Mr. A. Sinha
M/s Canoro Resources Ltd. has filed this application under section 245Q(1) of the Income-tax Act, 1961 (the Act). The applicant is a foreign company, registered in Canada.
2. The applicant states that it is engaged in the business of exploration and production of petroleum and natural gas, mainly in Canada and India. In India, it holds participating interest in three oil blocks, namely Amguri development block, AA-ON/7 exploration block and AA-ONN-2003/2 exploration block, all of which are situated in the State of Assam. Of these three blocks, AA-ON/7 and AA-ONN-2003/2 are still in exploration stage. Only Amguri block has started producing oil and gas, commercial production in this block having started in April, 2006.
3. The applicant has entered into separate Production Sharing Contracts (PSC) with the Government of India and the concerned participating company in respect of each of the above three blocks. The applicant, the Government of India and the Assam Company Ltd. are parties to the PSC in respect of Amguri block in which the applicant holds 60% participating interest and is also the operator.
4. The applicant states that it proposes to restructure its business in India by transferring its participating interest in Amguri block to a partnership firm to be formed in Canada between it and its wholly owned subsidiary company, namely Legasi Petroleum International Inc. which is incorporated in Canada. This arrangement will make Amguri a separate venture of the applicant. The applicant states that it has taken recourse to this restructuring with a view to attracting investment in Amguri block. According to the applicant, after the proposed restructuring, Amguri block would look more attractive to the potential investors.
5. In the light of these facts, the applicant sought the ruling of this Authority on a number of questions which have been recast by us vide our order dated 18.9.2008 as follows-
1) Can a partnership firm formed between the applicant and an entity in Canada be granted status of âfirm for the purpose of taxation under the Income-tax Act, 1961 (hereinafter referred to as âAct), if it satisfies the conditions listed under section 184 of the Act.
2) If answer to the question no. 1 above is affirmative, would tax rate prescribed under the Act for a âfirm be applied, while computing tax liability of the partnership in India?
3) If answer to the question no. 1 above is affirmative, what would be the residential status of the partnership under the Act, in view of the fact that all significant decisions relating to activities of the partnership would be taken by the management team of the firm outside India?
4) If answer to the question no. 1 above is affirmative, would share in post-tax profits of partnership firm be exempt in hands of the respective partners, as provided under section 10(2A) of the Act?
5) If answer to the question no. 1 above is affirmative, whether provisions of section 45(3), which relates to computation of capital gains in a case where a capital asset is transferred by a partner to the partnership firm as his capital contribution, would be applicable to Canoro on transfer of participating interest in Amguri block to the partnership firm as its capital contribution?
6) In view of transfer pricing provisions given under âChapter-Xâ of the Act, is it possible that Canoro and proposed partnership may qualify as âassociated enterprises and the transaction between two of them may qualify as an âinternational transaction
Whether provisions of section 45(3) being specific in nature and being in the nature of deeming fiction prevail over the transfer pricing provisions in case of conflict between these two provisions?
7) Whether by applying transfer pricing provisions for determining the consideration for transfer (of participating interest in Amguri block to the partnership firm as its capital contribution, the provisions of Article 24 (non discrimination clause) of DTAA between India and Canada would be attracted.
6. The case of the applicant is that the proposed partnership firm should be assessed to tax as a separate taxable entity, as it would satisfy the requirements of section 184 read with section 2(31) of the Act. It is also stated that as the control and management of the affairs of the partnership firm will be located wholly outside India, the said firm shall be a non-resident firm. But that will not make any difference so far as the rate of tax is concerned, as the Act does not differentiate between resident and non-resident partnership firms. The applicant also claims that its share in the income of the proposed partnership firm shall be exempt from taxation. The applicant further states that, no doubt, the capital contribution to be made by it in the proposed partnership firm shall be subject to capital gains tax, but the value of consideration shall be the book value of the capital asset as recorded in the books of accounts of the proposed firm, as stipulated in section 45(3) read with section 48 of the Act. The applicant states that since the proposed transaction will be in the nature of international transaction between two non-residents who would be regarded as âassociated enterprises, the Revenue might invoke the transfer pricing provisions of Chapter-X of the Act. In that case the proposed transaction of the applicant would be required to conform to âarms length price. However, the provisions of section 45(3) being, special provision for computation of capital gains in relation to a transaction between a firm and its partner, should prevail over the more general provisions of Chapter-X. The alternative submission of the applicant is that the provisions of Chapter-X are in conflict with article 24 of the Double Taxation Avoidance Agreement (DTAA) between India and Canada providing for non-discrimination between the nationals of the two contracting parties, as a similar transaction between two nationals of India would not have attracted the transfer pricing provisions of Chapter-X. The applicant states that in view of article 24, the tax liability of the applicant should not be more burdensome than that of residents entering into similar transaction.
