The stock market today is open for both residents and non-residents. While the long-term gain from the transfer of unlisted securities is taxable at 20%, gains in the case of listed securities are taxable only at 10% (without indexation) under the proviso to Section 112 of the Indian Income Tax Act. The question that arises in such cases is whether the benefit of reduced rate of 10% is applicable only to resident taxpayers or to non-resident taxpayers also.

Long-term gains arising on transfer of listed shares if entered into on a recognised stock exchange and subjected to securities transaction tax (STT) have already been exempted from income tax by the Finance Act 2004. The only dispute, therefore, remains in the case of listed securities traded otherwise than through recognised stock exchange.

The proviso to Section 112, which provides for the reduced rate of 10% in case of listed securities, deploys the expression before giving effect to the second proviso to Section 48. Second proviso to Section 48 provides for indexation benefits and is not applicable to sale of shares by non-residents to whom the first proviso to Section 48 (providing protection from foreign exchange fluctuations) applies.

Therefore, a controversy arises whether the words before giving effect to the second proviso to Section 48 used in the proviso to Section 112 has the effect of excluding those who cannot avail of the indexation benefit under the second proviso to Section 48, that is to say, non-residents.

The authority till now available in this respect was a decision of the Mumbai Tribunal in 2005 (ITA No 2552) wherein the Tribunal had held that as no effect had to be given for indexation in case of non-residents, the benefit under this section would also not be available to them and hence such long-term gains are taxable at 20%.

However, the Authority for Advance Rulings (AAR) has recently given a new turn to the controversy in the case of Timken France vs. DIT (294 ITR 513) by taking a view that the benefit of the proviso to Section 112 cannot be denied to the non-residents/foreign companies that are entitled to a different relief in terms of first proviso to Section 48.

The AAR has, in giving the said ruling, expressly differed from the interpretation adopted by the Tribunal and held that the benefit of concessional rate of 10% is available to all categories of taxpayers discussed in Section 112 (including non-residents) and clear words would have been deployed in the proviso if one particular category - for example, non-residents, were to be excluded. The AAR further noted that the words before giving effect to the second proviso to Section 48 do not by necessary implication exclude those ineligible for it and the eligibility to avail the benefit of indexation was not a sine qua non for applying the reduced rate of 10% prescribed by the proviso to Section 112.

The AAR also opined that the same interpretation would hold good for bonus shares also as the legislature did not intend to differentiate between the original and bonus shares in the matter of application of rate of tax.

The ruling by the AAR has come as a welcome relief to non-resident investors. However, as the ruling given by the AAR is binding only on the applicant who has sought the ruling and only has a persuasive/ argumentative value in other cases, the issue could lead to further litigation that can only be settled by the higher courts.

Till such resolution comes about, non-residents taxpayers may take an advance ruling in respect of such transactions to mitigate the associated risks.

Sunil M Lala is executive director and Pawan Kumar is associate director with PricewaterhouseCoopersTax Litigation Cell