Issue for consideration In recent times, many cases have surfaced involving the receipt of interest by a shareholder for delay in making a public offer for sale. The magnitude becomes considerably higher where the transfer of shares is by a Foreign Institutional Investor. In many cases, the interest is paid under an order of the regulator or a court.
The issue under taxation that arises for consideration, in the hands of the recipient, is about the treatment of such interest, received by him for the delayed offer for sale.
Whether such a receipt would lead to increase the value of consideration and would enter into computation of the capital gains or would it be separately taxable as income from other sources. Conflicting decisions are available on the subject that requires consideration, due to sheer magnitude of the receipt.
Morgan Stanley Mauritius Co.’s case
The issue recently arose before the Mumbai bench of the Tribunal in the case of Morgan Stanley Mauritius Co. Ltd., ITA No.1625/Mum/2014 adjudicated under an order dated 29.01.2016.
The assessee company, incorporated in Mauritius, was registered with SEBI as a sub-account of Morgan Stanley and Company International Ltd. (MSCIL). It had transferred 13,79,979 shares of I-flex Solution Ltd. held by it, to Oracle Global (Mauritius) Ltd.(Oracle) under the open offer for sale made by Oracle for an agreed consideration. In addition to the said consideration, it had received an additional consideration of Rs.2.20 crore from Oracle over and above the sales consideration. The assessee had treated the said additional consideration as the part of the full value of consideration and had accordingly computed the capital gains for which it had claimed exemption from Indian taxation as per the DTAA with Mauritius. The AO held that;
the additional consideration was not linked to original consideration and hence it was to be treated and taxed separately,
the amount received by the assessee was penal in nature,
while making the payment of additional consideration the deductor i.e., Oracle had deducted TDS,
the deduction of tax proved that it was not part of sales consideration, and
the ‘penal interest’ had to be taxed @ 41.82 %.
The Commissioner (Appeals) confirmed the action of the AO.
In the appeal by the company to the Tribunal, it was contended that that the original and revised schedule to the offer proved that the additional compensation @ Rs.16 per share was paid by Oracle for a period up to January 2007 and that the compensation paid was for the delay in making the offer and not for delay in making payment and was not interest. In addition, it was contended that the additional consideration was not received in respect of any monies borrowed or debt incurred or for use of money by Oracle; that the additional consideration was also not a service fee/charge in respect of money borrowed/credit facility which was not utilised by Oracle; that the amount in question would not fall within the definition of ‘interest’ as per section 2(28A) of the Act; that for a receipt to be taxed as interest, existence of a debtor/creditor relationship was a must as per Article-11 of the DTAA ; that there was no Debtor/Creditor relationship between the assessee and Oracle; that the assessee had not made available any capital/funds to Oracle; that the money received by it constituted an integral part of the sales receipts of the shares; that the consideration and sale price arose from the same source i.e., the shares transferred to Oracle under the open offer. In the alternative, it was contended that the additional consideration could not be taxed as capital gains under Article-13 of the Treaty; that it was also not covered under any of the specific Articles of the Treaty; that it would fall under the head ‘income from other sources’ under Article-22 of the Treaty; that the assessee had no Permanent Establishment (PE) in India; that the income from other sources would not be taxable in India as per the provisions of the Act. In a further alternative, with regard to rate of tax to be levied, it was contended that AO had erred in not taxing the additional consideration in accordance with the provisions of section 115AD of the Act; that he should have applied the rate of 20.91% as against the rate of 41.82%. The assessee relied upon the order of the Tribunal dated 14.8.2013 in the case of Genesis Indian Investment Company Ltd. (ITA/2878/Mum/2006) in support of its main contention and also referred to the decisions in the cases of Sainiram Doongarmal, 42 ITR392, (SC) ; Sahani Steel Works & Press Works Ltd. 152 ITR 39(AP); K.G. Subramaniam, 195 ITR 199 (Karn.) and Hindustan Conductors P. Ltd., 240 ITR 762 (Bom).