7. The stand of the Revenue is that the applicant has the financial capacity to carry out and develop exploration activities in Amguri block on its own. The stated business objective of the applicant of attracting investment is not convincing, and the proposed restructuring is merely a device for avoidance of tax. As such, the application deserves to be rejected having regard to the proviso(iii) of section 245R(2). We may mention here that in his initial comments dated 16.9.2008, the Director of Income-tax, International Taxation-I, New Delhi (DIT) did not object to the maintainability of this application. He, on the contrary, stated that he had no objection to its admissibility under section 245R(2). He sought permission to submit further comments on merits as the case involved substantial questions of law. In his subsequent comments dated 18.11.2008 also, relying on the annual report of the applicant for 2006, DIT, merely questioned the business objective of creating the partnership firm. It was only at the stage of argument that the learned Departmental representative for the first time raised the plea of tax avoidance. The learned representative of the applicant objected to the raising of this issue at the stage of hearing. But as the matter pertains to the maintainability of the present application, we allowed the Departmental representative to put forth his argument. On the merits of the case, the Revenue states that the proposed partnership firm would have characteristics more of a company or a corporation than a firm. Thus the provisions of sections 10(2), 45(3) and 184 would not be attracted. The proposed firm will be taxed in India as a foreign company. Without prejudice to this stand, the Revenue further states that the so called firm will be a resident of India because of the reason that, being operator of Amguri block, all its business activities will be carried on in India. The Revenue also states that the transfer by the applicant of its assets in Amguri block to the proposed firm would be an international transaction and the proposed firm would be regarded as an âassociated enterprise of the applicant. With regard to article 24 of the DTAA, Revenue states that what is prohibited is discrimination between nationals of the two contracting parties and not between resident and non-residents.
8.
8.1 As the question of tax avoidance is a threshold issue, we shall deal with it first. Section 245R dealing with procedure on receipt of an application, debars the Authority from entertaining an application designed to avoid tax. The relevant provisions of this section read as under-
â Procedure on receipt of application.
245R (1) xx xx xx xx
(2) The Authority may, after examining the application and the records called for, by order, either allow or reject the application:
Provided that the Authority shall not allow the application where the question raised in the application,-
(i) xx xx xx xx
(ii) xx xx xx xx
(iii) relates to a transaction or issue which is designed prima facie for the avoidance of income-tax[except in the case of a resident applicant falling in sub-clause(iii) of clause (b) of section 245N]
xx xx xx xxâ
8.2 The above provision enables the Authority to first scrutinize an application from the angle of its maintainability and to mandatorily reject the same if one of the grounds specified in (i), (ii) and (iii) exists. One such ground is that the transaction in respect of which ruling has been sought is prima facie designed to avoid tax. If on the initial scrutiny of the application the Authority is of the opinion that it is indeed meant to avoid legitimate tax, the Authority has to reject the application without going into the merits of the case. The use of the expression âprima facie in the above provision is significant. This expression has been defined in Blacks Law Dictionary (Sixth Edition) as follows-
âAt first sight; on the first appearance; on the face of it; so far as can be judged from the first disclosure; presumably; a fact presumed to be true unless, disproved by some evidence to the contrary.â
P. Ramnath Aiyars Law Lexican (1997 Edition) also gives the same meaning to this expression. Thus proviso (iii) of section 245R(2) seems to refer to a transaction which, on the face of it, would appear to be designed to avoid tax. Page 7 of 26
8.3 In his comments dated 18.11.2008, the DIT gives extracts from the annual report of the applicant for the year 2006, in which it is stated that âCanoro has the financial capacity to support its planned development and exploration activitiesâ. He points out that the applicant itself has the wherewithal to carry out these activities without having to raise fund from market. The learned departmental representative goes a step further and states during argument that the proposed restructuring of the business of the applicant is a mere tax avoidance measure. He seeks support from the interim report of the applicant for the period ended September 30, 2008, which refers to the availability of a working capital of US $ 24.8 million and absence of any debt liability. He further states that all the three oil blocks are already separate entities, inasmuch as different oil companies are partners of the applicant in them under different PSCs. Thus there is no question of further separation of Amguri block from other blocks. In reply, the applicant asserts that it heavily depends on finances to develop its operations in India and refers to another part of the same annual report for 2006 as cited by DIT, which says that âCanoro completed a $30 million private placement financing for the upcoming capital program.