5 min read.Updated: 08 Oct 2020, 12:58 PM ISTVikas Vasal
Under the Income Tax Act, 1961 (Act), taxability arises on 'transfer' of a 'capital asset' situated in India irrespective of the place of receipt of consideration
India has witnessed steady inflow of investments from foreign investors since it started its liberalization program in early 1990s.
This gives rise to a consequential question about the taxability of such investment in the hands of non-resident investors, especially where assets are transferred to another non-resident and the consideration is also received outside India.
Under the Income Tax Act, 1961 (Act), taxability arises on “transfer" of a “capital asset" situated in India irrespective of the place of receipt of consideration.
However, non-residents can evaluate if there is any relief available, both in terms of scope and rate of tax, under the tax treaty between India and their home country.
Capital assets and transfer
Under the Act, “capital asset" has been defined widely to include property/asset of any kind held by a taxpayer and includes shares or securities of an Indian company. However, it does not include stock in trade, consumable stores or raw materials held for the purposes of business or profession and personal effects of the transferor.
Certain other specified assets have also been kept outside this definition. Similarly, “transfer" has been defined exhaustively and inter-alia includes sale, exchange, relinquishment and extinguishment of rights. Capital gain income is taxable in the financial year (1 April to 31 March of the following year) in which transfer of the capital asset takes place.
The Act contains indirect transfer provisions as well. Accordingly, shares of an overseas company which derive its value substantially, directly or indirectly from the assets located in India, are deemed to be assets situated in India. Direct or indirect transfer of such share triggers tax liability in India.
Based on the period of holding, capital assets are classified as either short-term or long-term capital assets.
Short-term capital asset means any capital asset held by a taxpayer for not more than 36 months immediately preceding the date of its transfer. However, in the case of unlisted shares of an Indian company or an immovable property, being land or building or both, the holding period prescribed is 24 months. This period is further reduced to 12 months in case of India-listed securities and units of an equity-oriented funds. Long-term capital asset means any capital asset other than a short-term capital asset.
This classification between short-term and long-term capital asset is important as it has a bearing on the computation mechanism to be followed and the rate of tax. Capital gain on transfer of short-term capital assets or long-term capital asset is referred to as short term capital gain (STCG) or long-term capital gain (LTCG) respectively.
There are few specific carve-outs provided under the Act and accordingly, certain specified transactions are not considered as “transfers". Consequentially, there is no capital gain implications in such cases. Some key exemptions are:
· Transfer of capital asset under gift, under a will or to an irrecoverable trust;
· Transfer of capital asset by a company to its Indian subsidiary, provided specified conditions are met;
· Transfer of shares of an Indian company pursuant to tax neutral amalgamation/ demerger of foreign companies, provided specified conditions are met; and
· Transfer of bonds or Global Depository Receipts, rupee denominated bond of an Indian company, derivative made by a non-resident in recognized stock exchange located in any International Financial Services Center, if specified conditions are met.
Typically, to compute capital gain, the full value of the consideration received or accruing, is reduced by:
· Cost of acquisition of the asset; and
· Cost of any improvement; and
· Expenditure incurred wholly and exclusively in connection with such transfer.
In the case of a non-resident, capital gains arising from the transfer of shares or debentures of an Indian company are computed by converting the cost of acquisition, expenditure incurred in connection with transfer and the sale consideration into the same foreign currency as was initially utilized to purchase them. Post that, the capital gains so computed is reconverted into Indian currency. The intent behind this computation mechanism is to neutralize the impact of any foreign exchange fluctuations.
In case of other long-term assets, indexation benefit is available. The intent in this case is to neutralize the impact of inflation, to the extent possible.
Some key tax rates applicable in case of non-residents are:
· STCG in the case of an equity share in an Indian company or a unit of an equity-oriented fund and subject to securities transaction tax are chargeable at the rate of 15%.STCG on transfer of any other capital asset are taxable as per prescribed slab rates for individuals and 40% in case of non-resident companies.
· LTCG arising from transfer of unlisted securities or shares of a closely held company, is chargeable to tax in India at 10%, without giving indexation benefits and adjustment on account of forex fluctuation. LTCG on transfer of long-term capital asset being shares of a listed company or a unit of an equity oriented fund, if such gains exceed ₹0.1 million in a financial year (subject to certain condition relating to payment of securities transaction tax ) is taxable at 10%. In case of any other long-term capital assets, LTCG is chargeable at 20%.
There are tax controversies around provisions dealing with off-market sale of shares. Further, there are certain provisions dealing with capital gains in case of specified investors and/ or specified assets as well.
It is important to note that the tax rates are further increased by surcharge and cess, applicable in case of non-residents. Non-residents can, however, evaluate if any benefit is available under the tax treaty applicable in their case.
Transfer of capital assets requires various compliances to be completed both from transferor and transferee’s perspective. The transferee is required to withhold appropriate tax and remit it to the government. Obtaining a lower tax/nil withholding certificate from the tax department may also be required in some cases. In addition, non-residents are also required to file their Income tax return in India in case of transfer of capital asset in India. Non-compliance could invite penal consequences.
In the recent past, though several steps have been taken by the Indian government to simplify the tax regime including compliances, taxation of capital gains tax, in general, continues to be complex and litigation-prone. In fact, some of the cases have travelled up to the Supreme Court and invited global attention as well. Hence, non-residents should ensure that the applicable compliances are carried out in a timely manner.
Subham Kumar and Ankita Baid contributed to the article.
Vikas Vasal is national leader, tax, Grant Thornton India LLP.
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