Benefit of first proviso to sec. 48 r.w. sec. 112 concessional rate is available to a non-resident – Delhi HC
Cairn UK Holdings Ltd v DIT  38 taxmann.com 179 (Delhi)
IT/ILT : Proviso to section 112(1) doesn’t deny benefit of lower tax rate of 10% on long-term capital gains from sale of listed securities to a non-resident investor availing benefit of exchange rate neutralization under first proviso to section 48. The said benefit of lower tax rate of 10% can’t be denied on the ground that indexation benefit under 2nd proviso is not applicable. It is incorrect to say that 10% rate under proviso to section 112(1) applies only where indexation benefit under 2nd proviso to section 48 applies and still assessee opts to not avail it
• Petitioner-company a private limited company registered in Scotland transferred its 4,36,00,000 equity shares of Rs.10/- each of Cairn India Limited (‘CIL’) to Petronas International Corporation Limited, Malaysia for consideration of US$ 241,426,379 in October, 2009.
• This transaction was an off-market transaction i.e. not through a stock exchange.
• The transaction resulted in long-term capital gain of US$ 85,584,251 in the hands of the petitioner, after applying the benefit under first proviso to Section 48 of the Income Tax Act, 1961 (Act).
• The assessee 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%.
• Petitioner 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.
• 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 wanted to deny the said advantage/benefit where the assessee had taken benefit of the first proviso to Section 48, it was easy and this 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 tax @10%.
• Legislature had a far easier and simpler way to deny benefit of the proviso to Section 112(1) by using different words and phrases had thus been the intention. The legislature in fact did not intend to deny the said benefit.
• In Section 115AD(3) it is noticeably stipulated that nothing contained in the first and second proviso to Section 48 shall apply to transfer of securities and capital gains referred to in sub-section 1(b) of the said section.
• First proviso to Section 48 is applicable when a non-resident had purchased an asset being a share or debenture with foreign currency, converted into Indian rupee. It stipulates that on transfer or sale of the said share or debenture the consideration received in Indian rupee should be reconverted into the same foreign currency.
• Sale and purchase of shares has to be in Indian rupee, the legal tender in India, but the foreign investor had brought in foreign currency and, therefore, logically and naturally for him, the gain should be computed in foreign currency. The said investor would like to convert the sale consideration received in Indian rupee into foreign currency. This would reflect the true gain or income earned.
• For a non-resident who has utilized/brought in foreign currency for purchase of shares or debentures in Indian rupee, inflation in India is immaterial and inconsequential. For him, the gain or loss is to be computed with reference to the foreign currency utilized for purchase and foreign currency available to him for repatriation after the sale. From the said assessee’s view point and objective, he is most concerned with exchange rate fluctuation and his true and actual gain should take into account the exchange rate fluctuation.
• The second proviso is applicable to all others including non-residents, who are not covered by the first proviso and they are entitled to benefit of cost of indexation which neutralize inflation.
• It is a misnomer and wrong to state that inflation alone contributes and is the determinative factor in exchange rate fluctuation.
• No doubt, a country with persistent low inflation can expect rising currency value as purchasing power increases in relation to other currencies with high inflation rate, but it is equally true that countries with typically higher inflation rate might not see corresponding or equal depreciation in their currency value.
• Inflation by itself cannot be the sole or even a primary factor in exchange rate depreciation. Current account deficit and public debt, terms of trade, political stability, economic performance, etc. are various other factors, which determine the exchange rate. These are complex factors and several parameters can affect the foreign exchange rate fluctuation and, therefore, persons affected by exchange rate fluctuation indulge in hedging.
• The first proviso to Section 48 ensures that a non-resident, who utilized his foreign currency, is taxed after taking into consideration the fluctuation in exchange rate. Indian rupee can and has in past appreciated against foreign currencies. In such cases, the long-term capital gains payable can increase.
• On the contrary, one is not aware of occasions of deflation in India in last two decades and it would be incorrect to hold that the Legislature while enacting the second proviso had in mind or assumed that there would be deflation.
• The two provisos cannot be equated as granting same relief or benefit. They operate independently and have different purpose and objective.
• In view of the above, it is difficult to state that benefits under the first proviso and the second proviso to Section 48 are identical or serve the same purpose.
• There is some merit in the contention that if proviso to Section 112(1) is applied, then almost all assessees covered by the first proviso to Section 48 would be liable to pay tax @ 10% only and not @ 20% on long-term capital gains. This appears to be correct and a logical consequence of the proviso to Section 112(1) but this cannot be a ground to contextually read the proviso to Section 112(1) differently.
• The said proviso is applicable to listed securities or units or zero coupon bonds.
• Long-term capital gain is not payable on listed securities sold through stock exchanges as STT is payable.
• First proviso to Section 48 is applicable on sale of shares or debentures in Indian company, whether or not the said shares or debentures are listed or not. Thus, proviso to Section 112(1) is more restrictive and will not necessarily apply in all cases covered by the first proviso to Section 48.
• Secondly, the proviso to Section 112(1) is not applicable to debentures. Nevertheless, the proviso to Section 112(1) is applicable to units and zero coupon bonds, which are not covered by the first proviso to section 48 of the Act.
• Second proviso to Section 48 is not applicable on transfer of long-term capital asset being bond, debenture other than the capital index bond. Zero coupon bonds are, however, specifically made eligible for benefit under the proviso to Section 112(1).