â The applicant also filed copies of approved budget for 2008-09 and development plan for Amguri block to show that substantial expenditure is required for further development and exploitation of this block. The applicant further states that, since the other two oil blocks are still in exploration stage, it is not certain whether they contain any oil reserves. It is only Amguri which at present appears to have good commercial prospects. We specifically asked the learned departmental representative as to how the proposed restructuring plan was a tax avoidance device. He stated that Amguri block had already changed hands in the past and it might not be last time that it so happened. In the original PSC Assam Company Limited had 75% and Joshi Technologies International Inc. had 25% participating interest in this block. In 2004 Assam Company Limited transferred 35% and Joshi Technologies transferred its entire participating interest (i.e. 25%) to the applicant. The applicant may also decide in future to transfer its interest in Amguri block to somebody else. After the proposed restructuring, if the applicant decided to exit from Amguri block, all it had to do was to transfer its interest in the proposed partnership firm to somebody else. No taxes will be payable in India on such a transfer of interest. In this way the proposed restructuring could lead to tax avoidance. He places reliance on the ruling of this Authority in P-9 of 1995 (220 ITR 377)..
8.4 We may at this stage refer to the decision of the Supreme Court in Union of India vs. Azadi Bachao Andolan (263 ITR 706 Page 9 of 26). Some FIIs incorporated shell companies in Mauritius with the sole purpose of making investment in India in order to take advantage of the India-Mauritius tax treaty. It was alleged that the control and management of those companies lay in countries other than India and Mauritius and, therefore, they were not âresidents of Mauritius. Incorporation in Mauritius was sham and a device with improper motive of avoiding tax. It was also urged that âtreaty shopping was both unethical and illegal and amounted to fraud on the treaty. The Court observed that the Indo-Mauritius treaty did not preclude a national of a third country from deriving the benefits thereunder. The Court refused to judge the legality of âtreaty shopping, âmerely because one section of thought considered it âimproper â. The Court held â
âWe are unable to agree with the submission that an act which is otherwise valid in law can be treated as non est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests, as perceived by the respondentsâ.
The decision of the Constitution Bench in McDowell and Co. Ltd. v. Commercial Tax Officer (154 ITR 148)case was also referred to and the following observation therefrom was quoted with approval -
âTax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.â.
8.5 In the case of P-9 of 1995 (supra) also, the applicants were companies incorporated in Mauritius with the object of carrying on business as investment and holding companies. Each of the applicant companies invested in banks in India and was allotted shares. The applicants sought ruling of this Authority with regard to the rate of withholding tax on dividend payments to be made to them by Indian banks and taxability of capital gains to be derived from transfer of those shares, both under the Indo-Mauritius tax treaty. Under this treaty the rate of withholding tax was 5% and capital gains was exempt from taxation. During the course of hearing it was revealed that the whole of the share capital of both the applicant companies was held by a British bank. The Authority observed that had the British bank directly invested in shares in India, withholding tax under the Indo-UK tax treaty, would have been 15% and the capital gains would have been taxable both in India and in UK. In the light of these facts, the Authority held that the purpose of making investment through Mauritius based companies could not be for any purpose other than avoidance of income-tax in India. We notice that in P-9 of 1995, the facts were not the same as in the present case. In the present case, the applicant has, prima facie, given a convincing explanation for restructuring its business and such a step, according to the applicant, is a commercially prudent proposition. There is no material to view the transaction otherwise. The future possibility of the applicants exit from Amguri block by transferring its interest to someone else cannot by itself be a ground to conclude that the entire arrangement is primarily meant to avoid tax. That apart, in the case of Azadi Bachao Andolan (supra) which was decided subsequent to P-9 of 1995, the Supreme Court did not regard investment made in India through Mauritius by companies located elsewhere as an objectionable tax avoidance device. The Revenue cannot complain, when a taxpayer resorts to a legal method available to him to plan his tax liability, that the result would be more beneficial to the taxpayer. Of course, dubious methods and camouflaging of the real nature of the transaction cannot be countenanced.
