DIRECT TAX

LAWS

Taxability of Capital Gains on

Buy-back of Shares - Debate ignites
after AAR’s ruling in RST’s case
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BACKGROUND 12345678901234567890123456789012123456789012
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1. Recently, the Authority for Advance Rulings (“AAR”) in the case 12345678901234567890123456789012123456789012
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of RST, In re [2012] 19 taxmann.com 215 (AAR - New Delhi) (“the 12345678901234567890123456789012123456789012
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applicant”) held that the capital gains on buy-back of shares is 12345678901234567890123456789012123456789012
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taxable in India in the hands of the German company, being 99.99 12345678901234567890123456789012123456789012
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shareholders of an Indian public company. 12345678901234567890123456789012123456789012
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The AAR ruled as under : 12345678901234567890123456789012123456789012
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u Section 46A of the Income-tax Act, 1961 (“Act”) being a specific 12345678901234567890123456789012123456789012
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provision would apply while dealing with capital gains on buy- 12345678901234567890123456789012123456789012
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back of shares, and 12345678901234567890123456789012123456789012
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AMIT AGGARWAL
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Section 47(iv) (read with section 45) which excludes from the 12345678901234567890123456789012123456789012
u 12345678901234567890123456789012123456789012
Senior Manager
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definition of taxable “transfer”, a transfer of capital assets (Tax & Regulatory),
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KPMG, Gurgaon
(including shares) held by a holding company to a 100 per cent 12345678901234567890123456789012123456789012
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owned subsidiary, is not applicable to a case of buy-back. 12345678901234567890123456789012123456789012
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ALOK PAREEK
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CA
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2. FACTS OF THE CASE 12345678901234567890123456789012123456789012
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u The applicant is a company incorporated in Germany with limited liability. The applicant
files income-tax returns in India as a ‘non-resident’.
u The applicant has a wholly owned subsidiary in India, which is a public limited company
incorporated under the Indian Companies Act, 1956.
The applicant holds 99.99 per cent shares in the Indian company. Remaining shares are
held by 6 other companies, who are the applicant’s nominees, for the compliance of the
Companies Act.
u The shares in the Indian company are held by the applicant as an investment and not
as stock-in-trade.
u Indian subsidiary is proposing a buy-back of shares from the applicant. The buy-back would
result in transfer of shares of the Indian company from the applicant to the Indian company.

