Master Class: Tax treatment in case of transfer of shares from Non-Resident to Resident


[Master Class is a series where I try to survey the law surrounding the subject matter in brief]

This Master Class post tries to shed light on the tax treatment on the transfer of shares from a Non-resident (hereinafter "NR") Seller to a Resident (hereinafter "R") buyer.

Taxability under the provisions of Income-tax Act, 1961

Section 5 of the Income-tax Act, 1961 (hereinafter “IT Act”) provides for the scope of income taxable in India for NR. Section 5(2) of the Act provides that income which is received; accrues or arises; or is deemed to accrue or arise to an NR in India is taxable under the Act.

As per the provisions of sub-section (1) of section 45 of the IT Act, profits and gains arising on transfer of a capital asset are chargeable to tax under the head ‘Capital Gains’.

An income is chargeable to tax under the head capital gains, only if all the following five conditions are satisfied:
  • There must be a capital asset
  • The capital asset must be transferred
  • Such capital asset must be transferred during the previous year
  • As a result of such transfer of capital asset, there should be ‘Profit’ or ‘Gain’ arising thereon,
  • Such profit or gains on transfer of capital asset, should not be exempt from tax as per the specified provisions of the Act.
If all the above five conditions are satisfied, then such profit or gain arising on transfer of a capital asset shall be chargeable to tax under this head in the year in which the transfer took place. 

Meaning of ‘capital asset’

A capital asset is defined to include property of any kind held by a taxpayer, whether connected with their business or profession or not. It includes all kinds of property, movable or immovable, tangible or intangible, fixed or circulating. Thus, the property of any kind includes shares (equity and preference) as well as debentures of a company. Accordingly, equity shares of a company are capital assets for a taxpayer.

However, there are certain assets which are excluded from the definition of capital assets viz. stock in trade, personal movable property, etc. The definition of capital asset as per section 2(14) of the IT Act has been reproduced below. 

""capital asset" means – 

(a) property of any kind held by an taxpayer, whether or not connected with his business or profession;

(b) any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 (15 of 1992),

but does not include – 

i. any stock-in-trade [other than the securities referred to in sub-clause (b)], consumable stores or raw materials held for the purposes of his business or profession;

ii. personal effects, that is to say, movable property (including wearing apparel and furniture) held for personal use by the taxpayer or any member of his family dependent on him, but excludes – 

1. jewellery;

2. archaeological collections;

3. drawings;

4. paintings;

5. sculptures; or

6. any work of art.
.......

Explanation. - For the removal of doubts, it is hereby clarified that "property" includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever” 

Thus, shares would qualify as a capital asset.

'Transfer' of capital asset

Transfer means giving up your right on an asset and includes sale, exchange, relinquishment, compulsory acquisition under any law, etc. The definition of transfer as per section 2(47) of the IT Act has been reproduced below.

As per the provisions of section 2(47) of the IT Act, 

""transfer", in relation to a capital asset, includes,—

(i) the sale, exchange or relinquishment of the asset ; or

...."

Thus, sale of shares of  NR to a R should qualify as a transfer of a capital asset under the provisions of the IT Act.

Certain transactions not regarded as ‘transfer’ under the IT Act

As per the provisions of section 47 of the IT Act, certain types of transfer are not treated as taxable transfers since they are specifically excluded by operation of law. 

However, transfer of shares of NR to R does not fall within the list of transfers not being treated as taxable transfers. Hence as per the provisions of section 45(1) of the IT Act, transfer of shares should be subject to capital gains tax in India. 

Types of capital gains and capital assets

Before determining the type of capital gains, one needs to determine the type of capital asset as the type of capital gains depends on the type of capital asset. The IT Act has classified capital assets into two categories:
  • Short term capital asset; and
  • Long term capital asset.
Whether a capital asset is short term or long term, will depend on the period of holding for which the particular asset was held by the owner before its transfer. As per the provisions of section 2(42A) of the IT Act, short-term capital asset means a capital asset held for not more than the period outlined below immediately preceding the date of its transfer. 
  • Listed security, unit of the UTI, unit of an equity oriented fund, zero coupon bond - 12 months
  • Unlisted share of a company - 24 months 
  • Any other capital asset - 36 months 
Section 2(29A) of the IT Act provides that Long-term capital asset means a capital asset which is not a short-term capital asset

The reason for bifurcation of capital asset into short term and long term is because of:
  • Difference in the rate levied on gain(s) on transfer of these capital assets to tax; and 
  • Set-off of losses arising from sale of capital asset. 
The tax on capital gains will be computed as per the below table which summarizes the key provisions under the Act relating to capital gains on sale of shares of an unlisted Indian company by an NR:
  • Long term capital gains - 10% (plus applicable surcharge and cess) [112(1)(c)(iii) of the IT Act] 
  • Short term capital gains - 40% (plus applicable surcharge and cess) [normal rate of tax applicable for an NR] 

Taxability under the provisions of  DTAA(s) - India - UK DTAA (as an example) 

As per the provisions of section 90(2) of the Act, a taxpayer who is an R of a country with which India has a Double Taxation Avoidance Agreement (hereinafter "DTAA"), has an option to be governed by the provisions of such DTAA or the Act, whichever is more beneficial

Here we are invoking the India - UK DTAA in which case we are stating that the NR is an R of UK and holds a valid tax residency certificate (hereinafter "TRC") issued by the UK tax authorities. 

Therefore, the provisions of the DTAA between India and UK should apply, to the extent they are more beneficial vis-à-vis the provisions of the Act.

As per the provisions of Article 14 of the India - UK DTAA:

"ARTICLE 14

CAPITAL GAINS


1. Except as provided in Article 8 (Air Transport) and 9 (Shipping) of this Convention, each Contracting State may tax capital gains in accordance with the provisions of its domestic law."

From the above, it can be observed that capital gains arising to a UK R from the alienation of shares of an Indian company (other than those provided for in Article 8 and Article 9) may be taxed according to the domestic laws of both the Countries. 

Hence the transfer of shares of NR to R shall be taxable in India both under the provisions of the IT Act as well as under India – UK DTAA.

Determination of sale consideration 

As per the provisions of section 50CA of the IT Act, 

“Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of consideration received or accruing as a result of such transfer.

…”

This section provides that where consideration for transfer of share of a company (other than quoted share) is less than the Fair Market Value (hereinafter "FMV") of such share determined in accordance with the prescribed manner, the FMV shall be deemed to be the full value of consideration for the purposes of computing income under the head "Capital gains".

Computation of Long-Term Capital Gains Liability (illustrative) [Section 112(1)(c)(iii)]

Particulars
Reference
Amounts (in INR)
Actual full value of consideration
A

Deemed full value of consideration [S. 50CA of the IT Act] 
A1

Less: Cost of Acquisition
B

Long term capital gains 
C = A1 – B [if A1> A] 

Tax on capital gains
10%

Add: Surcharge
at applicable rates

Add: Cess (on tax plus surcharge)
4%

Total capital gains tax



Withholding Tax Obligation

As per the provisions of section 195 of the IT Act

“Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LD or section 194LC) or section 194LD or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries") shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force:
…”

As per the above provisions, any person responsible for paying any sum to an NR which is chargeable to tax in India shall withhold tax on such income at rates in force. The payer needs to determine the amount of capital gains earned by the payee and deduct appropriate tax at source.

The Hon’ble Supreme Court in case of GE India Technology Cen. (P.) Ltd. has held that section 195 of the Act casts an obligation on payer to deduct tax at source from payments made to NR which are chargeable to tax; and therefore, where sum paid or credited by payer are not chargeable to tax, no obligation to deduct tax would arise.

Comments