8.6 We find that the allegation of Revenue about tax avoidance is without substance. It cannot be said that the purpose behind restructuring of the applicants business is not acceptable. The stand of the Revenue that the three oil blocks are already separate from each other is misconceived. In fact, the applicant holds participating interest in all these blocks in the same capacity of Canoro Resources Ltd. As such, this companys balance sheet would also reflect the losses being incurred in the other two oil blocks and the profit made in Amguri block would be offset to that extent. By the proposed restructuring, the new partnership firm would own participating interest only in Amguri block and Canoro Resources Ltd. will be left with the remaining two blocks, namely, AA-ON/7 and AA-ONN-2003/2. Since the proposed firm will not be having any participating interest in AA-ON/7 and AA-ONN-2003/2 blocks, the balance sheet of the said firm would not include the losses being incurred in those blocks, and so it would look financially attractive. The Revenue has not shown how the proposed transaction on the face of it is a tax avoidance device. We notice that the applicant has offered to pay tax on the proposed transaction. As a matter of fact, the case of the Revenue is not really that the proposed transaction itself is a tax avoidance device, but that the possible future transactions might lead to loss of revenue. We feel that this argument is far-fetched and cannot be supported on facts or in law. True, it is possible that the applicant may in future exit from the proposed partnership firm, but that possibility will not render the present transaction itself as a tax avoidance device. Whenever that firm transfers its participating interest in Amguri block, it would be liable to capital gains tax in India. Therefore, we reject the Revenues plea that prima facie the transaction is designed only with a view to avoid tax.
9.
9.1 Now, adverting to the issue of assessment of the proposed partnership, according to Revenue, a partnership firm can be assessed as a firm under section 184 of the Act only if it is a partnership firm as understood under the Indian law. In support of its contention that the proposed firm would have characteristics of a company, it points out that the units in the proposed partnership firm appear to be similar to shares in a company. The managing partner has been given vast powers. No capital can be withdrawn or returned or sold without the approval of the managing partner. Surplus funds of the partnership is to be distributed between the partners in accordance with their participating interest. This is like payment of dividend which is a feature of a company or a corporation. According to Revenue, the dominant role of the managing partner resembles the position of the managing director in a company and is unlike a partnership firm. Accordingly, the transaction in question will be between two foreign companies and the transfer pricing provisions will be attracted. The alternative averment of Revenue is that one of the requirements of section 184 of the Act is that the individual shares of the partners should be specified in the instrument. In the proposed firm, the participating interest has been defined in terms of number of units, which are subject to adjustment. Thus the individual shares of the partners are variable and cannot be said to have been specifically defined in the partnership agreement.
9.2 In response, the applicant has filed a copy of the Partnership Act of Alberta. The applicant refers to the various provisions of this Act to show that its provisions are similar to those of the Indian Partnership Act and that in the Alberta Act the meanings of âpartner and âfirm and their relationship, etc., are similar to those in the Indian law. According to the applicant, the proposed firm will not be an incorporated entity. The representative of the applicant clarifies that article-4 of the draft partnership agreement read with Schedule-A clearly specifies the participating interest of the partners and their profit and loss sharing ratio. At Annexure-12 of the Paper Book, the applicant has explained with the help of tabular statements the assumed amounts of initial and additional capital contributions and distribution of net profits between the partners.
9.3 We may first peruse the relevant provisions of the Partnership Act of Alberta under which the proposed partnership will be registered. This Act recognizes three types of partnerships, namely, ordinary partnerships, limited partnerships and limited liability partnerships. Section 2 which is common to all the three, reads as under-
âMeaning of âfirm and âfirm name
2. Persons who have entered into partnership with one another are for the purposes of this Act called collectively a âfirmâ, and the name under which their business is carried on is called the âfirm nameâ.