12 May 1 to 15, 2012 u TAXMANN’S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 14

 u The consideration for the proposed trans-
fer is to be determined on the basis of
pricing guidelines prescribed by the Re-
serve Bank of India (RBI) as applicable to
transfer of shares by a non-resident to a
resident.
3. ISSUE BEFORE THE AAR
u Whether the transfer of shares in the course
of buy-back of shares by the Indian sub-
sidiary from the foreign company is tax-
able in India?
4. STATUTORY PROVISIONS
u Income-tax Act, 1961 (“Act”)
• Section 2(24)(vi)
Income includes any capital gains
chargeable under section 45
• Section 45
Charging section for capital gains
• Section 46A
Capital gains on purchases by company
of its own or other specified securities.—
‘Where a shareholder or a holder of
other specified securities receives any
consideration from any company for
purchase of its own shares or other
specified securities held by such
shareholder or holder of other speci-
fied securities, then, subject to the
provisions of section 48, the differ-
ence between the cost of acquisition
and the value of consideration re-
ceived by the shareholder or the holder
of other specified securities, as the
case may be, shall be deemed to be
the capital gains arising to such
shareholder or the holder of other
specified securities, as the case may
be, in the year in which such shares
or other specified securities were
purchased by the company.
May 1 to 15, 2012
Explanation. - For the purposes of
this section, “specified securities” shall
have the meaning assigned to it in
the Explanation to section 77A of the
Companies Act, 1956 (1 of 1956).’
• Section 47(iv)
Transactions not regarded as trans-
fer.— ‘Any transfer of a capital asset
by a company to its subsidiary com-
pany, if -
(a) The parent company or its
nominees hold the whole of the
share capital of the subsidiary
company; and
(b) The subsidiary company is an
Indian company;’
u Companies Act, 1956
• Section 77A
This provision enables a company to
purchase its own securities, subject
to certain conditions. The buy-back
should be of 25 per cent or less of
the total paid-up capital. On buy-
back, the company has to extinguish
and physically destroy the securities
bought back. If shares are bought
back, there can be no fresh issue of
shares within six months unless these
are bonus shares.
• Section 49
Subject to certain savings, all invest-
ments made by a company on its
own behalf shall be made and held
by it in its own name. Sub-section
(3) enables a company to hold shares
in its subsidiary in the name or names
of a nominee or nominees of the
company so as to ensure that the
number of members of the subsid-
iary is not reduced below seven, if it
is a public company, and below two,
if the subsidiary is a private company.
Sub-section (7) clarifies that securities
include stocks and debentures.
u TAXMANN’S CORPORATE PROFESSIONALS TODAY u Vol. 24 u 15 13
DIRECT TAX LAWS
In A. Ramaiya’s Guide to the Com-
panies Act (16th Edition Reprint 2006)
at page 614, the following passage
occurs :
“When the investment of a
company consists of shares in
another company the question
arises whether shares held by
the company in the name of its
nominee must be deemed to be
held by the company and
whether the investments should
be transferred to the name of
the company. In considering this
question, it is necessary to bear
in mind the provisions of section
153 which provide that no notice
of any trust, express, implied
or constructive, shall be entered
in the register of members or
debenture-holders. A company,
therefore, is bound to treat the
person in whose name the shares
are entered in its register of
members as a member. If a
company holds shares in the
name of its nominee it is not
entitled to any of the rights in
respect of the shares such as
right to dividend, to allotment
of rights shares under section
81, to exercise voting rights in
relation to the shares and other
privileges which shareholders
have. It does not, therefore,
appear to be an implication of
the provisions of section 49 that
if a company holds shares in
another company in the name
of its nominee, the shares must
be deemed to be held by the
company and not by the nominee.”
5. APPLICANT’S CONTENTIONS
u Section 46A of the Act is not a charging
section. Further, buy-back of shares would
14 May 1 to 15, 2012 u TAXMANN’S CORPORATE PROFESSIONALS TODAY
be chargeable to tax under section 45(1), read
with section 46A for computation thereof.
u The transaction shall be covered under
section 45 and section 47(iv) and, there-
fore, the transaction would not be taxable
in India.
u The applicant and its nominees together
held 100 per cent of the shares in the
Indian subsidiary. Therefore, the transfer
in the course of a buy-back would stand
exempted from taxation under section 47(iv).
u It is enough if a share is a capital asset
to attract sections 45 and 47.
u Provisions of India-Germany tax treaty
are not invoked since they are not ben-
eficial to the applicant and such capital
gains are taxable in source State, i.e., India.
6. TAX DEPARTMENT’S CONTENTIONS
u Existence of the share after the transfer
is a must for attracting section 47(iv). In
a buy-back the shares get destroyed and,
hence, section 47(iv) has no application.
u Section 47 also does not override section
46A.
Section 46A was introduced specifically
to deal with buy-back of shares and the
rate of tax has to be computed in terms
of section 48. Section 47 has no relevance
in this context.
Accordingly, the gains are taxable in India as
capital gain, both under section 46A or under
Article 13(4) of India-Germany tax treaty.
AAR’S RULING
7. The AAR held in favour of the revenue on
following two grounds :
u Section 47(iv) provides exemption if a
company holds 100 per cent shares in an
Indian subsidiary, either directly or through
its nominees.
u Vol. 24 u 16
 u In the context of section 49(3) of the Com-
panies Act, there cannot exist a subsid-
iary Indian company, whether public or
private, in which the parent company could
legally hold 100 per cent of the shares.
Treating the other six members as not
having independent existence, it would
mean that the subsidiary would become
an illegal entity in the face of section
49(3) of the Companies Act. It would mean
that the applicant would be founding its