In reply, the Department contended that the additional consideration was received for delay in making the payment of sales consideration; that it could not be taken as part of total sale value; that Oracle had deducted TDS while making payment to the assessee; that deduction of tax at source indicated that the amount was not part of sale consideration but represented the interest portion for delayed payments; that same had to be treated as income from other sources; that the letter of offer made by Oracle talked about interest payment of Rs.11.35 per share; that the assessee had accepted the open offer; that there was debtor/creditor relationship between the assessee and Oracle; that the buyer of the share should have paid the whole amount as per the scheduled dates of payments; that the nature of all consideration received by assessee was in the nature of interest; that it was governed by Article-11 of the India Mauritius DTAA ; that it could not be taxed under Article-22 of the treaty under the head “other income’; that the additional consideration was interest for late payment of the sale proceeds; that the interest income taxable in the hands of the assessee could not be treated as income from securities; and that the provisions of section 115AD were not applicable in the case under consideration.
The Tribunal found that an open offer was made by Oracle to the share holders of I-flex at the price of Rs.1,475/- per share; that the open offer indicated that additional offer of Rs.11.35 per share was to be payable to the share holders; that as per the letter of open offer the additional consideration per share was to be paid due to delay in making the open offer and in dispatching the letter of the offer based on the time line prescribed by SEBI; that later on, the consideration of open offer was revised to Rs.2,084/- per share; that the additional consideration for delay was revised to Rs.16/- per share; that the open offer letter and public announcement indicated that a revised offer of Rs.2,100/- per share (including additional consideration of Rs.16/-) was to be payable for the shares tendered by the share holders under the open offer; that in response to the open offer, the assessee tendered its holding of 13,97,879 shares of I-flex and received Rs.2,89,77,45,900/- which sum included additional consideration of Rs.2.20 crore.
The Tribunal found that the offer letter contained two schedules, original and revised, and the revised schedule contained the details of additional consideration to be paid by Oracle, which in the opinion of the Tribunal could not be treated as penal interest or interest for late payment of consideration by Oracle. It found that initially the additional consideration was fixed at Rs.11.35 per share, but, because of the delay in making the open offer and dispatching the letter of the offer, was later enhanced to Rs.16.00 per share and thus, there was increase in the offer price of the shares; it was a fact that the regulatory authority i.e. SEBI had approved the transaction; that the transaction could not be completed in due time because of certain reasons; that Oracle had revised the offer price. Considering all the factors, the Tribunal held that the additional consideration received by the assessee was part and parcel of the total consideration that could not be segregated under the heads ‘original sale consideration’ and ‘penal interest received from Oracle’. It observed that the business world was governed by its own rules and conventions and on due consideration of the time factor, if Oracle decided to increase the share price in the offer letter, it had to be taken as a part of original transaction. The Tribunal appreciated that in the original offer interest @ Rs.11.35 per share was offered by Oracle and after considering the delay in dispatch letter and other relevant factors, it decided to increase the interest @ of Rs.16 per share which was a business decision and the assessee had no control over the decision making process of Oracle. Importantly, it noted that the transaction did not have any debtor/creditor relationship between the assesse and Oracle and the sale of shares of I-flex in response to the open offer by Oracle was a pure and simple case of selling of shares; that the assessee had not entered into any negotiations with Oracle and transferred the shares as per a scheme that was approved by SEBI; that the assessee had not advanced any sum to Oracle and had not received any interest from it for delayed repayment of principal amount and in short, the additional consideration received by the assesse from Oracle was not penal interest and was part of the original consideration and was not taxable. The Tribunal noted with approval that in the decision in the case of Genesis Indian Investment Company Ltd.(ITA/2878/Mum /2006 / dated 14.08.2013) a similar issue had been decided by the Tribunal in favour of the assessee.
Dai Ichi Karkaria Ltd .’s case
The issue in the past had arisen in the case of Dai Ichi Karkaria Ltd, ITA No. 5584/Mum/2010 for A.Y. 2006- 07 decided on 28th December 2011. In that case, the assessee had raised the following issues in the appeal ;
“On the facts and in the circumstances of the case and in law, the ld CIT(A) erred in confirming the amount of Rs. 1,00,57,681/- as interest income and not allowing it as part of full value of consideration in computing long term capital gains in respect of buy back of shares and consequently erred in confirming long term capital gains at Rs.2,16,52,094/- as against Rs. 3,16,12,208 as claimed by the appellant.”
“On the facts and circumstances of the case, it is contended that the amount of interest of Rs. 1,00,57,681/- assessed by the Assessing Officer is not chargeable to tax under any provision of the I T Act.”