âPartnership has been defined in section 1(g) to mean the relationship between the persons carrying on a business in common with a view to making profit. We may now turn to the provisions applicable to ordinary partnerships, because it appears from the draft partnership agreement filed by the applicant that the proposed partnership will be an ordinary partnership. Section 3 reads as under-
âBody corporate not partnership
3. The relationship between members of any company or association who constitute a corporation under any law in force in Alberta is not a partnership within the meaning of this Act.â
Section 4 specifies certain tests to determine the existence or otherwise of a partnership. One such test is sharing of profits by the partners from the common property. Section 7 states that the act of each partner binds other partners as well as the firm. Section 11 makes each partner jointly liable with other partners for the debts and obligations of the firm. According to Section 15, every partner is jointly and severally liable for all the liabilities of the firm. Section 36 provides for modes of dissolution of the partnership. One such mode is dissolution of partnership at the instance of a partner. Section 43 provides that on dissolution of a partnership, its property shall be distributed amongst the partners, after debts of the firm have been defrayed. Page 14 of 26
9.4 From the above provisions of the Partnership Act of Alberta, we notice that these provisions are substantially similar to those of the Indian Partnership Act, 1932. Under the Indian Act also partnership is the relationship between the persons who have agreed to share the profits of a business carried on jointly by them. Such persons are individually called partners and collectively a firm. The properties of the firm belong to the partners collectively. The partners are severally and collectively responsible for the acts of the firm. The creditors of the firm are creditor of the partners and can seek execution against their property. Under both the laws, the firm is not an incorporated entity separate from its members. In fact, this is one of the main distinguishing features between a partnership and a company/corporation. Whereas a company is a separate legal entity, a firm is just an association of persons having no legal personality of its own. Apart from this, the shareholders of a Company do not carry on the business of the company, which is carried on by a board of directors elected by the members in the annual general meeting. The shareholders are liable to the debts of the company only to the extent of their shareholdings. They do not have any personal liability. Thus the proposed partnership of the applicant will be a partnership firm as understood under the Indian Partnership Act. The fact that shares of individual partners have been specified in the draft partnership agreement in terms of units, will not make the proposed partnership firm a company. Distribution of surplus fund is an aspect of joint sharing of profits by the partners. It is different from payment of dividend by a company. It is seen from the draft partnership agreement that the managing partner has been assigned a predominant role. Under the Indian Partnership Act also this is possible. The position of a managing partner of a firm is very different from that of a managing director of a company.
9.5 This takes us to section 184 of the Act, the relevant provisions of which are extracted below-
âAssessment as a firm.
184. (1) A firm shall be assessed as a firm for the purposes of this Act, ifâ
(i) the partnership is evidenced by an instrument ; and
(ii)the individual shares of the partners are specified in that instrument.
(2) A certified copy of the instrument of partnership referred to in sub-section (1) shall accompany the return of income of the firm of the previous year relevant to the assessment year commencing on or after the 1st day of April, 1993 in respect of which assessment as a firm is first soughtâ
x x x x x x x x x x x x x x x x x x xx xx xxâ
The proposed partnership of the applicant will have to satisfy the above requirements in order to become eligible for assessment as a firm. So far as (i) above, is concerned, it poses no difficulty. A certified copy of the partnership deed, as required in this section, is to be filed. It is about the precise requirement of (ii) above that some doubt arises. The applicant and the Revenue have different perceptions about the meaning of the expression âindividual shares of partners are specified. The applicant has referred to a number of judicial decisions on the issue. Section 26A of the Income-tax Act, 1922, which dealt with registration of partnership firm, had a similar requirement of specifying the âindividual shares of the partners. That section read as follows-
â26A. (I) Application may be made to the Income-tax Officer on behalf of any firm, constituted under an instrument of partnership specifying the individual shares of the partners, for registration for the purposes of this Act and of any other enactment for the time being in force relating to income-tax or super-tax.â
In Kylasa Sarabhaiah v. Commissioner of Income-tax (56 ITR 219)the Supreme Court held as follows regarding specification of individual shares-
â The word âspecifyâ is used in section 26A and rule 2 as meaning mentioning, describing or defining in detail: it does not mean expressly setting out in fractional or other shares.â
This decision followed the earlier decisions of the Supreme Court in the case of N.T. Patel and Co. v. CIT (42 ITR 224)and Parikh Wadilal Jivanbhai v. CIT (63 ITR 485). Again in the case of Addl. CIT v. Progressive Financiers (118 ITR 18)which was with reference to un-amended section 184 of the Act which contained a similar provision about the specification of the shares, the Supreme Court observed as follows-
âIn view of this decision the correct legal position is that the Assessing Officer cannot reject an application for registration merely because in the deed of partnership the shares of the partners are not expressly specified. The Assessing Officer will have to construe the instrument of partnership as a whole and if reasonably the shares of the partners in profits and losses can be ascertained, then to accept it as genuine for the purpose of registration.â
What follows from the above is that, where a provision indicating individual shares of partners exists, even if that provision is defective and does not precisely spell out such shares, but if from the construction of the deed as a whole, such shares can be ascertained, then the requirement of para(ii) of section 184(1) will be taken to have been satisfied. We find that in the present case the individual shares of the partners can be clearly ascertained with reference to article 4 and 5.1 read with Schedule-A.
