Facts of the case
As part of a reorganisation arising from bankruptcy proceedings Dana Corporation (DC), a US company, transferred shares in three Indian companies, along with the shares in other companies worldwide, to two of its subsidiary companies in the US. Subsequently, two new companies Dana Holding Company (DHC) and its 100% subsidiary Dana Companies Limited Liability Company (DC LLC) were set up in the US. The shares in the two subsidiary companies were then transferred to DHC, and DC was merged into DC LLC. In terms of the reorganisation proposal, liabilities of DC that were transferred to DHC were more than the assets that were transferred. Share transfer agreements were executed according to which the transfer was effected without consideration.
Question before AAR
DC LLC (as the successor of DC) filed an application with the AAR as to whether the transfer of shares of the Indian companies, by DC, is taxable under the Act.
Section 45 charges the profits or gains arising from the transfer of a capital asset to income tax and it shall be deemed to be the income of the previous year in which the transfer took place. Section 48 provides for “mode of computation” of capital gains. It is settled law that section 45 must be read with section 48 and if the computation provision cannot be given effect to for any reason, the charge under section 45 fails [reliance was placed on the Supreme Court decision in the case of CIT v BC Srinivasa Setty [(1981) 128 ITR 294] and Sunil Siddharthbhai v CIT [156 ITR 509].
The AAR held that the profit or gain arising to the transferor must be a distinctly and clearly identifiable component of the transaction. The consideration for the transfer of shares in terms of money or money’s worth is not something which can be implied or assumed. Shares may have been notionally valued for the purpose of preparing the financial statements of DHC or to facilitate the reorganisation process, however, it cannot be reasonably said that the book value or the market value of the shares really represents the consideration for the transfer or the profit arising from the transfer. In this context, DC had clarified that the valuation of individual assets was the value of the reorganised entity, that is, DHC, and had nothing to do with the value of the assets and liabilities of the entity under reorganisation, that is DC.
Where the application of transfer pricing regulations is concerned, the AAR held that section 92 of the Act is not an independent charging provision. It is a provision dealing with “computation of income from international transactions”. Meaning, the income referred in section 92 is nothing but the income captured by one or the other charging provisions of the Act. Section 92 is not intended to bring in a new head of income or charge the tax on income, which is otherwise not chargeable under the Act. If the charging section 45 fails, then section 92 does not come to the aid of the Revenue, even though it is an international transaction.
In view of this, the AAR held that the transfer of shares of the three Indian companies does not incur capital gains tax in India.
Scope of rules
This ruling emphasises that the transfer pricing provisions ought to apply only when income arises from an international transaction. Where no income arises under the charging provisions of the Act, the machinery provisions would not apply. The transfer pricing provisions of the Act are not intended to bring to charge income which is not otherwise chargeable.
It is interesting to note that the AAR also distinguished this ruling from another of its ruling in the case of Canoro Resources. The AAR held that the issue under consideration in this case was not about whether the income was taxable as capital gains but on the mode of computation.
Although, an AAR ruling is binding only on the applicant and the tax authority, it does have persuasive value and the revenue authorities and appellate authorities do take note of the principles laid down by the AAR in deciding similar cases.
Considering the significant transfer pricing adjustments in the recent past, this ruling provides a welcome relief to taxpayers for international transactions where no income arises under the charging provisions.
Samir Gandhi (firstname.lastname@example.org), Manisha Gupta (email@example.com) and Bhavik Mehta (firstname.lastname@example.org) of Deloitte Haskins and Sells in India.
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