Taxation of shares and securities - Recent controversies and development - April 2012 Vikram Bohra & Nehal D. Sampat
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Taxation of shares and securities –
Recent controversies and development
April 2012 Vikram Bohra &
Nehal D. SampatWhat is the capital of Brasil? …
• Buenos Aries
• Brasilia
• Rio de janerios
• None of the above
Any guesses?
Slide 2… It is
• Buenos Aries
• Brasilia
• Rio de janerios
• None of the above
That was just to catch attention!
Slide 3Contents
• Long-term Capital Asset – “exactly 12 months”
• Conversion of preference shares into equity shares
• Conversion of warrants to equity shares
• Buy-back of equity shares
• Gains arising on transfer of CCDs
• Capital reduction
• Transfers pursuant to family arrangements
• FCCBs/ FCEBs/ ADRs/ GDRs; and
• Evergreen controversy – characterisation?
Slide 4Controversies
Long-term Capital Asset – “Exactly 12 months” [1/2]
• Definition of the term “long-term capital asset” [section 2(29A)]
o Means a capital asset which is NOT a short-term capital asset
• Definition of the term “short-term capital asset” [section 2(42A)]
o Means a capital asset held by an assessee for not more than [ “12 months”?
Slide 6Long-term capital asset – “Exactly 12 months”?
[2/2]
• Recent decision of the Delhi HC (as reported by Taxsutra.com on
13 April 2012)
o Mutual fund units held for exactly 12 months immediately preceding the date
of transfer regarded as long-term capital asset
Slide 7Conversion of preference shares into equity shares
[1/2]
• Arguments in favour of NOT a transfer
o Circular dated 12 May 1964 [F. No. 12/1/64 – IT (AI) ]
– No transfer where one type of share is converted into another type of share
o Section 55 – Cost of acquisition of converted shares to be computed with
reference to the cost of acquisition of original shares
• Arguments against
o Definition of term “transfer” under section 2(47) includes “exchange” of an asset
– Does conversion of preference shares amount to an “exchange”?
Slide 8Conversion of preference shares into equity shares
[1/2]
• Held, taxable
o Additional CIT v HEH Nizam Trust [102 ITR 248] [1974] (AP)
o CIT v Santosh L. Chowgule [234 ITR 787] [1998] (Bom)
• Held, NOT taxable
o ITO v Vijay Merchant [19 ITD 510] [1986] (Mum)
Slide 9Conversion of warrants into equity shares [1/2]
• Arguments in favour of NOT a transfer
o Conversion represents mere working out of rights
• Arguments against
o Definition of term “transfer” under section 2(47) includes “exchange” of an
asset
– Does conversion of warrants amount to an “exchange” or
“extinguishment of rights in an asset”?
Slide 10Conversion of warrants into equity shares [2/2]
• Lapse of warrants
o Ajay C. Mehta v DCIT [115 TTJ 281] [2007][Ahd]
o “Transfer”, but for “without consideration”
Slide 11Buy-back of equity shares [1/2]
• Position prior to section 46A:
o Anarkali Sarabhai v CIT [224 ITR 422] [1997] [SC] – Redemption of preference
shares amounts to a “transfer” (falls within the ambit of “sale, exchange or
relinquishment of an asset”)
o Kartikeya Sarabhai v CIT [228 ITR 163] [SC] – Reduction of preference shares
amounts to a “transfer (falls within the ambit of “extinguishment of any rights
therein”)
• Section 46A and exclusion of buy-back from section 2(22) inserted to
provide “clarity” on taxability of buy-back transactions
o Purchase of shares by a company under a scheme of arrangement under section
391 to 394 of the Companies Act - whether taxable in a manner similar to buy back
under section 77A?
Slide 12Buy-back of equity shares [2/2]
• Buyback of shares by a wholly owned subsidiary
o [Section 45 v. Section 46A ] read with [section 47(iv)]
o Recent AAR ruling in case of RST, In Re [AAR No. 1067 of 2011]
• Buyback of shares held by a Mauritius holding company
o Buyback regarded as a distribution of profits (purportedly held to be
“colourable” device)
o Income on buy-back re-characterized as “dividends” (not liable to Dividend
Distribution Tax)
o Recent AAR ruling in case of XYZ India [TS-196-AAR-2012]
Slide 13Gains arising on transfer of CCDs
• Recent AAR ruling in case of Z Mauritius [AAR No. 1048 of 2011]
o Sale of 0% CCDs held by a Mauritius company in an Indian company to its Indian
JV partner on exercise of a call option by the JV partner
o Debenture construed as an acknowledgement of debt liable to be repaid or
discharged
o “Interest” defined widely under the domestic law and the treaty
o Issuer of CCDs i.e. the Indian company and the Indian JV Partner are one and the
same entity (following observations of the SC in Vodafone’s case); amount paid
towards debt
o Recharacterised gains arising on sale of CCDs as “interest”
Slide 14Capital reduction
• Bennett Coleman & Co. Ltd. [TS-580-ITAT-2011 (Mum SB)]
o Reduction of face value followed consolidation
o Mere substitution of one kind of shares with another; no effective change in the
rights of shareholders
o Provisions of section 45 read with section 48 do not apply as transfer not for any
consideration
o SC decision in the following cases distinguished :
– Kartikeya Sarabhi [228 ITR 163]
– Anarkanli Sarabhai [224 ITR 422]
– Grace Collis [248 ITR 323]
Slide 15Transfers pursuant to family arrangements [1/2]
• CIT v R Nagaraja Rao [TS-222-HC-2012 (Kar)]
o Family members have anterior title to family property; accordingly, “family
arrangements” represent working out of rights in common property which always
existed
o “Transfer”, for the purposes of section 2(47), does not include any transfer
pursuant to “family arrangements”
o Decision in Ram Charan Das v. Girija Nandini Devi AIR 1966 SC 323 followed
Slide 16Transfers pursuant to family arrangements [2/2]
• “Family arrangements” – key ingredients
o Family: term “not defined” but could have a wider connotation
o Property: individual or self-acquired properties not considered unless there is an
antecedent title, claim or interest in the property
o Dispute: pre-existing dispute not necessary; bona fide arrangement in
anticipation of dispute could be regarded as valid
• Can there be an exposure under “Income from Other Sources”: receipt of
property without or for less than adequate consideration?
