It is quite common these days that foreign companies, which hold shares in Indian companies (whether as holding companies or otherwise), transfer the Indian shares to other group companies or other non-residents outside India.
When the transaction of sale and purchase takes place outside India between the two non-residents, a question arises as to whether any capital gains tax would be chargeable in India or not. In such a situation, does the transaction has any nexus with India?
The above issue has been recently examined by Authority for Advance Rulings in case of Trinity Corporation, (2007) 165 Taxman, 272. In the said case, a non-resident was a shareholder in an Indian company. He entered into an agreement with a USA-based company, to transfer his aforesaid shares to the US company in a phased manner.
The share transfer agreement was entered and executed in the USA. The US company filed an application seeking advance ruling on the questions: (i) Whether transfer of shares by the non-resident to the US company is liable for capital gains tax in India and (ii) whether the applicant, transferee of shares in question, is liable for capital gains tax on purchase of such shares as an agent/representative assessee of transferor as per provisions of Income Tax Act.
Section 9(1)(i) of the Income Tax Act specifically provides that income through the transfer of a capital asset situated in India will be deemed to accrue or arise in India.
The Authority therefore observed that: The insertion of the clause, i.e., the situs of the capital asset being in India, has been ushered in the statute to take care of the situations like transactions between two non-residents taking place outside India. In simple words, even if the transaction relating to a capital asset takes place outside India, but if the capital asset is situated in India, the profits or gains thereon is accruing or arising in India in consonance with the provisions of section 9(1)(i) of the Act and is thus assessable under the head Capital gains under the relevant provisions of Income-tax Act.
When a transaction of sale and purchase is made amongst non-residents wholly outside India, no consideration will be remitted to India or from India.
Therefore, there may be practical difficulties in collection of tax by Indian authorities. Tax is basically payable by the seller of shares. But where the capital gains arise to the non-resident by reason of transfer of capital assets situated in India, the transferee may be assessed as a representative assessee of the transferor.
In the above case, the Authority observed that the US company, the transferee, has purchased the asset and has also paid the sale-consideration. Such transferee, as the provision of the section 163 of the Act stipulates, may either be a resident or non-resident. The Indian Parliament has devised the method of deeming the capital gains as having accrued or arisen in India so that on the basis of such deeming fiction, the tax authorities are entitled to levy tax on the transferee (purchaser), as a representative assessee, and the tax can be realised from him.
Interpretation of Indian law as discussed above, is of course subject to specific provision, if any, in the relevant tax treaty.
Therefore, unless the tax treaty provides otherwise, capital gains arising on sale of an Indian companys shares will be liable to tax in India even if the transaction takes place between non-residents wholly outside India.