M/S. Four Star Oil and Gas Co. Vs. Director of Income Tax (intl.Taxn.), Chennai - Court Judgment

Mr. Rao Ranvijay Singh

The applicant, M/s. Four Star Oil and Gas Co., is a non-resident company incorporated in United States of America and is engaged in the business of exploration and production of hydrocarbon, marketing of gas and oil and other energy products having assets in various regions around the world. The applicant states that it owns 1,92,684 equity shares in Tide Water Oil and Gas Co.(India) Ltd. (in short Indian Company). The Indian company is a listed public company. The applicant holds 22% of the paid up share capital of the Indian Company. The equity shares held by the applicant consist of original shares, bonus shares and rights shares acquired by or allotted to the applicant over a period of time. The original shares were acquired in US Dollars long back i.e. in 1928. The applicant proposes to sell its equity interest in the Indian Company and for that purpose the applicant has entered into shares sale/purchase agreements with two identified buyers. The proposed transfer of shares will be, as stated, undertaken under a private arrangement and will be ‘off market transactions, as permitted by RBI. The applicant has given details of the number and nature of shares proposed to be sold to two identified buyers.

2. On the above facts, the applicant seeks advance ruling from this Authority in respect of the following two questions:

(1) Whether the long-term capital gains arising on the proposed sale of shares held in an Indian listed company by Four Star Oil and Gas Company (hereinafter referred to as the “Applicant”) will be taxable at the rate of 10 percent as per the proviso to Section 112(1) of the Income Tax Act, 1961.

(2) Whether the Applicant can avail the option of substituting Fair Market Value on April, 1, 1981 as the cost of acquisition for the bonus shares allotted to it before April, 1981 as per the provisions of Section 55(2)(b)(i) of the Act.

1st Question

3. The applicant contends that since the second proviso to section 112(1) is attracted, the rate of 10(ten) per cent, specified therein, would apply. The applicant relies on the ruling of this Authority in the case of Timken France SAS, reported in 294 I.T.R. 513 which has subsequently been followed by the Authority in some other cases also.

4. In the comments furnished, the Revenue contends that the applicant cannot avail of the lower rate of 10 percent envisaged by section 112 of the Act in as much as the 2^nd proviso to section 48 of the Act is not applicable to a non-resident. The stand of the Department is that the expression ‘before giving effect to the second proviso to section 48 pre-supposes the existence of a case where computation of long-term capital gain could be made in accordance with the formula contained in the second proviso to section 48. In other words, according to Revenue, no occasion arises to apply the proviso to section 112(1) where the second proviso to section 48 in terms is not applicable to the non-residents like the applicant. That means, the legislature never intended to extend the benefit of proviso to section 112(1) to the long-term capital gains arising to non-residents from the transfer of shares required to be computed under the 1^st proviso to section 48 of the Act. The Revenue has placed reliance on the order of the I.T.A.T. Mumbai H Bench in I.T.A. No.2552/Mum/2005.

5. The Revenue further contends that the 1^st Proviso and 2^nd Proviso to section 48 of the Act are mutually exclusive and since the applicant has acquired the shares in foreign currency, the long-term capital gains arising to the applicant will be computed by taking into account the foreign exchange fluctuations and the benefit of indexation will not be available to the applicant. Since the non-residents are allowed to claim benefit of the first proviso to section 48, extending the benefit of 10 per cent rate after giving effect to the first proviso to section 48 would amount to granting double benefits to non-residents and this does not seem to be the intention of the legislature, submits the Director (International Taxation) Chennai. According to the Revenue, while framing the proviso to section 112(1), the intention of the legislature was to include the cases that fall under the second proviso to section 48 and any other interpretation to the proviso to section 112(1) would defeat the intention of the legislature.

6. It has also been contended by the Revenue that the decisions of the Authority for Advance Rulings given in favour of the applicant are likely to be contested before the Apex Court and, for the same, approval from the CBDT have already been obtained. In effect, the Revenue takes the stand that the rulings of this Authority in earlier cases i.e. Timken France (supra) and a few other cases need not be followed.

7. The learned counsel for the applicant has, on the other hand, contended that the lesser rate of 10 per cent is applicable to long-term capital gains derived by non-resident foreign companies as well, and the benefit of reduced rate is not to be confined to residents only. The argument, in this regard is, sought to be buttressed by the rulings of this Authority cited supra.

