Gift of shares of one foreign subsidiary

274 views

Published on

Published in: Education
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
274
On SlideShare
0
From Embeds
0
Number of Embeds
20
Actions
Shares
0
Downloads
4
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Gift of shares of one foreign subsidiary

  1. 1. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG FLASH NEWS KPMG IN INDIA Gift of shares of one foreign subsidiary to another foreign subsidiary without consideration is not liable to capital gains tax. Transfer pricing adjustment on transfer of shares without consideration, free of charge corporate guarantee, and trademark license fee deleted 23 July 2014 Background Recently, the Chennai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Redington (India) Limited 1 (the taxpayer) ruled as follows:  The transfer of shares of one foreign subsidiary to another foreign subsidiary without consideration is a valid gift. The Tribunal held that the Income-tax Act, 1961 (the Act) does not prescribe that only persons can make a gift on the grounds of ‘natural love and affection’. Therefore, such transfer of shares cannot be regarded as transfer of capital asset for the purpose of capital gains taxation, and should be eligible to claim exemption under Section 47(iii) 2 of the Act.  Above mentioned transfer of shares as gift results in no income in the hands of the taxpayer, and thereby transfer pricing (TP) provisions are not invoked. ______________ 1 Redington (India) Limited v. JCIT (ITA No.513/Mds/2014) – Taxsutra.com 2 The capital gain provisions of Section 45 shall not apply to any transfer of a capital asset under gift or will or an irrevocable trust  Upholds guarantee extended by the taxpayer to its Associated Enterprises (AEs) have no bearing on profits, income, loss or assets of the taxpayer and TP adjustment deleted (Relying on Delhi Tribunal decision in case of Bharti Airtel Ltd).  Upholds commercial expediency for trademark fee paid by taxpayer to its AE and deletes TP adjustment. Facts of the case  The taxpayer, an Indian company, provides supply chain solutions for various categories of Information Technology (IT) products. It provides supply chain solutions in India, Middle East and Africa.  The taxpayer is having a wholly owned subsidiary company in Dubai i.e. Redington Gulf FZE (RGF Gulf). RGF Gulf is engaged in the same line of business carried on by the taxpayer. RGF Gulf is mainly focusing its operations in the Middle East and African countries (MEA).
  2. 2. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.  The taxpayer first set-up a wholly owned subsidiary company in Mauritius in July, 2008 (RIML Mauritius). RIML Mauritius, in turn, set-up its own wholly owned subsidiary in Cayman Islands (RIHL Cayman).  Investcorp, a private equity fund evinced interest in investing in the overseas operations of the taxpayer. The purpose for setting up the above subsidiaries was to attract investments to expand its business operations in MEA countries, and also for listing the shares in such subsidiaries on stock-exchanges abroad.  Subsequently, on 13 November 2008, the taxpayer transferred its entire shareholding in RGF Gulf to RIHL Cayman without any consideration. Once this transfer of shareholding was made, RGF Gulf became a step down subsidiary of RIML Mauritius and the taxpayer.  According to the taxpayer, the transfer is a gift eligible to exemption under Section 47(iii) of the Act. Further, as the shares were transferred without consideration, provisions of Section 45 of the Act should not be applicable. Also, the transaction was not an international transaction and provisions of Section 92 of the Act were not applicable. Consequently, the taxpayer did not offer any capital gain in relation to the transfer of shares or did not report the same as an international transaction.  The Transfer Pricing Officer (TPO) held that transfer of shares made by the taxpayer is an international transaction falling within the transfer pricing regulations. Accordingly, the TPO determined the Arm’s Length Price (ALP) of RGF Gulf at INR8,654 million. Thereafter, the Assessing Officer (AO) has made addition of long-term capital gain arising on transfer of shares at ALP adjustment suggested by the TPO.  The taxpayer had outstanding corporate guarantee extended on behalf of its AEs for which no guarantee fee was charged. No fresh corporate guarantee was extended by the taxpayer during the year. Adjustment was made by the TPO adopting a commission rate of 2 per cent on the outstanding corporate guarantee. The TPO, in light of the amendment brought in by Finance Act, 2012, with retrospective effect, held that corporate guarantee has to be treated as international transaction, and therefore ALP determination is called for.  The taxpayer paid trademark fee to its AE for use of the ‘REDINGTON’ trademark. TPO determined the ALP of the trademark fee at nil on the grounds that there was no rationale for such trademark fee payment.  