In that case, the assessee had computed the long term capital gains of Rs. 3,16,12,208 on transfer of shares under a scheme of buy back of shares of Colour Chem Ltd. The assessee had sold 71,233 shares @ Rs. 318 per share and had also received interest @ Rs.149.62 per share. In computing the capital gains, the assessee had added interest received as a part of sale consideration. The AO asked the assessee to explain as to why the interest of Rs. 1,06,57881, received on the investment, should not be treated as Income from other sources and taxed as such. In response, the assessee submitted that the said interest was paid by the company to eligible shareholders, including the assessee, pursuant to the order of the Supreme Court. It was explained that Colour Chem Ltd. had not deducted tax while making payment of the same, u/s. 194A of the Act, for the reason that the said payment was considered as part of sale consideration for calculating the Long Term Capital Gains.
The AO held as under: “The assessee has received interest in terms of the Supreme Court Order mentioned in the para 4.1 of the Letter of Offer to buy the shares of Colour Chem Ltd by EBITO Chemiebetelligungen AG, Claraint International Ltd and Clariant AG. The Supreme Court in its order has worked out interest at Rs. 149.62 per share. Assessee’s case falls under income by way of interest on securities which is specifically covered u/s 56(2)(id) of Income Tax Act. In fact the matter has been discussed in detail by the Hon’ble Madras High Court in the case of South India Shipping Corporation Ltd. (240 ITR 24), wherein, it has been held that the ratio of the decision of Supreme Court is applicable for existing Company also.” On appeal, the CIT(A) concurred with the view of the AO.
In an appeal to the Tribunal, it was contended by the assesseee company that the assessee had no statutory right to receive the interest or any compensation; the amount of interest received by the assessee was for the period prior to the time of the payments as well as actual transfer of the shares; the amount therefore was a part of the sale consideration and not a separate income of the assessee; there was no agreement or statutory rights to receive such interest; there was no mercantile practice to receive the interest and the amount was only compensatory in nature and could not be treated as a separate income.
It was contended that the interest paid by the acquirer of the shares was treated as the part of purchase consideration in the case of Burmah Castrol Plc., 307 ITR 324 (AAR) wherein interest paid by the acquirer was held as cost of acquisition of shares and on similar analogy, the interest received by the assessee on buyback of share, should be part of the sale consideration.
Highlighting the decision of the Supreme Court in the case of CIT vs. Ghanshyam (HUF), 315 ITR 001(SC), it was submitted that the court in that case held that the interest payable prior to the possession taken over shall be part of the compensation. Reliance was placed on the decision in the case of Manubhai Bhikhabhai vs. CIT, 205 ITR 505(Guj).
Narrating the litigation history of the case of acquiring the shares, it was explained that the purpose of the Supreme Court in awarding interest of Rs. 149.62 per share (net of dividends) was to compensate the shareholders of the target company for the loss of time or delay in making the offer and hence, such interest could under no stretch of imagination be construed to be interest income accruing in the hands of the assessee. Attention was drawn to the provisions of section 2(28A) of the Act, defining the term ‘interest’ to contend that for a receipt to be considered as interest the amount should arise from money borrowed or debt incurred and that in the given case, the assessee had invested in shares of the target company i.e. CCL and had not given any loans and that the scope of definition could not be expanded to include in itself something which by its very basic nature, did not amount to interest.
The facts of the case, it was explained, confirmed that the compensation was not on the grounds that the acquirer delayed the payment of the consideration to the shareholders but was awarded for making good the loss caused to the shareholders of CCL, due to the delay in making the offer of buy back by the acquirer.
It was pointed out that while deciding the issue of interest, the Supreme Court had clearly held that the shareholder did not have any right to get interest and the shareholders were only to be compensated for the loss of interest and nothing more ; therefore, when there was no right or any agreement to receive the interest then, the amount received by the assessee was only a part of the sale consideration.
Lastly, it was submitted that when there was no right to receive the interest and there was no source of income then, there was no provision to tax the same, as there was no source. CIT vs. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd.,179 ITR 157(P&H).
On the other hand, the Department submitted that interest was received by the assessee for delay in payment of offer price; that ‘income’ included any amount received by the assessee and would fall u/s. 56 of the I. T. Act, since the money was lying with the acquirer and the interest was a compensation for such loss; that as per the provision of section 46A, only the consideration received by the shareholder, after adjustment of the cost of the acquisition of shares was deemed as capital gains arising to such shareholder.
