non-deduction of TDS as would result in "impossibility of performance

29 Case Study Indirect transfer

30 Case study: Indirect transfer Sanofi Pasteur Holding case M D French HoldCo Shantha Transfer of ShanH s shares France India Sanofi Facts of the case Merieux ( M ) & Dassault ( D ) held shares of the Indian company viz. Shantha through a French holding company, ShanH ( French HoldCo ) M & D transferred the shares of this French Holdco to Sanofi Pasteur Holding ( Sanofi ), a French resident third-party buyer Ruling of AAR The AAR had held the sale to be taxable in India under the ITA as well as under the India-France DTAA Ruling of HC The HC decided the matter in favor of seller and held that: ShanH is an independent corporate entity that had commercial substance and was not a device for avoiding Indian tax The retrospective amendments to the ITA would not impact the allocation of taxing rights under a DTAA Taxation of capital gains arising as a consequence of the transaction is allocated exclusively to France under the France DTAA [Article 14(6)], and therefore, not taxable in India

31 Practical approach on TDS on indirect transfers

32 Section 195(1). Whether payment made by a NR to another NR outside India is covered under the ambit of Section 195? No Yes Vodafone International Holding BV(SC) Finance Act 2012 Amendment in the Finance Bill Section 195 would be applicable on NR to NR transactions 32

33 Contrasting position between buyers and sellers in India What should sellers do : Obtain Nil withholding tax certificate or advance ruling from tax department What should buyers do : Primary advice to buyer is generally to withhold tax unless the seller provides a Nil withholding tax certificate or has obtained an advance ruling in relation to the said transaction Obtain indemnification from the seller for not withholding tax till such time the process of obtaining Nil withholding tax certificate or advance ruling is completed 33

34 Recent controversy on LTCG taxation

35 Cairn UK Holdings Ltd 38 taxmann.com 179 Delhi HC Recent Ruling Facts of the case Cairn UK a private limited company registered in Scotland transferred equity shares of Cairn India Limited ('CIL') to Petronas International Corporation Limited, Malaysia. Transaction was an off-market transaction i.e. not through a stock exchange Transaction resulted in long-term capital gain in the hands of Cairn UK after applying the benefit under first proviso to Section 48 of the Act. Cairn UK had filed an application for advance ruling to AAR querying whether the tax payable on long term capital gains arisen on sale of equity shares of CIL will be 10% of the amount of capital gains as per proviso to Section 112(1) of the Act? AAR ruled that lower rate of 10% under proviso to section 112(1) shall not apply and capital gains shall be taxed at 20% Cairn UK filed SLP against AAR's ruling to SC which directed petitioner to first approach HC under Article 226. Hence, this instant writ petition before Delhi HC against AAR's ruling. 35

36 Cairn UK Holdings Ltd 38 taxmann.com 179 Delhi HC Recent Ruling Held The proviso to Section 112(1) of the Act does not state that an assessee, who avails benefits of the first proviso to Section 48, is not entitled to benefit of lower rate of tax. The said benefit cannot be denied because the second proviso to Section 48 is not applicable. The stipulation for taking advantage of the proviso to Section 112(1) is that the aggregate of long-term capital gains to the extent it exceeds 10% of the amount of capital gains, should be before giving effect to the provisions of second proviso to Section 48. Inflation indexation shall be ignored. In case the Legislature intended to deny the said advantage/benefit where the assessee had taken benefit of the first proviso to Section 48, it would have been specifically stipulated, that an assessee, who takes advantage of neutralization of exchange rate fluctuation under the first proviso to Section 48 would not be entitled to pay lower rate of Cairn UK was liable to pay tax 10% and not 20% 36

37 Applicable rate of tax on LTCG in case of unlisted securities Prospective amendment by Finance Act, 2012 w.e.f , substituting clause (ii) and (iii) in section 112(c), to provide tax rate of 10 % on LTCG in case of non-resident investors Memorandum to Finance Act 2012 explains the rationale for the amendment to be an enabler of parity between FII and other non resident taxpayers Issues Whether the term securities as per Securities Contracts law (SCRA) would include shares of a Private Limited company? Whether the tax rate of 10% can be applied to LTCG accruing to a non resident on sale of shares of a Indian Private Limited company? What could be an appropriate approach for withholding tax from a buyer s / seller s perspective? 37

38 Thank You