The Hindu Business Line : GDR regime falls foul of the I-T Act

Global Depository Receipts and its American equivalent American Depository Receipts — both compendiously referred to as GDR in this article — are both about mobilising equity in foreign currency from non-residents.

The reason why the shares of Indian companies have perforce to be offered in the form of GDR is that in foreign stock exchanges, the quotations are not in Indian rupees but in the national currency of the country concerned or the currency it has adopted for the purposes of dealings in its bourses, usually the dollar.

To conform to the stock exchange regulations of the foreign country therefore, each GDR may consist of one or more underlying shares of the Indian company. Indeed the underlying assets of GDR are shares of Indian companies.

If this is granted, then there should be no mind block in accepting GDR as an equity instrument. But there are discordant notes. First, GDR holders are not conferred voting rights by the Indian companies though there is nothing in the GDR regime which expressly denies voting rights.

Be that as it may, this article is concerned with the discordant notes vis-À-vis the Income-Tax Act, 1961. A shareholder basically earns dividend from a company and earns capital gains when he sells his shares in the market or elsewhere. Let us see how the GDR regime falls foul of the I-T Act in both these areas.

Capital Gains

The GDR regime is contained in Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993.

When a GDR is sold in a foreign stock exchange or at any place outside India in a transaction between two non-residents, there is no liability to capital gains tax in India.

The problem arises when the GDR is redeemed in favour of the underlying shares. The Scheme says when this happens, the cost of the shares thus got released would be the market quotation therefor in the BSE or the NSE.

This is against the letter and spirit of the I-T Act. The market quotation on the given day may be very high or very low, thus having no bearing with the actual money paid for the acquisition of GDR.

The problem of foreign currency conversion has been mixed up with the quotation for shares. In all fairness to both the non-resident and the Indian exchequer, the cost should be determined by applying the exchange rate on the date of allotment of GDR or on the date he purchased the GDR from another non-resident in a foreign bourse.

It would be unfair to the non-resident if he is done in by the extremely low quotation on the date of redemption compared to what he had actually paid. And it would be unfair to the Indian exchequer, if on the date of redemption, the market quotations are very high vis-À-vis the actual amount paid on investing in GDR.

Dividends

The Scheme says dividend received on GDR is taxable at the rate of 10 per cent. This is clearly untenable in the face of Section 10(34) of the I-T Act which exempts dividend from tax in the hands of the shareholders read with Section 115-O which shifts the burden of tax to the company by asking it to pay Dividend Distribution Tax (DDT) on the entire dividend paid no matter whether it is paid to the GDR holder or a resident shareholder.

In fact, this is more a reflection of the contradiction in the I-T Act itself. The villain of the piece is Section 115AC of the I-T Act.

I-T Act vs I-T Act

The villain of the piece is Section 115AC of the I-T Act. It imposes a 10 per cent tax on dividend received by GDR holders which is why paragraph 9 of the Scheme also says that the Indian company should deduct tax at the rate of 10 per cent and remit only the balance to the overseas depository bank.

To be sure, Section 115AC spares dividend from tax if it belongs to the Section 115-O variety. But then there was no need to talk about tax on dividend at all given the fact that a listed company would be paying dividend only of the kinds envisaged by Section 115-O — only a unlisted company can pay deemed dividend (loans and advances).

Section 115AC and the Scheme also says that on long-term capital gains earned by a non-resident by sale of shares obtained on redemption of GDR, tax payable is 10 per cent. The truth is long-term capital gains are exempt from tax under Section 10(38) if the shares were sold in a recognised stock exchange in India and Securities Transactions Tax (STT) was paid on the transaction.

One cannot blame the Scheme when the I-T Act itself speaks with a forked tongue.

(The author is a Delhi-based chartered accountant. blfeedback@thehindu.co.in)

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