The Dispute Resolution Panel (DRP) held that the transfer of shares by the taxpayer amounted to international transaction. However, in view of the clause in the buyback agreement between the taxpayer and Investcorp that provided for a minimum guaranteed return to Investcorp, the DRP agreed that the market price of the shares would be lesser than the price paid by Investcorp. Accordingly, the DRP granted a marginal relief of 10 per cent. Further, the DRP, consistent with the prior assessment years, reduced the adjustment on corporate guarantee from 2 per cent to 0.85 per cent of the outstanding corporate guarantee. In respect of the trademark fee, the DRP upheld the addition made by the TPO. Tribunal’s ruling Taxability of gift under the Act  The term ‘gift’ is not defined in the Act. Therefore, the enactments that may be relied on for the purpose of deciding the issue under the Act, is the Transfer of Property Act, 1882 and the erstwhile Gift Tax Act, 1958.  Section 5 of the Transfer of Property Act, 1882, defines the expression ‘transfer of property’. ‘Transfer of property’ means an act by which a living person conveys property, in present or in future, to one or more other living persons, or to himself, or to himself and one or more other living persons; and ‘to transfer property’ is to perform such act. The section further provides that ‘living person’ includes among other things a company.  As per Section 122 of the Transfer of Property Act, 1882, gift is the transfer of certain existing movable or immovable property made voluntarily and without consideration by one person, called the donor, to another, called the donee, and accepted by or on behalf of the donee.  On reference to the provisions of Sections 5 and 122 of the Transfer of Property Act, 1882, it indicates that a company being a living person can transfer a property by way of gift.  The essential ingredients of a valid gift are the existence of the property, voluntary nature of the transfer, and absence of consideration. As a pre- condition for making a valid gift, the law does not prescribe any attributes like ‘love and affection’.  Transfer of property as the general law contemplates is the transfer of both existing property and future property. But in a gift, the transfer must be of an existing property. The meaning given to the expression ‘gift’ in the erstwhile Gift Tax Act, 1958 is the same.
  3. 3. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.  As per Section 2(xii) of Gift Tax Act, 1958, a gift is defined to mean the transfer by one person to another person of any existing movable or immovable property made voluntarily and without consideration of money or money’s worth. As per the Gift Tax Act, 1958, a person includes a company as well, and there is no attributes like ‘love and affection’. Therefore, it has been held that the lower authorities have erred in law in concluding that the taxpayer being a corporate body cannot make a gift.  The Mumbai Tribunal in the case of DP World (P) Ltd. 3 had held that the corporate body can make a gift. As long as the articles of association of the donor company permit it, it can do so under Section 82 of the Companies Act, 1956. It was held that the gift of shares to a foreign company without consideration has to be treated as gift within the meaning of Section 47(iii) of the Act.  The AAR in the case of Deere & Co. 4 had held that ‘love and affection’ are not required to make a gift, and a corporate body construed as not having natural love and affection can also make a valid gift.  A company is a person both for the purpose of Transfer of Property Act, 1882 and Gift Tax Act, 1958, and can make a gift to another company, which is valid in law. Accordingly, the legal capacity of the taxpayer to gift its shares in RGF Gulf to RIHL Cayman was to be accepted. Exemption for the gift under Section 47(iii) of the Act  Section 47(iii) of the Act provides that Section 45 of the Act shall not apply to the transfer of a capital asset made under a gift. There is no restriction provided under the Act, which prohibits a company from claiming exemption under Section 47(iii) of the Act. If that was the intention, the legislature would have specifically stated that the exemption is available for the individuals alone, as the law has specifically provided such conditions in other provisions relating to capital gains tax i.e. Section 54, 54F, etc.  When there is no such specific rider in Section 47(iii) of the Act in respect of a person eligible for claiming exemption under Section 47(iii) of the Act, there was no need to read the law to make an interpretation that a company cannot claim exemption under Section 47(iii) of the Act. That view is not permissible in law. ________________ 3 DP World (P) Ltd. v. DCIT [2013] 140 ITD 694 (Mum) 4 Deere & Co. [2011] 337 ITR 277 (AAR)  In order to apply the provisions of Section 47(iv) 5 of the Act, it is necessary that the subsidiary company should be an Indian company. However, in the present case, the step down subsidiary, RIHL Cayman is not an Indian company.  A gift is a transfer of capital asset from one person to another, without consideration. The transaction contemplated in Section 47(iv)/(v) is a transfer arising out of contractual obligation and it must also be enriched by consideration. The transfer without consideration is not the subject matter of Section 47(iv)/(v) of the Act. The law stated in those sections 6 presupposes a consideration for the transfer, while Section 47(iii) of the Act is applicable only to a transaction without consideration.  