October 28, 2013
Delhi High Court Applies Reduced 10% Rate to Non-Resident Capital Gains
The Delhi High Court has recently held in the case of Cairn U.K. Holdings Ltd ("CUHL")1, that a non-resident investor is entitled to the reduced 10%2 tax rate on long term capital gains3 from sale of listed securities off the floor of the stock exchange. Ordinarily, such gains from sale of listed securities off the floor of the stock exchange would be taxable at 20%.
The petitioner CUHL is a private limited company registered in Scotland. CUHL sold its 2.29% stake in an Indian listed company, Cairns India Ltd. ("CIL") for a consideration of USD 241,426,378. This transfer took place off-market. CUHL sought a ruling from the Authority for Advance Rulings ("AAR") on whether such gains were entitled to the beneficial 10% tax rate under the proviso to section 112(1) of the Income Tax Act, 1961 ("ITA"). The AAR ruled in the negative, reversing all its earlier judgments4 (our earlier hotline on the AAR ruling can be accessed at: http://tmp.nishithdesai.com/old/New_Hotline/Tax/taxhotline_Aug_25.htm). Consequently, CUHL filed a special leave petition before the Supreme Court ("SC") challenging the AAR's ruling. Pursuant to the SC ruling in Columbia Sportswear5 (our earlier hotline on the SC ruling can be accessed at: http://tmp.nishithdesai.com/old/New_Hotline/Tax/Tax%20Hotline_Aug1712.htm), the taxpayer was directed to approach the High Court, as a result of which this writ petition was filed.
ARGUMENTS AND RULING
The case revolved around the applicability of the proviso to section 112(1) ("Proviso"). The Proviso levies a reduced 10% tax on long term capital gains covered within its ambit, as compared to higher rates of tax otherwise prescribed in section 112(1). Thus, the issue was whether long term capital gains of a non-resident from transfer of listed shares is entitled to the benefit of the Proviso, as compared to section 112(1)(c)(ii), which levies a 20% tax on such transfer. The Proviso reads:
The second proviso to section 48 provides indexation benefit to offset the effect of inflation while calculating long term capital gains, except those arising from transfer of shares / debentures by a non-resident (for which the ITA provides benefit of offsetting exchange rate fluctuations). The third proviso to Section 48 also excludes gains from transfer of bonds and debentures (other than capital indexed bonds issued by the government) from the second proviso. In this context, the issue in this case was whether the language of the Proviso quoted above restricts its applicability to only those transfers entitled to the benefit of inflation indexation under the second proviso.
It was argued by the Petitioner that the lower rate of 10% should be allowed to them because: (a) There is no prohibition on double benefit to non-residents from allowance of exchange rate fluctuations and reduced tax rate of 10%; (b) The language of the Proviso is unambiguous and it should therefore be interpreted literally; (c) A contrary interpretation would render the reference to zero coupon bonds in the Proviso redundant, since the third proviso to section 48 expressly excludes bonds from the Referred Proviso). The revenue authorities argued that denying a non-resident taxpayer the benefit of the 10% rate would lead to equality in the treatment of residents and non-residents. They also argued that the purpose and intention implicit in the language of the Proviso should lead to a denial of the 10% beneficial rate.
Delhi High Court Ruling: On the technical arguments made, the Delhi High Court ruled in favour of the Petitioner, also reasoning that the benefit of offsetting exchange rate fluctuations (which benefit is in addition to the benefit under the Proviso), cannot be equated with the benefit under the second proviso for offsetting inflation as inflation is not the only factor which contributes to exchange rate fluctuations. The High Court also made some important observations on the obligation of the AAR to follow its earlier rulings and held that it should do so "unless there are strong grounds and reasons to take a contrary view" as "[c]ertainty is integral to rule of law" and is the foundation of tax law.
This judgment brings about long-awaited clarity on non-resident investors being eligible to a lower rate of 10% on transfer of listed securities of Indian companies. There continues to be uncertainty in relation to the rate applicable to transfer of unlisted securities, and whether this should be 10% or 20% (our earlier hotline which also discusses the uncertainty, as one of the changes introduced by the 2012-13 budget, can be accessed at: http://tmp.nishithdesai.com/old/Budget2012/BUDGET%20HOTLINE_March1712.htm).
Further, the decision of the Delhi High Court that an AAR ruling should maintain consistency with its earlier rulings is a step forward in bringing certainty in tax laws. While AAR rulings are binding only on the parties involved, this is especially important as there have been many recent instances (involving varied questions of law) where the AAR has passed rulings contrary to its sound earlier rulings on the same question of law. It is also relevant to note that within the one and a half years since the Supreme Court's ruling in Columbia Sportswear which disposed nine petitions and appeals together (our earlier hotline on the SC ruling can be accessed at: http://tmp.nishithdesai.com/old/New_Hotline/Tax/Tax%20Hotline_Aug1712.htm), about five High Court decisions (including this ruling)6 have concluded and been ruled on, which is a positive sign considering the general time taken by the Indian judicial process. This is based on the Supreme Court's instructions that these petitions from AAR applications be disposed of on an expeditious basis, to provide certainty. Thus, while there continue to be challenges involved in navigating through tax controversies in India, rulings such as Cairn provide some relief to non-resident investors.
1 Cairn U.K. Holdings Ltd. v. DIT, dated October 7, 2013.
2 All tax rates mentioned in this hotline are exclusive of applicable surcharge and education cess
3 They refer to gains from transfer of capital assets held for more than prescribed period (3 years generally and 1 year in case of shares, listed securities, mutual fund units, Unit Trust of India units and zero coupon bonds) prior to being transferred.
4 In re, Timken France,  164 Taxman 354 (AAR); In re, McLeod Russel India Ltd.,  168 Taxman 175 (AAR); In re, Burmah Castrol Plc.,  175 Taxman 353 (AAR); In re, Compagnie Financiere Hamon,  177 Taxman 511 (AAR); In re, Four Star Oil & Gas Co.,  179 Taxman 167 (AAR); In re, Fujitsu Services Ltd.,  182 Taxman 263 (AAR).
5 Columbia Sportswear Co. v. DIT, 2012] 210 Taxman 42 (SC).
6 The other rulings are NETAPP B.V. vs. AAR,  213 Taxman 427 (Delhi); DIT v. Goodyear Tire & Rubber Co.,  214 Taxman 669 (Delhi); Sanofi Pasteur Holding SA vs. Department of Revenue, Ministry of Finance,  213 Taxman 504 (Andhra Pradesh); DIT vs. OHM Ltd.,  212 Taxman 440 (Punjab & Haryana).