Section 112(1) Capital gain to Non Resident arising from Sale of Shares of Indian Listed Company

Shagun Parashar for the Petitioner. Abhishek Maratha and Ms. Anshul Sharma for the Respondent.

ORDER

Sanjiv Khanna, J. – Cairn U.K. Holdings Limited questions order dated 1st August, 2011 passed by the Authority for Advance Rulings (AAR, in short).

2. Petitioner, a private limited company registered in Scotland, had earlier filed Special Leave Petition (Civil) No. 30343/2011 challenging the impugned order but vide order dated 30th July, 2012 the Supreme Court directed the petitioner to approach the High Court under Articles 226 and 227 of the Constitution of India. Thereafter, the present writ petition was filed.

3. Petitioner during the period relevant to the assessment year 2010-11 had transferred 4,36,00,000 equity shares of Rs.10/- each of Cairn India Limited to Petronas International Corporation Limited, Malaysia for consideration of US$ 241,426,379. This transaction dated 12th October, 2009, pursuant to an agreement dated 14th October, 2009, was an off market transaction i.e. not through a stock exchange. The transaction resulted in long-term capital gain of US$ 85,584,251 in the hands of the petitioner, after applying the benefit under first proviso to Section 48 of the Income Tax Act, 1961 (Act, for short). The question raised relates to the rate of tax applicable/payable on the long term capital gains earned.

4. On an application filed by the petitioner, AAR had framed the following question to be answered:—

“Whether on the stated facts and in law, the tax payable on long term capital gains arisen to CUHL on sale of equity shares of CIL will be 10% of the amount of capital gains as per proviso to Section 112(1) of the Act?”

5. The case of the petitioner was that under proviso to Section 112(1) they are liable to pay lower rate of tax @ 10% on the said long-term capital gains. The case of the Revenue i.e. Director of Income Tax (International Taxation) was that the proviso to Section 112(1) of the Act was not applicable and, therefore, the petitioner was liable to pay tax @ 20% on the long-term capital gains.

6. AAR has accepted the plea and contention of the Revenue and has held that the proviso to Section 112(1) was not applicable and, therefore, the petitioner cannot avail the lower rate of tax @ 10% on capital gains. The reason and ratio applied was that for the proviso to Section 112(1) to apply, second proviso to Section 48 should be also applicable and as second proviso to Section 48 was excluded and was not applicable to the petitioner, benefit of lower rate of tax @10% was not available.

7. In order to decide the question, we are required to interpret sections 48 and 112(1) of the Act. For the purpose of clarity and for understanding the controversy, the said Sections are reproduced below:

Section 48

’48. Mode of computation.— The income chargeable under the head “Capital gains” shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely:—

Provided that in the case of an assessee, who is a non-resident, capital gains arising from the transfer of a capital asset being shares in, or debentures of, an Indian company shall be computed by converting the cost of acquisition, expenditure incurred wholly and exclusively in connection with such transfer and the full value of the consideration received or accruing as a result of the transfer of the capital asset into the same foreign currency as was initially utilised in the purchase of the shares or debentures, and the capital gains so computed is such foreign currency shall be reconverted into Indian currency, so, however, that the aforesaid manner of computation of capital gains shall be applicable in respect of capital gains accruing or arising from every reinvestment thereafter in, and sale of, shares in, or debentures of, an Indian company:

Provided further that where long-term capital gains arises from the transfer of a long-term capital asset, other than capital gain arising to a non-resident from the transfer of shares in, or debentures of, an Indian company referred to in the first proviso, the provisions of clause (ii) shall have effect as if for the words “cost of acquisition” and “cost of any improvement”, the words “indexed cost of acquisition” and “indexed cost of any improvement” had respectively been substituted.

Provided also that nothing contained in the second proviso shall apply to the long-term capital gain arising from the transfer of a long-term capital asset being bond or debenture other than capital indexed bonds issued by the Government.

Provided also that where shares, debentures or warrants referred to in the proviso to clause (iii) of Section 47 are transferred under a gift or an irrevocable trust, the market value on the date of such transfer shall be deemed to be the full value of consideration received or accruing as a result of transfer for the purposes of this section.

Provided also that no deduction shall be allowed in computing the income chargeable under the head “Capital gains” in respect of any sum paid on account of securities transaction tax under Chapter VII of the Finance (No. 2) Act, 2004.