The Tribunal considered the rival contentions and perused the relevant material on record. It examined in detail the factual background giving rise to the dispute of interest payment and transfer of the shares under buy-back scheme. It noted that the Supreme Court while deciding the issue of rate of interest, observed that “by reason of Regulation 44, as substituted in 2002, the discretionary jurisdiction of the Board is curtailed. In terms of Regulations 1997 could award interest by way of damages but by reason of Regulation 2002, its power is limited to grant interest to compensate the shareholders for the loss suffered by them arising out of the delay in making the public offer.” The tribunal noted that it was clear from the observations of the court that interest payable as per Regulations 44 was to compensate the shareholders for loss suffered by them for delay in making the public offer and that it was not penal in nature and was not towards a statutory right or a right arising from contract but the nature of payment of interest was to compensate the loss due to the delay in the payment by the acquirer and thus, the interest was paid to compensate the shareholder who were deprived of interest payable on difference of offer price and market price.
Importantly, the tribunal extensively quoted from the decision in the case of CIT vs. Ghanshyam (HUF) (supra) wherein the court after analysing the provisions of Land Acquisition Act, 1894 had given a detailed finding on the issue of interest payable u/s. 23, 28 as well as section 34 of the Land Acquisition Act. The Supreme Court in that case had addressed the issue whether the interest paid on enhanced compensation u/s. 23,28 and section 34 would be treated as part of compensation u/s. 45(5) of the I. T. Act 1961. The Tribunal quoted the following paragraph form the said decision;
“It is to answer the above questions that we have analysed the provisions of sections 23, 23(1A), 23(2), 28 and 34 of the 1894 Act. As discussed hereinabove, section 23(1A) provides for additional amount. It takes care of increase in the value at the rate of 12 per cent. per annum. Similarly, under section 23(2) of the 1894 Act, there is a provision for solatium which also represents part of enhanced compensation. Similarly, section 28 empowers the court in its discretion to award interest on the excess amount of compensation over and above what is awarded by the Collector. It includes additional amount under section 23(1A) and solatium under section 23(2) of the said Act. Section 28 of the 1894 Act applies only in respect of the excess amount determined by the court after reference under section 18 of the 1894 Act. It depends upon the claim, unlike interest under section 34 which depends on undue delay in making the award. It is true that “interest” is not compensation. It is equally true that section 45(5) of the 1961 Act refers to compensation. But, as discussed hereinabove, we have to go by the provisions of the 1894 Act which awards ” interest” both as an accretion in the value of the lands acquired and interest for undue delay. Interest under section 28 unlike interest under section 34 is an accretion to the value, hence it is a part of enhanced compensation or consideration which is not the case with interest under section 34 of the 1894 Act. So also additional amount under section 23(1A) and solatium under section 23(2) of the 1894 Act forms part of enhanced compensation under section 45(5)(b) of the 1961 Act. ”
In the opinion of the Tribunal, there was a fine distinction between the additional amount payable u/s. 23, award of interest u/s. 28 and interest payable u/s. 34 of the Land Acquisition Act which had led the court to hold that the additional amount u/s. 23 (1A) and solatium u/s. 23(2) of Land Acquisition Act formed a part of enhanced compensation u/s. 45(5)(b) of the I. T. Act, 1961 and when the amount was paid as a compensation for enhancement in the value of the asset transferred, the same would be part of full consideration; but when the interest was paid as a compensation to loss of interest, then it could not be treated as a part of sale consideration.
The Tribunal held that the interest received by the assessee, as was held by the court, while deciding the dispute of rate of interest was only a compensation for loss of interest, which was akin to payments made due to delay in public offer and delayed payments and was not the compensation for enhancement in the value of the asset. The fact that the offer price was more than the value of the share from 24.2.1998 till 7.4.2003 weighed heavily with the Tribunal. The Tribunal accordingly held that the interest received by the assessee as per the directions of the SEBI and in pursuance of the decision of the Supreme Court could not be treated as part of sale consideration of shares and accordingly, the lower authorities had rightly treated the same as taxable under the head ‘income from other sources’.
The Tribunal noted that merely by reason that the interest paid by the acquirer would be a part of acquisition of shares would not ipso facto conclude that the said interest in the hands of the shareholder would be part of sale consideration.
Observations
The issue though moving in a narrow circle has multiple dimensions;
Does the amount go to increase the ‘full value of consideration’ for the purposes of the Income-tax Act?