Accordingly, the transfer of shares made by the taxpayer without consideration was a valid gift and as the transaction was a gift, the transfer of shares cannot be regarded as transfer of capital asset, liable to capital gains tax. Therefore, it was eligible for exemption under Section 47(iii) and consequently, it was not liable for capital gains tax. Computation mechanism under Section 48 of the Act  In the scheme of capital gains taxation, Section 45 is the charging section. However, Section 48 of the Act provides the mode of computation of income chargeable under the head ‘capital gains’. When there is no consideration involved in a transfer, the computation provisions contained in Section 48 fail.  Capital gains are computed by deducting the cost of acquisition of the asset with cost of improvement if any, and the expenditure incurred in connection with the transfer from the value of consideration received or accruing as a result of a transfer. Therefore, the essential ingredients necessary for computing the capital gains under Section 48 of the Act are the value of full consideration and the cost of acquisition of the asset. The above two ingredients are inescapable. ________________ 5 The capital gain provisions of Section 45 shall not apply to any transfer of a capital asset by a company to its subsidiary company if (a) the parent company or its nominees hold the whole of the share capital of the subsidiary company (b) the subsidiary company is an Indian company 6 Section 47(iv) and 47(v) of the Act
  4. 4. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.  Relying on the decision of B.C.Srinivasa Setty 7 it was held that when the fundamental ingredient for computing the capital gains is missing, the computation provisions provided in Section 48 of the Act cannot be applied. The inevitable consequence is that the case does not fall within the charging Section 45 of the Act. The same analogy was applied by the Supreme Court in a later decision rendered in the case of PNB Finance Ltd. 8  The principle laid down by the Supreme Court in the case of B.C.Srinivasa Setty has been followed by the AAR in a series of rulings 9 given by them in matters relating to international transactions.  In the present case also the transfer of shares was made without consideration, the foremost ingredient of computation provisions is missing and as such, capital gains cannot be computed under Section 48 of the Act. Accordingly, Section 45 of the Act cannot be applied and capital gains tax cannot be levied. Transfer pricing on gift transaction  Section 92 of the Act provides that any income arising from an international transaction shall be computed having regard to the Arm’s Length Price (ALP). The computation of the ALP, therefore, is dependent on the income arising to the taxpayer from an international transaction.  The AAR in the various cases 10 had held that TP provisions would apply only to those international transactions, which are liable to income tax in India. However, in case of transfer of shares, TP provisions do not apply.  In the present case, the shares were transferred by way of gift and no income arose in the hands of the taxpayer. As such, ALP determination does not extend to this transaction and therefore, the gift of shares made by the taxpayer was not liable for TP provisions. ________________ 7 CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC) 8 PNB Finance Ltd. v. CIT, R 75 [2008] 307 ITR 75 (SC) 9 Dana Corporation, [2009] 227 CTR 441 (AAR) Amiantit International Holding, [2010] 230 CTR 19 (AAR) Goodyear Tire and Rubber Co., [2011] 334 ITR 69 (AAR) 10 Vanenburg Group B.V. [2007] 289 ITR 464 (AAR), Dana Corporation, Amiantit International Holding, Goodyear Tire and Rubber Co., Praxair Pacific Ltd. [2010] 326 ITR 276 (AAR), VNU International BV (871 of 2010) - [2011] 334 ITR 56 (AAR) TP adjustment for corporate guarantee and trademark fees  The Tribunal observed that the corporate and bank guarantees extended by the taxpayer were for the overall interests of its business. Relying on the decision in the case of Bharti Airtel Ltd 11 , the Tribunal upheld that the guarantee extended by the taxpayer is not an international transaction as the same does not have any bearing on profits, income, losses or assets of the taxpayer.  The Tribunal observed there was nothing uncommon in the taxpayer making payment for the use of trademark. Further, the Tribunal observed that such payment made is not unique to the taxpayer and it is for the taxpayer to decide the dynamics of its business. Tribunal, relying on the decision of S.A. Builders 12 , upheld that any expenditure incurred by the taxpayer, if justified by commercial expediency, is an expenditure allowable for the purpose of taxation, and what is commercial expediency is something for the taxpayer to decide, and accordingly the TP adjustment was deleted. Our comments This is a welcome ruling of the Chennai Tribunal wherein it was held that the transfer of shares by a company without consideration is a valid gift since the living person’ includes a company, and the Act does not prescribe existence of ‘natural love and affection’ as a precondition for making a gift. Therefore, such transfer of shares cannot be regarded as transfer of capital asset for the purpose of capital gains taxation and it was eligible for exemption under Section 47(iii) of the Act. It is important to note the decision of the Karnataka High Court in the case of Nadatur Holdings and Investment Pvt Ltd 13 wherein the High Court has held that there is no bar for gifting of shares to a company. The definition of gift means transfer by one person to another of an existing property made voluntarily and without consideration, and includes deemed transfer or conversion of any property. Since the taxpayer was a separate legal entity, shareholders of the company can gift shares to the company. _______________ 11 Bharti Airtel Ltd v. ACIT [2014] 63 SOT 113 (Del) 12 S.A. Builders v. CIT [2007] 288 ITR 1 (SC) 13 CIT v. Nadatur Holdings and Investment Pvt Ltd [2012] Taxman 597 (Kar)