Explanation.—For the purposes of this section,—

Section 112

112. Tax on long-term capital gains.— (1) Where the total income of an assessee includes any income, arising from the transfer of a long-term capital asset, which is chargeable under the head “Capital gains”, the tax payable by the assessee on the total income shall be the aggregate of,—

Explanation.—

Provided that where the tax payable in respect of any income arising from the transfer of a long-term capital asset, [being listed securities or unit] [or zero coupon bond], exceeds ten per cent of the amount of capital gains before giving effect to the provisions of the second proviso to Section 48, then, such excess shall be ignored for the purpose of computing the tax payable by the assessee.

Explanation.—For the purposes of this sub-section-

8. As per Section 48, income chargeable under the head “capital gains” shall be calculated after deducting from the full value of consideration received or accruing, expenditure wholly and exclusively for the transfer in question plus the “cost of acquisition” of the asset and “cost of improvement” incurred.

9. First proviso to Section 48 applies to a non-resident, who has income by way of long term capital gains arising from transfer of a capital asset being shares or debentures of an Indian company, when the shares and debentures were acquired/purchased by conversion of foreign currency into Indian rupee (i.e. purchase price). In such cases capital gains is computed on reconversion of Indian rupee into the same foreign currency (i.e. sale price). The first proviso neutralizes exchange rate fluctuation in case the shares or debentures were purchased by a non-resident in foreign currency, which was converted.

10. The second proviso to Section 48 stipulates that where long-term capital gains results from transfer of a long-term capital asset, the words “cost of acquisition” and “cost of improvement” will be read as “index cost of acquisition” and “index cost of improvement”, respectively. The “index cost of acquisition” and “index cost of improvement” have been defined in the explanation to mean the amount calculated as provided by taking into consideration cost inflation index. The second proviso tends to neutralize the gain as a result of inflation, to ensure that the true gain or increase in capital value is tax and the gain as a result of inflation is not taxed. However, second proviso is not applicable to non-resident on transfer of shares or debentures of Indian company, referred to in the first proviso of Section 48. Thus, a non-resident, who is entitled to take benefit of the first proviso, i.e., neutralization of exchange rate fluctuation, cannot take benefit of “index cost of acquisition” or “index cost of improvement”.

11. The third proviso to Section 48 stipulates that the second proviso will not apply when long-term capital gain arises from transfer of a bond or debenture, other than capital index bonds issued by the Government.

12. Section 112(1) as the heading suggests, deals with rate of tax payable on the long-term capital gains. In case of a non-resident, sub-clause (c) to Section 112(1) applies. As per clause (c), income tax is calculated on long-term capital gains @ 20%.

13. Proviso to Section 112(1), however, gives a beneficial option to taxpayers on transfer of long-term capital asset being listed securities, units or zero per cent coupon bonds. They are liable to pay tax @ 10% on the amount of capital gains, but before giving effect to the provisions to the second proviso of Section 48, i.e., the assessee have the option to pay tax @ 10% without benefit of inflation indexation. Tax @ 10% is payable on the consideration received, less the expenditure wholly and exclusively incurred on the transfer, and the cost of acquisition and cost of improvement.

14. The petitioner submits that they are covered by the proviso to Section 112(1) as they are not taking benefit of indexation under the second proviso to Section 48. The assets sold by them were shares listed on the Bombay Stock Exchange and National Stock Exchange.

This satisfies the statutory requirement of assets to be listed securities. The proviso nowhere stipulates that if an assessee takes benefit of first proviso to Section 48, the proviso to Section 112(1) is not applicable. Neither does the language postulate that an assessee must be entitled to benefit of the second proviso to Section 48 and only when the said proviso is applicable but not applied, that an assessee can get benefit under proviso to Section 112(1) of the Act. Language of the provisions is clear and unambiguous. It is submitted that the view of the petitioner was repeatedly accepted and followed by the AAR at least in six prior cases before the present decision and even in one decision after the present decision. Our attention was drawn to the decision dated 1st October, 2007 in Timken France SAS, In re [2007] 294 ITR 513/164 Taxman 354 (AAR – New Delhi).

15. Learned Senior Standing Counsel for the Revenue, on the other hand, has placed reliance on the impugned order and the reasoning given therein. Second proviso to Section 48 should be applicable to an assessee before proviso to Section 112(1) could be applied. This was implicit from the provisions, when read together and from the purpose and intention behind the provisions.