cause of action on an illegality.
Relying on A. Ramaiya’s Guide to the
Companies Act [as above], the AAR held
that in the applicant’s case even if it is
taken that the other six members of the
subsidiary are the nominees of the appli-
cant, it cannot be claimed that the appli-
cant is holding 100 per cent of the shares
in the subsidiary.
If under Indian law, a parent company
cannot hold 100 per cent in a subsidiary,
it would only mean that the Parliament
did not intend to confer the benefit of
section 47(iv) on such a parent company.
Therefore, the AAR held that the applicant is
wrong in assuming the words under section
47(iv) of the Act ‘the parent company or its
nominees’ as ‘the parent company and its
nominees’.
u Section 46A being a special provision dealing
with buy-backs, has to prevail over the
general provisions incorporated in sec-
tion 45.
u Further, even if the plea of the applicant
is accepted to read ‘or’ as ‘and’ in section
47(iv), it is of no avail to the applicant
in view of the fact that section 46A would
be applicable in the case of a buy-back
of shares and it is not subjected to section
47 (which only overrides section 45).
u Once section 46A is attracted when there
is a buy-back of shares, the gains have
to be taxed in terms of said provision,
read with section 48.
May 1 to 15, 2012
Therefore, the gains on proposed buy-back of
shares would not be exempt under section
47(iv) and liable to be taxed in India under
special provisions dealing with buy-back under
section 46A.
SECTION 47(iv) - THE CONTROVERSY
AHEAD - VIEWS
8. The AAR’s conclusion of requirement of
100 per cent shareholding by a single shareholder
[without nominee shareholding to comply with
minimum number of shareholders requirement
as per Companies Act] is highly impracticable,
since in such a scenario, practically no holding
company will be able to take benefit of transfer
of any capital asset, even other than shares in
a buy-back scheme.
This will render operation of section 47(iv)
redundant. Such redundancy would not have
been the intention of the Legislature.
That apart, since the AAR based its conclusion
also on the applicability of section 47(iv)
exemption vis-a-vis section 46A [irrespective
of the above conclusion], the same needs to
be discussed as below:
One view
u As per section 2(24)(vi) “income” includes
any capital gains chargeable under sec-
tion 45. Section 46A is not expressly covered
and also cannot be said to be covered
under the “inclusive” definition, since it
is not a receipt of a recurrent nature to
fall under the general connotation of income.
u When section 47(iv) provides for a trans-
action of transfer1 of capital asset not to
be regarded as a “transfer” (subject to
fulfilment of conditions). Section 46A is
a deeming provision taxing a specific
transaction (i.e., buy-back), irrespective of
whether it is a ‘transfer’ or not.
u Going by a strict interpretation of section
47(iv) for its applicability to only a select
species of companies, (aligning with the
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 DIRECT TAX LAWS
view of AAR), it can be construed that
the benefit of section 47(iv) ought not to
be available to a holding company, where
it does not hold all shares in its subsid-
iary and even a single share is held by
its nominees.
Second view
u However, section 45 is the only charging
section for capital gains as contemplated
under section 2(24)(vi). There is only one
charging section for each head of income,
i.e. section 15 for salaries, section 23 for
house property, section 28 for profits from
business, section 45 for capital gains and
section 56 for other sources.
9. CONCLUSION
The Supreme Court in CIT v. B.C. Srinivasa
Setty [1981] 128 ITR 294/5 Taxman 1 has held :
“The charging section and the computation
provisions together constitute an integrated
code And ordinarily the operation of
the charging provision cannot be affected
by the construction of a particular
computation provision.”
Section 46A provides for deemed capital gains.
Consequently, it can be argued that section
46A derives its ‘chargeability’ from section 45
itself.
u Further, use of the words ‘subject to the
provisions of section 48’ in section 46A
is a reference to the mode of computation
as per the provisions of section 48, mak-
ing section 46A also a ‘computation’ sec-
tion providing the extent of charge, i.e.,
the difference between the cost of acqui-
sition and the buy-back consideration
received by the shareholder.
u The intention of the law makers while
inserting section 46A is subjecting the gains
1. The Supreme Court in the case of Anarkali Sarabhai v. CIT [1997] 90 Taxman 509, held that redemption of
preference shares by the company is considered to be a sale and also transfer of asset by shareholder.
• DT - Secs. 46A and 47(iv).
16 May 1 to 15, 2012 u TAXMANN’S CORPORATE PROFESSIONALS TODAY
arising on buy-back of shares to the capital
gains tax. However, in the light of the
intention of the section alone it cannot be
a ground for taxing the buy-back in all
cases. When a buy-back falls under the
exempting provisions [section 47(iv)], it
cannot be taxed under section 46A.
u Section 46A would be rendered otiose if
it was not regarded to fall under the charging
provisions of section 45 and, hence, un-
der the definition of ‘income’ under sec-
tion 2(24).
The second view appears to be more well-
founded based on the provisions of law.
u The force of section 46A alone should not
be sufficient to tax capital gains arising
on buy-back in every situation. Thus, the
benefit of exemption vide provisions of
section 47(iv) should be possible in re-
spect of transactions involving buy-back
of shares by the wholly owned Indian
subsidiaries.
Given that AAR ruling only has a persua-
sive value and is not binding on other
taxpayers, it remains to be seen what in-
terpretation is placed by the tax Tribu-
nals/courts in interpretation of these
provisions.
u The AAR ruling has opened a debatable
issue on interpretation of section 47(iv)
which could lead to redundancy of the
section in almost all cases, since practi-
cally no holding company will be able to
take benefit of transfer of any capital asset,
even other than shares (in a buy-back
scheme). This is highly negative fall out
of the decision.
•••
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