[Swetha is a student at Gujarat National Law University.]
The recent case of Legatum Ventures Limited v. ACIT (Legatum Ventures) has served to muddy the waters than towards the development of our Income Tax regime. The Income Tax Appellate Tribunal, Mumbai (ITAT) has ruled that the capital gain for a foreign company on selling shares of an unlisted Indian company is to be computed without giving effect to foreign exchange fluctuations.
The interpretation of the law regarding long-term capital gains Legatum Ventures has significant implications in the attribution of profit in India. This is because it affects the computation of capital gains for non-residents by establishing that the taxing provision under Section 112(1)(c)(iii) of the Income-tax Act 1961 (Act) will prevail over the general computation under Section 48 in matters dealing with unlisted shares.
The article analyses the recent order interpreting Sections 112(1)(c)(iii) and 48 of the Act by assessing whether the use of the maxim generalia specialibus non derogant to this case was correct or whether it goes beyond the powers of ITAT. The author concludes by stating that this tribunal’s interpretation will have certain legal implications, thus, an appeal should be pursued.
Brief Factual Matrix
The company being evaluated was established in the United Arab Emirates and was primarily engaged in investment activities. During the examination, the Assessing Officer (AO) noticed that the company had sold shares of an unlisted Indian private limited company and calculated the capital gains using the first proviso to Section 48 of the Act, along with Rule 115A of the Income Tax Rules 1962. This calculation resulted in a loss of INR 3,63,87,392. Consequently, the assessee filed a tax return with nil income.
Later, the tax return filed by the assessee was chosen for an audit, and the AO argued that capital gains on the sale of unlisted shares should only be computed according to Section 112(1)(c)(iii) of Act. According to this section, the first proviso should be disregarded. As a result, the AO assessed the Assessee's total income at INR 17,13,59,838 which was to be taxed at 10%.
Section 48 merely specifies the method of calculating income in the form of capital gains and the effect of foreign exchange fluctuations on non-residents' income is basically mitigated by the first proviso of the section. Meanwhile Section 112 establishes the tax rate (10%) applicable to long-term capital gains.
The AO determined that the provision of Section 112(1)(c)(iii) is applicable only to non-residents. Consequently, the AO calculated the capital gains using Section 112(1)(c)(iii), resulting in its finding of long-term capital gains exceeding INR 17 crores.
Aggrieved by the order, the assessee objected before the Dispute Resolution Panel (DRP). The DRP upheld the AO's additions. In response to DRP’s order, the assessee appealed to ITAT.
Arguments Made by the Assessee
The assessee contended that Section 112 applies only when the total income includes income generated from the sale of a long-term capital asset that falls under the ‘capital gains’. This is because it specifies how the tax payable by the assessee on the total income should be calculated in such instances. On the other hand, Section 48 of the Act outlines the method for computing income under the ‘capital gains’ category.
It was asserted that Section 112 of the Act is applicable only when the taxpayer's total income includes capital gains from the sale of a long-term asset. In such cases, Section 112 determines how the tax on the total income should be calculated. However, since the present situation involves a long-term capital loss after adjusting for inflation, Section 112 does not apply. Instead, the taxpayer has the right to carry forward this loss to future years as per the provisions of Section 74 of the Act. Therefore, the assessee stated that there is no requirement to pay tax under Section 112 in the current scenario.
Thus, the assessee argued that since the computation as per Section 48 resulted in a long-term capital loss, the provisions of Section 112(1)(c)(iii) are not applicable.
Arguments made by the Departmental Representative (DR)
On the other hand, the DR strongly argued that the term ‘income’ has a broad meaning and includes negative income as well. The DR relied heavily on the decisions made by the lower authorities. It was contended that Section 112(1)(c)(iii) of the Act is applicable to the current situation because the taxpayer is a non-resident who sold shares of an Indian unlisted company. Furthermore, the DR stated that even if the tax liability is calculated in accordance with Section 112(1)(c)(iii), it would result in long-term capital gains in this particular case.
Issue Framed
Whether the computation prescribed under Section 112(1)(c)(iii) or Section 48 is applicable in matters where a non-resident sells shares of an unlisted company.
ITAT’s Observations and Order
Firstly, the ITAT observed that Section 112 deals with the calculation of tax payable by the taxpayer on their total income, including income derived from the transfer of a long-term capital asset subject to ‘capital gains’. However, for non-residents (excluding companies) or foreign companies, sub-clause (iii) of clause (c) in subsection (1) provides a specific method for computing capital gains. According to Section 112(1)(c)(iii) of the Act, in the case of a non-resident, capital gains from the transfer of unlisted securities or shares of a company with limited public interest should be calculated without considering the first and second provisos of Section 48 of the Act. Therefore, the court deemed it a specific provision that applies to non-residents and the transfer of unlisted shares. On the other hand, Section 48 was deemed to be a general provision that applies to the computation of capital gains in all cases of asset transfer.
Moreover, with the understanding of the two sections in question, the court made its interpretation of the statutory provisions using the well-established principle of generallia specialibus non derogant (general provisions does not derogate from specific ones) and held that it in scenarios as such, it is Section 112(1)(c)(iii) that should be used instead of Section 48 of the Act.
After that, the court also considered yet rejected the possibility of using harmonious interpretation, by reconciling both Section 112(1)(c)(iii) and Section 48 of the Act, for the reason that if the assessee followed the method prescribed under Section 48, it would render the computation method provided in Section 112(1)(c)(iii) completely unnecessary and redundant.
Hence, the ITAT ruled that since the Assessee was a non-resident, the provision under Section 112 (1)(c)(iii) is attracted while simultaneously negating the first and second provision of Section 48 of the Act.
Notable Observations
Section 112(1)(c)(iii) of the Act was incorporated to provide clarity and specific guidelines for calculating and taxing capital gains for non-residents and foreign companies in relation to the transfer of unlisted shares/securities. It prescribes the computation of capital gains in these unique circumstances. Meanwhile, Section 48 was introduced to provide a general provision that governs the computation of capital gains in a systematic and equitable manner, ensuring uniformity in the tax treatment of different types of asset transfers.
This judgement has completely disregarded the inclusion of foreign exchange fluctuations as a factor in calculating capital gains derived from the transfer of unlisted securities or shares. It is also to be noted that the current stance is attracted only to transfers of shares of an unlisted company and not a listed one.
Further, it is a matter of thought that since both the provisions in question exist for different objectives, can both objectives coexist without rendering other provisions unnecessary? If so, does ITAT have the power to read down a particular provision in relation to another?
Moreover, the established stance causes a substantial disadvantage for non-residents. With the consistent depreciation of INR against USD, non-residents may incur substantial long-term capital losses as per Section 48. However, Section 112(1)(c)(iii) continues to enforce a 10% tax on the INR-denominated value of these long-term capital gains. This situation appears unjust for non-residents, as they are subjected to taxation based on foreign exchange movements between the purchase and sale prices.
Concluding Remarks
In sum, the order is a significant blow as the current computation becomes a disincentive to the non-resident investors from participating in the practice of buying and selling unlisted shares, also known as over-the-counter securities. Section 48 of the Act is very intrinsic. It is a core provision in the Act which cannot be negated entirely by putting the special provision of Section 112(1)(c)(iii) on a higher pedestal merely because the latter is a specific provision. Hence, it is recommended that the higher courts examine these facets of law for a more comprehensive understanding and interpretation of this legal issue at hand.
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