The Hindu Business Line : A cost that merits correction

"ON REDEMPTION, the cost of acquisition of the shares underlying the Global Depository Receipts (GDRs) shall be reckoned as the cost on the date on which the Overseas Depository Bank advises the Domestic Custodian Bank for redemption. The price of the ordinary shares of the issuing company prevailing in the Bombay Stock Exchange or the National Stock Exchange on the date of the advice of redemption shall be taken as the cost of acquisition of the underlying ordinary shares."

Thus reads para 7(3) of the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 (GDR Rules). The above regime for computation of cost of shares derived from GDR is apparently for tax purposes. Indeed, it cannot be for any other purpose. This then raises a fundamental issue: Should not a matter relating to income-tax be addressed by the legislation concerned, the Income-tax Act? Be that as it may, the point for consideration is whether the above regime is at once fair to the exchequer as well as to the investor. There is a special regime available for non-residents vide the first proviso to Section 48. It says when a non-resident subscribes to shares or debentures of an Indian company in a foreign currency, capital gains would be computed on transfer of such shares or debentures by ironing out the profit or loss on account of foreign exchange rate fluctuations.

To wit, if a non-resident had purchased 100 shares of an Indian company by remitting $1,000 when the exchange rate was Rs 20 per dollar, effectively his cost of investment would have been Rs 20,000. Suppose, he had disposed of these shares for Rs 40,000 when the exchange rate was Rs 40 per dollar, his capital gain would be deemed to be nil because after ironing out the gain on account of foreign exchange rate fluctuation, his profit is nil — he brought in $1,000 and is taking back the same number of dollars. This is as it should be.

Unfortunately, Section 115AC (3) — Section 115AC governs computation of tax liability of non-residents from investments in GDRs — rules out the invocation of the first proviso to Section 48 while computing such tax liability. So much so, one has to rely on the dispensation provided by the GDR Rules.

The GDR Rules may suit those investors who are out to make profit from arbitrage opportunities — they may sell the shares in the Indian bourses hot on the heels of redemption of the GDRs in which case the cost and selling price would be virtually be the same. But this does not mean that such patently irrational rule should hold sway. How can the market price of the share on the date of redemption be deemed to be its cost? Such market price could possibly have been taken as cost had the non-resident been taxed at two stages — one on the date of redemption on the notional gains and again on actual sale of shares. But even this would be unfair given the fact that it ignores the fact that what matters for a non-resident is dollar profit and not rupee profit.

It is strange that the income-tax law should have yielded space to GDR Rules when its own dispensation is eminently fair to both the investor and the exchequer.

(The author is a Delhi-based chartered accountant.)