Does the additional amount, received in addition to the sale consideration, represent interest or can be classified as in the nature of interest?
Can such amount be treated as ‘interest’ within the meaning of the term as defined in section 2(28A) of the Act?
Do the provisions of section 46A alter the treatment of receipt? and
Can such an amount be classified as a capital receipt not liable to tax?
The issue on hand becomes more twisted when it is examined in the context of the provisions of Double Taxation Avoidance Agreements and in particular w.r.t. certain Articles that deal with the ‘capital gains’, ‘interest’ and ‘other income’. Issue also arises as to the applicability of rate of tax and the liability to deduct tax at source under the domestic laws. But then, these are the issues that are not intended to be discussed here for the sake of focusing on the issue under debate.
There is no dispute that the amount in question in both the cases, that has been received by the shareholder, is for compensating him for the delay made by the acquirer company in making a public offer for sale. The payment is made as per the SEBI regulations to compensate the shareholder for the delay in making the offer and is calculated as per the rules of SEBI. In the matters of dispute as to the quantification and the period, the courts have the jurisdiction to intervene and provide the finality to the dispute. There is also not a dispute that the shareholders have not lent any money to the acquirer company nor is there a debtor-creditor relationship between the company and the shareholder. It is also not anyone’s case that the company had delayed the payment of the offer price or even the additional payment ordered by the SEBI.
In computing the income under the head ‘capital gains’, an assessee, to begin with, is required to reduce the cost of acquisition from the full value of consideration. The term ‘full value of consideration’ is not defined under the Income-tax Act, but is largely held to represent the sale consideration or the consideration for transfer of a capital asset. It is immaterial whether the said consideration is received in part or in full at the time of transfer, and it is also not relevant whether such consideration is received from the transferee or not.
Obviously,the compensation paid, in our respectful opinion cannot be a part of the sale consideration simply, because it is not an ‘interest’ or that it is paid for the delay in making an offer. On a first blush, the consideration moving from the company to a shareholder can be taken to be the offer price, i.e. the price at which the company has agreed to purchase or buy the shares. However, when one takes in to account the event that has preceded the actual offer, on account of which event the company has been made to offer and pay an additional amount for delaying the offer, it is appropriate to say that the shareholder in question has accepted the said offer with full knowledge of the total receipt which he is likely to receive at the time of accepting the offer and in that view of the matter, it is apt to hold that the ‘full value of consideration’ in his case represents the acceptance price, i.e the total price. It is a settled position in law that the full value of consideration referred to in section 48 does not necessarily mean the apparent consideration. It rather is the price bargained for by the parties to the transaction. ‘Full value’ is the whole price and in its whole should be capable of including the additional amount agreed to be paid before the offer is accepted.
We do not think the receipt in any manner could ever be held to be representing interest. Interest is a compensation for delay in tendering the payment of the consideration. In the case under consideration, no consideration ever became payable before the offer for sale was made and was accepted. Importantly, once it was accepted, there was no delay in the payment thereof. These aspects of the facts are even confirmed by the Tribunal in the case of Dai Ich Karkaria Ltd.(supra). It is true that the compensation for the delay is measured in terms of the period of delay and is linked to the rate of interest but the methodology adopted for quantifying the damages can not be held to change the character of the payment which remains to be compensation, and not interest.
A bare reading of section 2(28A) confirms that the receipt inn question cannot be termed as ‘interest’. Not much will turn on section2(28A) in support of the case that it represents interest. None of the parameters help the case in favour of treating the receipt as interest.
Before we deal with the last part, it is relevant to examine whether provisions of section 46A of the I. T. Act, have any implication in deciding the issue. Apparently, the scope of section 46A is restricted to the buy back of shares by the issuing company and it’s scope cannot be extended to the case of public offer by a raiding company or any person other than the issuing company. Secondly, the provision requires the difference between the cost of acquisition and the value of consideration to be taxed under the head ‘capital gains’. The ‘value of consideration’ cannot be largely different than the ‘full value of consideration’ and as such the discussion in the earlier paragraphs will largely apply to section 46A with the same force.
Lastly, whether the receipt in question could be held to be a capital receipt, not liable to taxation, is an issue that was not before the Tribunal in any of the cases, but in our opinion is a possibility worth considering, in view of the fact that the receipt is in the nature of damages and represent compensation for an injury, which can be presented to represent a capital receipt not liable to taxation.
