The Hindu Business Line : When non-residents make gains on the bourses

A major controversy has arisen between the Income-Tax Appellate Tribunal (ITAT) and the Authority for Advance Rulings (AAR). The controversy centres around the rate of tax applicable to long-term capital gains (LTCG) made by a non-resident in the Indian share market by selling listed securities.

Section 112 of the I-T Act lays down that such LTCG tax should be taxed at 10 per cent. But when the shares are purchased in foreign currency, the first proviso to Section 48 requires that the sale consideration must be converted in the same foreign currency in which the shares are purchased and then the gain or loss is to be determined in the foreign currency, which again is to be re-converted into Indian currency. Section 48 also provides for indexation benefits. When cost indexation benefit is utilised, the tax rate will be 20 per cent.

What should be the rate of tax for a non-resident who purchases Indian listed securities in foreign currency and sells the same for a gain? Is it open to the non-resident to claim tax rate at 10 per cent?

The BASF case

In this case (293 ITR AT1Mumbai), the non-resident, Basf Aktiengesellschaft, derived LTCG of Rs 5.41 crore in the Indian share market pertaining to the assessment year 2001-02. Since these shares were acquired in foreign currency, LTCG was computed as per the first proviso to Section 48. The gain was converted into foreign currency and then reconverted into Indian currency. The non-resident claimed that the rate of tax should be 10 per cent as per the proviso to Section 112. The Department took the view that the proviso to Section 112 would not apply and the rate should be 20 per cent.

The object behind Section 48 was to ensure protection from fluctuation in rupee value in terms of foreign currency and guard against inflation. The first proviso to Section 48 enables computation of LTCG in foreign currency and it takes care of inflation. The proviso to Section 112 envisages a situation where the tax rate exceeds 10 per cent before giving effect to the provisions of cost inflation index under the second proviso to Section 48.

The applicability of the second proviso to Section 48 is a sine qua non for applying the proper rate of tax. Option is available to resident investors to take advantage of cost inflation index. Non-residents will fall under Section 112(1)(c). The proviso to Section 112 was not applicable in the case of non-resident companies deriving LTCG in the Indian share market. The rate of tax should be 20 per cent.

The Tribunal examined the question whether Section 112(1)(c) would apply to all non-residents or only to certain categories of non-residents. The Finance Act, 1999 inserted the proviso to Section 112(1) which, effective from the assessment year (AY) 2000-01, gave rise to dispute.

LTCG for non-residents has to be computed by converting the same first into foreign currency and then reconverting it into Indian currency. In such a situation, according to the Tribunal, the question of applying the rate of 10 per cent as per the proviso to Section 112 cannot arise. The benefit of 10 per cent is not available to cases where computation is made by applying the first proviso to Section 48. The Tribunal decided the matter in favour of the Revenue.

The Timken case

In this case (Timken France — 294 ITR 513 AAR), Timken France SAS, a non-resident French company, had acquired shares in NRB Bearings Ltd, an Indian company. These shares were quoted in the Bombay Stock Exchange. The non-resident company sold the entire shareholding consisting of original and bonus shares in November 2005 to the Indian promoters for Rs 57,964.

The French company sought advance ruling regarding the manner of computation of capital gains and the rate of tax to be applied. The aforementioned Tribunal ruling was cited before the AAR and it was argued that the non-resident foreign company cannot have the double benefit of protection against rupee value fluctuation as well as the reduced rate of tax of 10 per cent.

It referred to CBDT (Central Board of Direct Taxes) Circular of August 31, 1992, containing explanatory notes on the provisions of the Finance Act, 1992. The principle of cost inflation index was introduced by the Finance Act, 1992.

Non-residents were excluded from the purview of the second proviso to Section 48 (providing for cost inflation index). The CBDT had laid down that relief in terms of indexation will not be available to non-residents enjoying the concession of 10 per cent. The rate of 10 per cent is available only when cost indexation is not resorted to. The AAR rejected the argument of double benefit advanced by the Revenue. Such double benefit is not taboo under the law.

Finally, the AAR held that the rate of 10 per cent should be applied for LTCG made in the Indian share market as per the proviso to Section 112(1). The same rate will apply to the gains arising out of sale of bonus shares, subject to the condition that the cost in this case will be taken as nil and the gain will equal the amount of sale consideration.

The AAR decision comes as a boon to non-resident investors in the share market.

(The author is a former Chief Commissioner of Income-Tax.)

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