8. On almost similar facts, the case of TIMKEN FRANCE (supra) was examined by this Authority at length. This Authority took the view that the benefit of the proviso to section 112(1) of the Act could not be denied to non-residents / foreign companies even if they are entitled to a different relief in terms of the first proviso to section 48 of the Act. The Authority also held that the proviso to section 112(1) of the Act was a special provision in relation to transfer of certain long-term capital assets viz listed securities, units etc. and there was no warrant to limit the 10 per cent effective rate provided therein as against the normal rate of 20 per cent only to the three categories of resident assessee specified in clause (a), (b) and (d). In fact, clear words would have been deployed in the proviso if one particular category i.e. non-residents were to be excluded. Here, it may not be out of place to give the following extract from the Head Note of the ruling in the case of Timken France (supra), which is in the following terms: -

“In plain and peremptory words, the proviso to section 112(1) limits the rate of tax on long-term capital gains from the transfer of listed securities to 10 per cent but with an important rider that the quantum of capital gains should be arrived at without taking into account the formula laid down in the second proviso to section 48 based on the indexed cost of acquisition. In other words, while computing the gains on listed securities held for more than 12 months, one should not give effect to the calculation spelt out in the second proviso to section 48 wherever applicable. The indexation formula will not enter into the computation process – that is the mandate of the proviso to section 112(1). It does not say: deny the concessional rate of tax to the category of assesses who are not eligible to have the benefit of indexed cost of acquisition under the second proviso. In other words, the eligibility to avail of the benefit of the indexed cost of acquisition is not a sine qua non for applying the reduced rate of 10 per cent, prescribed by the proviso to section 112(1). The second proviso to section 48 is only a mode of computation of capital gains : it cannot be construed as words of exclusion of a category of assesses, i.e. non-residents who cannot avail of indexation benefit.

The protection in terms of the first proviso to section 48 made available to a non-resident might be a justification to deny the benefit of cost of indexation but the same cannot be said of the application of lesser rate.”

9. Further, it was ruled in Timken France SAS (supra) that the phrase in section 112(1) “…before giving effect to the provisions of second proviso to section 48” means before giving effect to the 2^nd proviso wherever it is applicable, but, the non-applicability of the 2^nd proviso will not preclude the applicant to avail the relief of lower rate of tax of 10(ten) percent. This Authority also distinguished the decision of the Mumbai Income Tax Tribunal, as referred to above and differed with their view. Thus, the ruling of this Authority in Timken, France, SAS, squarely applies to the present case. Following that Ruling, the first question is answered in the affirmative i.e. in favour of the applicant.

2nd Question

10. The second question relates to the substitution of fair market value as on 1.4.1981 as the cost of acquisition of the bonus shares as per the provisions of section 55(2)(b)(i) read with section 55(2)(aa)(iiia) of the Act. These bonus shares have been allotted to the applicant before 1^st April, 1981. The Revenue is of the view that the cost of the acquisition of the bonus shares, being a capital asset as specified in section 55(2)(aa) of the Act, is to be determined subject to the provisions of sub-clause(i) and (ii) of clause(b) under section 55(2)(b)(i) of the Act. As per Revenue, these bonus shares, being financial assets, have been allotted without payment of any consideration, the cost of acquisition can only be taken as ‘Nil.

11. The counsel for the applicant, on the other hand, submits that no doubt the cost of acquisition of bonus shares, in terms of provisions of section 55(2)(aa)(iiia) of the Act, is to be taken at nil, but it has been specifically provided in section 55(2) itself that the provisions of section 55(2)(aa)(iii) are subject to the provisions of, interalia, section 55(2)(b)(i) of the Act which grants an option to an assessee to adopt fair market value (FMV) as on 1^st April, 1981 in respect of a capital asset acquired before 1^st April, 1981. Reliance in this regard has been placed on the decision in the case of Timken France (supra) by the applicant.

12. The learned counsel for the applicant has further contended that this very issue came up for adjudication before this Authority in the case of Kern-Liebers International GmbH (AAR No.761 of 2007) reported in 301 ITR 178 and the decision has been given against the Revenue.