9.6 Coming to the residential status of the proposed firm, the same would have to be determined with reference to the sub-section(2) of section 6 of the Act which is given below:
â6. Residence in India
For the purposes of this Act,-
(1) x x x x x x x x x x
(2) A Hindu undivided family, firm or other association of persons is said to be resident in India in any previous year in every case except where during that year the control and management of its affairs is situated wholly outside India.
xx xx xx xx xx xx xx xx xx xxâ
As may be seen from the above, the normal presumption is that a firm will have to be considered a resident unless its control and management are wholly situated outside India. This provision has been considered in a number of cases. In B.R. Naik v/s CIT (13 ITR 124), a partnership firm registered in Salisbury, South Rhodesia carried on business there. Mr. B.R. Naik who had been actually controlling the business returned to India permanently and settled in Bombay. The Salisbury business thereafter was being managed by other partners living in Salisbury. While deciding the question of residential status of the firm, the High Court laid down a number of principles, which still hold good. The Court also observed that the control and management must be de facto and not de jure. The rights of the partners defined in the partnership deed could not give a correct answer as to where the control and management is actually situated. These principles were later approved by the Supreme Court in the case of Erin Estate, Galah, Ceylon v/s CIT (34 ITR 1). The Court also observed that control and management refers to the controlling and directing power often described as âhead and brain. In the present case before us though the firm will be registered in Alberta, it will be carrying on business of oil exploration in Amguri block in India. It cannot be said at this point of time as to where the control and management of the affairs of Indian business will actually be situated. This question cannot be decided on the basis of the draft partnership agreement in view of the above case laws. This would depend on the actual facts, which can be ascertained by the assessing officer only at the relevant point of time. But so far as taxability of the firm is concerned, its residential status is not relevant, as the rate of tax applicable to every firm is 30 per cent as per paragraph (c) of the First Schedule of the Finance Act, 2008.
10.
10.1 It is the common stand of both - the applicant and the Revenue, that the nature of income arising from the transfer of the applicants participating interest in Amguri block to the proposed partnership firm, shall be capital gains. Where they differ is regarding the mode of computation of that income. Whereas the applicant submits that sub-section(3) of section 45 of the Act provides a particular mode of computation of value of consideration, the contention of the Revenue is that the said transaction shall be in the nature of international transaction between two associated persons, and so, the transfer pricing provisions will be attracted and the value of capital gains should be computed with reference to arms length price. The response of the applicant to this is that sub-section(3) of section 45 is a special provision so far as computation of capital gains arising from the capital contribution made by a partner to the firm is concerned, and for this purpose, the provisions of sections 92 to 92F relating to computation of income from international transactions are general provisions. The applicant submits that in the present case, the provisions of sub-section(3) of section 45 would prevail over the transfer pricing provisions contained in sections 92 to 92F.
10.2 In order to examine the rival contentions, it would be appropriate to first peruse the relevant provisions. Sections 45 to 55A deal with âcapital gains. Sections 45 and 48 are relevant for the present purpose. Sub-section(1) of section 45 states that gains arising from the transfer of capital asset shall be regarded as âcapital gains and assessed as such. Section 48 specifies the method of computation of capital gains. According to this provision, capital gains shall be computed by deducting the cost of acquisition of the asset, including the cost of improvements, if any, and the expenditure incurred in connection with its transfer, from the full value of the consideration. Sub-section (3) of section 45 which provides for special mode for computation of capital gains in respect of transfer of capital asset by a partner to the firm, is extracted below:
âSection 45 Capital Gains
xx xx xx xx xx xx xx xx xx
(3) The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.â
xx xx xx xx xx xx xx xx xx
Sub-section(3) was inserted by the Finance Act, 1987 w.e.f. 1.4.1988. Explaining the amendment, the CBDT Circular No. 495 dated 22.09.1987 states that, to avoid payment of tax on capital gains, many assessees used to convert individual asset into asset of a firm in which the assessee would be a partner. With a view to plugging this loophole, sub-section(3) has been inserted in section 45. As stated in the said circular-
âThe effect of this amendment is that profits and gains arising from the transfer of a capital asset by a partner to a firm shall be chargeable as the partners income of the previous year in which the transfer took place. For purposes of computing the capital gains, the value of the asset recorded in the books of the firm on the date of the transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of the capital assetâ.