16. The impugned decision dated 1st August, 2011 and the earlier decision of the AAR in Timken France SAS(supra) cannot be reconciled and are diametrically opposite. We have to decide which of the two legal findings and ratio is correct. This is a classic case where provisions have been interpreted with operatic opposite conclusions by applying two different principles of interpretation to enunciate and propound the legislative intent. In the case in hand contextual or purposive interpretation principle has been adopted, whereas in the earlier decision of Timken France SAS, In re (supra), literal interpretation rule was applied and contextual interpretation, it was held, should not be adopted because the purpose itself was ambiguous. It has also been observed that contextual interpretation put forward by the Revenue was faulty and misconceived.

17. In Timken France SAS, In re (supra), the reasoning of AAR can be crystallized as under:

18. AAR in the present or the impugned order has given the following reasoning:

19. Having considered the two provisions i.e. Section 48 and Section 112(1) of the Act, the reasoning given in the case of the petitioner and in Timken France SAS (supra), we are inclined to accept the legal position approved and accepted in Timken France SAS (supra). Our reasons are elucidated below.

20. Language of proviso to Section 112(1) syntactically and grammatically mandates one interpretation. If one squarely focuses and orates the words used in the proviso and interprets them without extracting or subtracting any phrase or word, a non-resident assessee is entitled to benefit of the said provision. The proviso to Section 112(1) of the Act does not state that an assessee, who avails benefits of the first proviso to Section 48, is not entitled to benefit of lower rate of tax @ 10%. The said benefit cannot be denied because the second proviso to Section 48 is not applicable. The stipulation for taking advantage of the proviso to Section 112(1) is that the aggregate of long-term capital gains to the extent it exceeds 10% of the amount of capital gains, should be before giving effect to the provisions of second proviso to Section 48. Inflation indexation shall be ignored. In case the Legislature wanted to deny the said advantage/benefit where the assessee had taken benefit of the first proviso to Section 48, it was easy and this would have been specifically stipulated, that an assessee, who takes advantage of neutralization of exchange rate fluctuation under the first proviso to Section 48 would not be entitled to pay lower rate of tax @10%. Legislature had a far easier and simpler way to deny benefit of the proviso to Section 112(1) by using different words and phrases had thus been the intention. The legislature in fact did not intend to deny the said benefit.

21. In Section 115AD(3) it is noticeably stipulated that nothing contained in the first and second proviso to Section 48 shall apply to transfer of securities and capital gains referred to in sub-section 1(b) of the said section.

22. High Court of Andhra Pradesh in their recent decision in W.P.(C) 14212/2010, Sanofi Pasteur Holding SAv. Department of Revenue, Ministry of Finance [2013] 354 ITR 316/213 Taxman 504/30 taxmann.com 222 has lucidly observed and laid down the following principles:—

“We notice and have endeavored to conform to principles of statutory construction, relevant to the lis before us. We are conscious that the democratic integrity of law, depends entirely upon the degree to which its processes are legitimate and as Judge Robert H. Bork cautioned, a judge who announces a decision must be able to demonstrate that he began from recognized legal principles and reasoned in an intellectually coherent and politically neutral way to his result; and that the desire to do justice, whose nature seems to him obvious, is compelling while the concept of the legal process is abstract, the signals occasionally ambivalent and the abstinence it counsels (from encroaching into the realm of other organs of Government) unsatisfying. We are also conscious of Cardozo’s stately admonition, more appropriate to pursuing the interpretive role in adjudication; and that choice of appropriate interpretive principles is a hermeneutic choice not a political or a policy choice. The relevant principles:

23. Courts are bestowed with the power to interpret Legislation and decide what is the Legislative intent behind a provision. The court declares the legal meaning of what is intended by the Legislature. There is difference between legal meaning and literal meaning which is equivalent to grammatical or linguistic meaning. Normally, the legal meaning of an enactment corresponds to the grammatical meaning. Linguistic or grammatical interpretation means, the meaning as the word bears when construed according to rules and usages of grammar, syntax, punctuation and linguistic canons of construction. Legal meaning does not mean ignoring rational reasoning but accepts that the legislative intent is best stated in the words used. The words reflect the legislative intent and the court should not enact or create Legislation by adding or subtracting words to the provision. Nevertheless the courts have accepted another principle of interpretation, contextual or purposive interpretation which may ignore the literal meaning when one or more of the following tests are satisfied:

24. Blackstone has written “In general law all cases cannot be foreseen, or if foreseen cannot be expressed: some will arise that will fall within the meaning, though not within the words of the Legislation, and others which may fall within the letter may be contrary to the meaning, though not expressly expected. These cases thus out of the letter, are often said to be within the equity of an act of Parliament, so cases within the letter are often out of the equity.”