  5. 5. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The AAR in the case of Orient Green Power Pte Ltd 14 has held that inter-corporate gift is ‘strange transactions’ and that such transactions may not be eligible for exemption under Section 47(iii) of the Act, as it covers only gifts made by an individual, Hindu Undivided Family. The Tribunal has not considered or dealt with this decision. It can be observed in the ruling that the TPO had brought the transfer of shares within the purview of ‘business restructuring/reorganisation’ in view of the retrospectively amended definition of international transaction. The taxpayer had rebutted this argument, on the grounds that the transfer of shares was merely a change in holding structure and does not tantamount to business restructuring/reorganisation. Further, the taxpayer, referring to OECD guidelines, argued that business restructuring would arise only in case of a change in functions, assets, and risks of the enterprise involved in the transaction. However, the Tribunal has not commented on this aspect in the decision. It would be prudent to note here that the definition of international transaction was amended to include business restructuring/reorganisation, irrespective of whether the transaction has a bearing on the profits, income, losses or assets of such enterprise. In the absence of the definition of business restructuring/business reorganisation in the Act, it is a contentious issue as to whether transfer of shares would fall within the purview of business restructuring/reorganisation, and if so whether the same would be an international transaction irrespective of whether it results in income taxable in the hands of the taxpayer. On trademark fee Tribunal has upheld the trademark fee paid by the taxpayer on the grounds that such payment is not unique to the taxpayer, and is justified by commercial expediency. This is a welcome decision in view of the increasing number of TP adjustments in case of royalty payments and brand fee payments faced by taxpayers. On corporate guarantee This ruling, following the decision of Bharti Airtel Ltd., has kept free of charge corporate guarantee out of the purview of the retrospectively amended definition of international transaction. _____________________ 14 Orient Green Power Pte Ltd. [2012] 346 ITR 557 (AAR) CBDT issued notification on safe harbour rules based on the recommendation of the Rangachary Committee Report. On explicit guarantee, safe harbour rules prescribes safe harbour guarantee commission of 2 per cent/1.75 per cent based on the value of loans. The Rangachary Committee analysed and concluded that corporate guarantee is an international transaction. Further on benefit test, the committee has observed that, “The main intention of keeping a safe harbour for corporate guarantee is that explicit guarantees do provide benefit to the borrower, though the benefit may vary from case to case. So the committee is of the view that the benefit test is not required for explicit guarantee as, by its very nature, it provides a benefit to the giver and the receiver.” In this ruling, the taxpayer had not extended any corporate guarantee during the year and the TP addition was only in respect of the subsisting corporate guarantee extended in the previous years. Accordingly, the Tribunal upheld that the corporate guarantee did not have a bearing on the profits, income, losses, or assets of the taxpayer. However, though the corporate guarantee was extended in the previous year, still there remains an underlying liability which would crystallise in case of any default by the AE, and the taxpayer carries the risk associated therewith and needs to be compensated for the same. In view of CBDT’s intent in including explicit corporate guarantee under safe harbour rules, and the amended definition of international transaction, corporate guarantee extended free of charge still remains a debatable issue.
  6. 6. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. www.kpmg.com/in Ahmedabad Commerce House V, 9th Floor, 902 & 903, Near Vodafone House, Corporate Road, Prahlad Nagar, Ahmedabad – 380 051 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Bengaluru Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Kochi Syama Business Center 3rd Floor, NH By Pass Road, Vytilla, Kochi – 682019 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Kolkata Unit No. 603 – 604, 6th Floor, Tower – 1, Godrej Waterside, Sector – V, Salt Lake, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010

×