10.3 We may now turn to sections 92 to 92F. These find place under Chapter X of the Act under the heading âSpecial Provisions Relating to Avoidance of Tax. Provisions on the subject existed even in the Income-tax Act, 1922 in the form of section 42(2). The corresponding provision contained in section 92 of the present Act was thoroughly amended w.e.f. 1.4.2002 by the Finance Act, 2001. Section 92 was substituted by sections 92 to 92F. The amended section 92 now reads as under-
âComputation of income from international transaction having regard to arms length price.
92. (1) Any income arising from an international transaction shall be computed having regard to the arms length price.
Explanation.âFor the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arms length price.
(2) Where in an international transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arms length price of such benefit, service or facility, as the case may be.
(3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) or the determination of the allowance for any expense or interest under that sub-section, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under subsection (2), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into.] (Emphasis supplied)
Section 92A defines âassociated enterprise; section 92B gives the meaning of âinternational transaction; section 92C specifies the methods of determining âarms length price and the rest of the sections are procedural in nature. CBDT Circular No. 14 of 2001 explains the reasons for making these amendments and the object sought to be achieved. It states that the increasing participation of multi-national companies in our economic activity gave rise to new and complex issues. Cross border transactions between the group companies could be manipulated leading to loss of revenue. The erstwhile provision of section 92 was limited in scope and inadequate to tackle the emerging problems. With a view to providing a detailed statutory framework for computation of reasonable, fair and equitable profits and tax in India, the new sections 92-92F have been inserted.
10.4 As may be seen from the above, sub-section(3) of section 45 provides for a method of computation of capital gains, which is different from the general method specified in section 48. This special provision is, however, limited in scope, inasmuch as it only applies to computation of capital gains in relation to capital contribution made by a partner to the firm. This provision does not distinguish between residents and non-residents, or between domestic and international transactions. Sections 92-92F, on the other hand, provide for determination of fair and equitable profits and tax in India in relation to international transactions, regardless of their nature. The wordings used in these sections suggest that they apply to all kinds of international transactions entered into between a resident and a non-resident and between two non-residents. No particular type of international transaction has been kept out of its purview. We notice from the foregoing that section 45(3) is a special provision insofar as computation of capital gains resulting from capital contribution made by a partner to the firm is concerned, and sections 92 to 92F are special provisions so far as international transactions are concerned. It is also noticed that sub-section(3) of section 45 was inserted earlier and the transfer pricing provisions were comprehensively updated later. Thus a doubt is created as to what would be the most appropriate provision for computing capital gains in the present case.
10.5 It may be stated that conflict between the provisions of two different statutes or between different provisions of the same enactment, is not a new issue. This has been comprehensively dealt with in the works of eminent jurists and decisions of law courts. âMaxwell on the Interpretation of Statutes (Twelfth Edition) states â
â If two sections of the same statute âare repugnant, the known rule is that the last must prevailâ. But, on the general principle that an author must be supposed not to have intended to contradict himself, the Court will endeavour to construe the language of the legislature in such a way as to avoid having to apply the rule, leges posteriores priores contrarias aborgantâ¦â¦â¦â¦â¦ One way in which repugnancy can be avoided is by regarding two apparently conflicting provisions as dealing with distinct matters or situationsâ¦â¦â¦.. Collision may also be avoided by holding that one section, which is ex-facie in conflict with another, merely provides for an exception from the general rule contained in that orderâ.