25. The above principles elucidate that literal meaning of the provision carry weight but Judges and interpreters recognize that some cases justify another interpretational criterion. However, the textual ambiguity should not be presumed on the basis of apriori ideas or thinking as to the Legislative intent or readily accepting the argument of fallible drafter. Court should not doubt the grammatical meaning merely on conjecture or fanciful reasoning to hold that doubt or ambiguity is real and substantial. Hairsplitting and unduly recondite arguments have to be rejected. The rule laid down by Oliver LJ in relation to taxing statute is “that the subject is not to be taxed except by clear words, the words must, nevertheless, be construed in the context of the provisions in which they appear and of the intention patently discernible on the face of those provisions from the words used”. [see Wicks v. Firth (Inspector of Taxes), 1982 Ch.355)] .

26. From the reasoning given in the impugned order, it is apparent that contextual and purposive interpretation has been adopted mainly on the following grounds; non-resident under the first proviso to Section 48 are entitled to neutralize exchange rate fluctuation for computing long-term capital gains, when the shares/derivatives were purchased utilising foreign currency. The second proviso is not applicable to non-residents covered by the first proviso and entitles an assessee to claim benefit of indexation while computing long-term capital gains. Thus the second proviso to Section 48 has object of neutralizing the effect of inflation. Proviso to Section 112(1) is certainly not applicable in case where an assessee is entitled to benefit of indexation under the second proviso to Section 48. If an assessee does not take benefit of indexation under the second proviso of section 48, they are eligible for the lower rate of tax @10%. Otherwise, an assessee is liable to pay tax @ 20% after taking benefit of indexation. If an assessee covered by the first proviso to Section 48 is allowed benefit of the proviso to Section 112(1), two consequences flow: (i) a non-resident becomes entitled to two or double deductions. Firstly, under the first proviso to Section 48 and then benefit of lower rate of tax under the proviso to Section 112(1); and (ii) this interpretation would discriminate between the assessees covered by the first proviso and those covered by the second proviso to Section 48.

27. Similar contention was raised on behalf of the Revenue in the case of Timken France SAS (supra) but was rejected observing that the circular of the Central Board of Direct Taxes or explanatory memoranda were not equivocal and clear enough to throw light on the rationale of extending or not extending the benefit of reduced rate of tax in terms of the proviso to Section 112(1). The expression ‘level playing field’ was flexible and capable of being understood in more than one way. The argument of double benefit was not a taboo under law and protection against exchange rate fluctuation under the first proviso to Section 48 does not go against the concept of lower rate of tax. It has been further observed that enquiry to delve into legislative intent and purpose would be a hazardous guess.

28. Argument of the Revenue on the surface is plausible, but on deeper scrutiny, we do not think that contextual interpretation underscoring contention of the Revenue is applicable and the contention or plea is in fact reflective of the true intention of the legislature.

29. First proviso to Section 48 is applicable when a non-resident had purchased an asset being a share or debenture with foreign currency, converted into Indian rupee. It stipulates that on transfer or sale of the said share or debenture the consideration received in Indian rupee should be reconverted into the same foreign currency. Sale and purchase of shares has to be in Indian rupee, the legal tender in India, but the foreign investor had brought in foreign currency and, therefore, logically and naturally for him, the gain should be computed in foreign currency. The said investor would like to convert the sale consideration received in Indian rupee into foreign currency. This would reflect the true gain or income earned. For a non-resident who has utilized/brought in foreign currency for purchase of shares or debentures in Indian rupee, inflation in India is immaterial and inconsequential. For him, the gain or loss is to be computed with reference to the foreign currency utilized for purchase and foreign currency available to him for repatriation after the sale. From the said assessee’s view point and objective, he is most concerned with exchange rate fluctuation and his true and actual gain should take into account the exchange rate fluctuation. The second proviso is applicable to all others including non-residents, who are not covered by the first proviso and they are entitled to benefit of cost of indexation which neutralize inflation. It is a misnomer and wrong to state that inflation alone contributes and is the determinative factor in exchange rate fluctuation. No doubt, a country with persistent low inflation can expect rising currency value as purchasing power increases in relation to other currencies with high inflation rate, but it is equally true that countries with typically higher inflation rate might not see corresponding or equal depreciation in their currency value. Inflation by itself cannot be the sole or even a primary factor in exchange rate depreciation. Current account deficit and public debt, terms of trade, political stability, economic performance, etc. are various other factors, which determine the exchange rate. These are complex factors and several parameters can affect the foreign exchange rate fluctuation and, therefore, persons affected by exchange rate fluctuation indulge in hedging.

