Non-residents who get benefit of the first proviso to section 48 (exchange fluctuation benefit) are not eligible to avail benefit of lower tax rate of 10% under proviso to section 112(1) on capital gains accruing on sale of shares of an Indian company to a foreign company in an off-market mode.

The applicant, a company incorporated in Scotland (FCO), acquired shares of Cairn India Limited (CIL), a Indian listed company, by initial subscription, primary and secondary acquisitions. FCO subsequently sold some shares of CIL to another Indian company. The shares transferred were held for a period exceeding 12 months and consequently, constituted long-term capital asset.

The transaction of sale took place in an off-market mode and was not transacted through a recognised stock exchange in India. By relying on the first proviso to section 112(1) of the Income-tax Act, FCO made section 195(2) application praying for lower withholding rate of 10% on the gains made on sale of such shares. The Tax Authority rejected the claim of FCO and passed withholding tax order at 20%. FCO thereafter filed an application before the AAR to determine the withholding tax rate. The issue raised before the AAR was whether Nonresidents (NR) who are covered by the first proviso to section 48 of Income-tax Act (which gives benefit of Exchange fluctuation calculation) can avail the benefit of the proviso to section 112 of Income-tax Act which requires that tax on long-term capital gains on transfer of listed securities beyond 10% of gains before giving benefit of indexation in terms of second proviso, is to be ignored. The main contentions of the Tax Authority before the AAR were:

•  The Mumbai ITAT in the case of BASF Aktiengesellchaft5 rightly held that proviso to section 112 would not apply to an NR and consequently, the rate of tax would be 20%.

•  The proviso to section 112 before giving effect to the provisions of the second proviso to section 48 presupposes the existence of a case where computation of capital gain is to be made in accordance with the second proviso to section 48.

•  The first and second provisos to section 48 are ‘mutually exclusive’ as they provide distinct modes of computation of capital gains to two different sets of persons, i.e., a resident and an NR. Consequently, an NR cannot claim double benefit of protection against foreign exchange fluctuation as also the indexation benefit. FCO primarily relied on AAR ruling in the case of Timken France (294 ITR 513) wherein it was held that the proviso to section 112(1) applies to all clauses of section 112(1) i.e., residents as well as non-residents. It also contended that benefit of the proviso to section 112(1) could not be denied to NRs who were also entitled to relief in terms of first proviso to section 48. Clear words would have been deployed in the proviso if one particular category i.e., NRs were to be excluded. AAR Ruling AAR rejected the contentions of FCO and held as:

•  While interpreting a taxing statute, the duty of the Court is to give effect to the intention of the Legislature which can be gathered from the language employed and its context.

•  The ambit of proviso to section 112 extends to all sub-clauses of section 112(1) i.e. it covers residents as well as non-residents.

•  A ZCB is separate and distinct in nature from a bond as understood in common parlance. Hence, the third proviso to section 48 which restricts the benefit of indexation to bonds and debentures does not cover ZCB. A ZCB is eligible for indexation benefit under the second proviso to section 48. Even if there is second view on the eligibility of ZCB to the benefit of indexation, the explicit reference of ZCB in the proviso to section 112 confirms that the benefit of indexation should be available to ZCB.

•  Proviso to section 112 requires determination of the amount of liability which ‘exceeds’ by comparing the tax payable @ 20% on capital gains computed from transfer of listed securities, unit or ZCB and 10% of capital gains computed before giving effect to CII.

•  The indexation formula under the second proviso to section 48 enters into the computation in the limb (a) to section 112. The scheme of the provisions thus requires that proviso (b) restricted to assets and taxpayers who are entitled to the benefit of indexation. Any other meaning would result in rewriting of the provisions of the statute.

•  The term ‘before giving effect to’ connotes that effect has otherwise to be given. Hence, for application of section 112 proviso, the asset must be one qualified for CII benefit under the second proviso to section 48 of the Incometax Act. If proviso to section 112 was supposed to apply also to the first proviso to section 48, specific provision to that effect would have been made.

•  The Ruling of AAR in the case of Timken France had not considered the legal proposition that ZCB are entitled to the benefit of indexation. Also, in the said ruling, proviso to section 112 was regarded as applicable to all the taxpayers rather than confining to those taxpayers who are entitled to benefit of CII.

•  Each ruling is confined to the facts and is binding only to the parties to the transaction. In a case where certain aspects germane to the issue are not examined by the authority in the earlier ruling, the subsequent AAR is not hampered from taking a fresh look at the issue.

•  Application of section 112 proviso is based on capital assets (being units, securities and ZCBs) to which the provisions of second proviso to section 48 apply and it does not apply to taxpayers who are not entitled to benefit of the CII. The non-resident who are given protection against inflation in respect of shares/debentures of Indian company and who are kept out of CII benefit in respect of such assets, are not eligible for benefit of 10%.