13. To appreciate the above rival contentions, it would be worthwhile to refer to relevant provisions of the Act i.e. section 48 and section 55(2) respectively. Section 48 provides for the computation of capital gains. The key factors to be taken into account while computing the capital gains are (1) the full value of consideration for transfer (ii) the cost of acquisition of the capital asset and the cost of improvement; and (iii) the expenditure incurred in connection with the transfer. Items (ii) and (iii) have to be deducted from item (i). Section 55(2) defines the expression “cost of acquisition”. The relevant parts of the said sub-section i.e. section 55(2) are extracted hereunder:

“55. (1) xxx xxx xxx

(2) For the purposes of section 48 and 49, “cost of acquisition”: -

(aa) In a case where, by virtue of holding a capital asset, being a share or any other security, within the meaning of clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) (hereafter in this clause referred to as the financial asset), the assessee –

(A) becomes entitled to subscribe to any additional financial asset ; or

(B) is allotted any additional financial asset without any payment,

then, subject to the provisions of sub-clause (i) and (ii) of clause (b)@

(iiia) In relation to the financial asset allotted to the assessee without any payment and on the basis of holding of any other financial asset, shall be taken to be nil in the case of such assessee; and

(ab) In relation to a capital asset, being equity share or shares allotted to a share- holder of a recognized stock exchange in India under a scheme for demutualisation or corporatisation approved by a Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992), shall be the cost of acquisition of his original membership of the exchange.

Provided that the cost of a capital asset, being trading or clearing rights of the recognized stock exchange acquired by a shareholder who has been allotted equity share or shares under such scheme of demutualisation or corporatisation, shall be deemed to be nil.

(b) in relation to any other capital asset,-

(i) where the capital asset became the property of the assessee before the 1^st day of April, 1981, means the cost of acquisition of the asset to the assessee or the fair market value of the asset on the 1^st day of April, 1981, at the option of the assessee (emphasis supplied);

(ii) where the capital asset became the property of the assessee by any of the modes specified in sub-section (1) of section 49, and the capital asset became the property of the previous owner before the 1^st day of April, 1981, means the cost of the capital asset to the previous owner or the fair market value of the asset on the 1^st day of April, 1981, at the option of the assessee.”

14. From the above, it emerges that there are four categories of capital assets enumerated in clauses (a),(aa), (ab) and (b) of sub-section (2) of section 55. Clause(b) is a residuary provision governing “any other capital asset”. We are concerned here with the capital asset falling within the scope of sub-clause (aa) and category (B) thereof. The bonus shares allotted without payment of consideration is an additional financial asset that falls within part (B) of clause (aa) and, therefore in the normal course, the cost of acquisition shall be taken to be ‘nil in view of stipulations in sub-clause (iiia). But, we are of the view that in relation to clause (aa) asset that principle of computation stands excluded by the phrase ”subject to the provisions of sub-clause (i) and (ii) of clause (b)”. The said expression “subject to….” is significant and it points to the applicable provision for the purpose of ascertaining the cost of acquisition of an asset falling under clause (aa). In other words, the rules of computation of cost laid down in various sub-clauses of clause (aa) have been expressly made subject to the provisions of sub-clause (i) and (ii) of clause (b). Thus, in the case of a capital asset answering the description given in sub-clauses (i) and (ii) of clause (b), the rules of computation laid down by those sub-clauses of clause (b) would prevail over the rules in the preceding sub-clause (aa). The expression “subject to the provisions” of sub-clause (i) and (ii) of clause (b)” was advisedly introduced to extend the benefit of deduction of deemed cost of acquisition in respect of a capital asset of the nature specified in clause (aa), if it was acquired before 1^st April, 1981. Otherwise, there is no purpose in ordaining that the operation of clause (aa) is subject to the provisions of sub-clause (i) and (ii) of clause (b). The ‘capital asset referred to in clause (b) takes within its fold the financial assets in the form of shares or other securities as specified in clause (aa). It is clear from clause (b) of Section 55(2) that in the case of a capital asset falling within the ambit of that clause, acquired before 1April, 1981, the cost of acquisition can be taken as fair market value of the that asset as on 1^st April, 1981. This provision prevails over sub-clause (iiia) of clause (aa). The applicant is therefore entitled to the benefit conferred by clause (b)(i) of S.55(2). We are of the opinion that the ruling of this Authority in Kern-Liebers International GmbH, In RE reported in 301 I.T.R. 178 squarely applies to the present case.

15. Accordingly, we answer the 2^nd question in the affirmative and hold that the fair market value prevailing on April 1, 1981 ought to be taken as the cost of acquisition in the case of bonus shares held by the applicant on April 1, 1981.

16. Accordingly, the ruling is given answering both the questions in affirmative, as contended by the applicant.

Pronounced by the Authority on this 31st day of March 2009.