30. Inflation in India has been relatively high but there have been occasions when Indian rupee has appreciated against foreign currencies for varied and diverse reasons. Indian rupee had earlier appreciated, before the present day depreciation, in spite of the fact that India had relatively higher rate of inflation as compared to several countries. It is difficult to determine which factors are the most relevant for determining exchange rate fluctuation. There are several important causes or factors, which are opaque in principle and difficult to decipher and pin-point in practice.

31. As already stated above, the first proviso to Section 48 ensures that a non-resident, who utilized his foreign currency, is taxed after taking into consideration the fluctuation in exchange rate. Indian rupee can and has in past appreciated against foreign currencies. In such cases, the long-term capital gains payable can increase. On the contrary we are not aware of occasions of deflation in India in last two decades and it would be incorrect to hold that the Legislature while enacting the second proviso had in mind or assumed that there would be deflation. The two provisos cannot be equated as granting same relief or benefit. They operate independently and have different purpose and objective.

32. In view of the above, it is difficult to state that benefits under the first proviso and the second proviso to Section 48 are identical or serve the same purpose.

33. There is some merit in the contention that if proviso to Section 112(1) is applied, then almost all assessees covered by the first proviso to Section 48 would be liable to pay tax @ 10% only and not @ 20% on long-term capital gains. This appears to be correct and a logical consequence of the proviso to Section 112(1) and the interpretation given by us, but this cannot be a ground to contextually read the proviso to Section 112(1) differently. The said proviso is applicable to listed securities or units or zero coupon bonds. Long-term capital gain is not payable on listed securities sold through stock exchanges as STT is payable. First proviso to Section 48 is applicable on sale of shares or debentures in Indian company, whether or not the said shares or debentures are listed or not. Thus, proviso to Section 112(1) is more restrictive and will not necessarily apply in all cases covered by the first proviso to Section 48. Secondly, the proviso to Section 112(1) is not applicable to debentures. Nevertheless, the proviso to Section 112(1) is applicable to units and zero coupon bonds, which are not covered by the first proviso to section 48 of the Act. Second proviso to Section 48 is not applicable on transfer of long-term capital asset being bond, debenture other than the capital index bond. Zero coupon bonds are, however, specifically made eligible for benefit under the proviso to Section 112(1).

34. It is clear from the aforesaid discussion that it is not possible to decipher and clearly elucidate the exact legislative purpose and object behind the proviso to Section 112(1) in a categorical and unambiguous manner. The purpose and object behind the proviso to Section 112(1) itself is somewhat debatable, except that the legislative intention was to tax long-term capital gain on listed shares, bonds and units @ 10%, without benefit of indexation under second proviso to Section 48 of the Act. Legislative policy and object is nothing more, and it is impermissible to read into the said provision an affirmative legislative intention on assumption and guess work and this would be beyond the acceptable principles of interpretation.

35. There is another aspect which should be taken into consideration and not ignored. Decision in the case ofTimkin France SAS (supra) was pronounced on 1st October, 2007, which has been followed by AAR in several cases over the last 3-4 years. Several decisions of AAR have been accepted by the Revenue on merits. We are informed that there are six such decisions and only in one case Revenue has challenged the decision of AAR. The decision of AAR in the present case dated 1st August, 2011, taking a diametrically reverse view has brought about an uncertainty in understanding the impact and the effect of the proviso to Section 112(1). Certainty is integral to rule of law. Certainty and stability form the basis foundation of any fiscal laws. Highlighting this fact in Vodafone International Holdings B.V. v. Union of India [2012] 341 ITR 1/204 Taxman 408/17 taxmann.com 202, the Supreme Court has observed that foreign direct investment flows towards a location with a strong governance infrastructure which includes enforcement of laws and how well the legal system work. There should be consistency and uniformity in interpretation of provisions as uncertainties can disable and harm governance of tax laws. Authority should follow their earlier view, unless there are strong grounds and reasons to take a contrary view, but in the present case there is no compelling justification and reason to override and disturb the earlier view.

36. With the aforesaid observations, we allow the present writ petition and a writ of certiorari is issued and the impugned decision dated 1st August, 2011 passed by the Advance Ruling Authority in AAR No.950/2010 is quashed. It is declared that the petitioner will be entitled to benefit of proviso to Section 112(1) of the Act on sale of equity shares in question. This direction is being issued as it is not disputed and contested before us that other conditions of first proviso to Section 112(1) of the Act are satisfied.

37. The writ petition is accordingly disposed of. There will be no order as to costs.