A Constitution Bench of the Supreme Court, in the case of Ashoka Marketing Ltd. Vs. Punjab National Bank ([1990] 4 SCC 406)considered an apparent conflict between the provisions of the Delhi Rent Control Act, 1958 and the Public Premises (Eviction of Unauthorized Occupants) Act, 1971, with regard to the manner of eviction of a tenant whose tenancy has been terminated. While reconciling the conflict, the Court referred to a large number of cases on the subject decided earlier. The Court held â
âThe principle which emerges from these decisions is that in the case of inconsistency between the provisions of two enactments, both of which can be regarded as special in nature, the conflict has to be resolved by reference to the purpose and policy underlying the two enactments and the clear intendment conveyed by the language of the relevant provisions therein.â
10.6 Coming back to the present case, since transfer pricing provisions are later in time, the rule of leges posteriores priores contrarias aborgant would be attracted. However, leaving that apart, it appears from the close reading of CBDT Circular No. 495 dated 22.9.1987 that the mischief which was sought to be curbed by insertion of sub-section(3) in section 45 related to the prevailing domestic practice. It was perhaps the propensity of some residents to avoid payment of capital gains tax by making transfer of asset look like capital contribution to the firm. However, the wordings of the said sub-section(3) are wide enough to cover even an international transaction. On the other hand, sections 92 to 92F apply exclusively to international transactions carried out between associated persons â whether individuals, firm or company. These provisions are aimed at tackling the issue of price manipulation associated with international transactions. The apprehension of price manipulation is real even in international transactions between partners and firm, who are associated persons. Therefore, transfer pricing provisions should apply to such transactions as well. Otherwise, the purpose for which these provisions have been made will not be fully achieved and many transactions will go out of its purview. We are of the view that the provisions of sub-section(3) of section 45 and the relevant transfer pricing provisions, when read in harmony, would lead to the inference that sub-section(3) would not apply to international transactions, which should be dealt with in accordance with the transfer pricing provisions. As such, when a transaction referred to in section 45(3) is in the nature of international transaction, the value of consideration shall not be the value as recorded in the firms account books, but the same shall be determined on the basis of arms length price in accordance with transfer pricing provisions contained in Chapter-X of the Act.
11. We shall now deal with the last contention of the applicant relating to conflict between article-24 of DTAA and the transfer pricing provisions of the Act. The relevant provisions of the said article are extracted below-
âARTICLE 24 : Non-discrimination - 1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.
xx xx xx xx xx xx xx xx xx xx xx
Article 24 contains a non-discrimination provision. It prohibits a Contracting State from making any discrimination in the matter of taxation between its own national and a national of the other Contracting State, who are placed in similar circumstances. In other words, a Contracting State is obliged to provide the same tax treatment to a national of the other Contracting State as it would give to its own nationals. Article 3(h) of the DTAA defines the term ânational to include both â natural persons and artificial persons, such as companies, etc.. The transfer pricing provisions relate to international transactions between associated enterprises. As we have noticed above, international transactions give rise to their own peculiar problems. âInternational transaction has been defined in section 92B of the Act to mean transaction between enterprises, either or both of whom are non-residents. It may also be seen that section 92B makes a distinction between enterprises on the basis of their residential status, and not with reference to their nationality. As we know, the residential status of an individual depends on the number of days he lives in India. In the case of a legal person, like a company, or in the case of a firm, it would depend on factors, such as place of registration, situs of control and management, etc. It is possible that a national of India could be a non-resident for the purpose of this Act and a national of the other Contracting State could be a resident. Be that as it may, a cross-border transaction between Indian nationals, one or both of whom are non-residents and who are associated enterprises, will also attract the transfer pricing provisions, as they would apply to similarly situated Canadian nationals. Viewed from this angle, the plea of discrimination raised by the applicant has no basis.
12. In the light of the above discussion, we rule as follows-
(1) The proposed partnership firm to be formed by the applicant with Legasi Petroleum International Inc. at Alberta, Canada can be assessed as a firm under the Income-tax Act, 1961, provided the requirements of section 184 are complied with.
(2) The aforesaid firm shall be liable to tax @ 30 per cent plus applicable surcharge and cess in accordance with paragraph (c) of the First Schedule of the Finance Act, 2008.
(3) The residential status of the said partnership firm is a question of fact which can be determined by the assessing officer at the relevant point of time.
(4) If the proposed partnership is assessed as a firm, then the share of the partners in the total income of the firm shall not be included in the total income of such partners.
(5) and The proposed transfer of the participating interest of the applicant
(6) in Amguri block to the partnership firm shall be regarded as an international transaction between two associated enterprises, and the resulting capital gains can be assessed in accordance with the transfer pricing provisions contained in Chapter X of the Act. As regards the second part of the question, the answer is in the negative.
(7) The answer is in the negative. Article 24 of DTAA does not come to the aid of the applicant.
The Ruling is accordingly given and pronounced on this the 23 day of April, 2009.