o Decision in Ziauddin Ahmed [102 ITR 253] [Gau]: family arrangements cannot
be taxed under the erstwhile Gift-tax law
Slide 17FCCBs / FCEBs/ ADRs/ GDRs
• Issue of FCCBs & Ordinary shares (Through Depository Receipt Mechanism)
Scheme , 1993
• NR to NR transfer outside India – exempt under Scheme
• NR to R transfer ?
• Conversion of FCCBs/ ADRs/ GDRs into equity shares not a taxable event
• Conversion of equity shares into ADRs/ GDRs – whether taxable ?
• Amendment by Finance Act, 2008 – Cost of acquisition and whether
retrospective ?
• Taxability of gains on buy-back of FCCBs
• Treaty applicability
Slide 18Evergreen controversy - characterisation
• Taxability of capital receipts?
• Definition of term “capital asset”
• Definition of term “business”
o Covers an adventure in the nature of trade, commerce or manufacture
Held adventure Held not an adventure
• Raja J. Rameshwar Rao v CIT [42 ITR 179] • CIT. P.K.N & Co. [60 ITR 65]
• G. Venkataswami Naidu & Co v CIT [35 ITR 594] • Saroj Kumar Mazumdar V CIT [37 ITR 242]
• Mohammed Meerakhan v CIT [73 ITR 735] • CIT v Rajasthan Mines Ltd [78 ITR 45]
Slide 19Gains earned by FIIs
• Principles emerging
o Volume and frequency of transactions
o Intention – To earn profits or dividend / capital appreciation
o Objects of the company
• Relevant case laws
o TCW – ICICI [250 ITR 194] : Held business income
o Fidelity Advisors Series VII [192 CTR 201]: Held business income
o GEPT: Held business income
o Fidelity Northstar Fund [288 ITR 641]: Held Capital gains
Direct Taxes Code Bill, 2010 sought to resolve this controversy –
Gains earned by FIIs to be taxable as Capital Gains
Slide 20Circulars and recent case laws [1/2]
• Instruction 1827 dated 31.08.1989
• Draft Instruction - F. No. 149/287/2005 dated 16.05.2006
• Circular No. 4/2007 dated 15.6.2007
• Various judicial pronouncements
o ACIT v Rajesh Patel (ITAT Ahemdabad) [2012-TII-02-ITAT-AHM-INTL]
o CIT v. Arvind Prakash Malpani (Karnataka HC) [2011-TIOL-59-HC-KAR-IT]
o Gopal Purohit v. JCIT ( Bombay HC) [188 Taxman 140]
o Renato Finance & Investments Ltd v. DCIT [2011-TIOL-157-ITAT-Mum]
o ACIT v Tripuraprasad N. Pandya (ITAT Mumbai) [ITA No. 1336/ Mum/ 2010]
An Evergreen Controversy !!!
Slide 21Circulars and recent case laws [2/2]
Merely because shares are purchased from borrowed funds, share
transactions should not be treated as a business income. Even
ACIT v Rajesh
though money was borrowed to invest in shares, neither the
Patel
interest paid on such borrowed money nor STT was claimed as
expense while computing capital gains.
CIT v Arvind
High volume of transactions in shares constitute business income
Prakash Malpani
Gopal Purohit v Delivery based transactions were rightly treated as being
JCIT investment transactions giving rise to capital gains
Renato Period of holding a guiding factor for characterising income as
Investment „capital gains‟ or „business profits‟
Income from share transactions held as „business income‟ on
ACIT v Tripura
account of active regular transactions and high volume thereof
Prasad N Pandya
Slide 22PMS transactions
• Ms Radials International v CIT – Delhi ITAT [ITA No. 1368/Del/2010]
o Portfolio Manager carries on buy and sell transactions on behalf of investor as an
agent
o Investor has no control on his investment which is left to choice of manager
o Volume of transactions were significant and motive was to earn maximum profit
o Characterisation of holding as investment not to change character
o Income taxable as Business Income
• ITO v Radha Birju Patel – Mumbai ITAT [ITA No. 5382/ Mum/ 2009]
o Systematic activity of holding securities through PMS cannot be said that main
objective of holding the portfolio is to make profits
o Income taxable as Capital Gains
Slide 23Thank You Vikram Bohra Contact No.: 9920179903 Nehal D. Sampat Contact No.: 9987529708
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