The Indian tax laws [Income-tax Act, 1961 (“the Act”)] provides for the taxation of income arising from the “transfer” of a capital asset under the head “Capital Gains”.  Further, the Act also provides a list of transactions that will not be considered as “transfer” (subject to satisfaction of certain prescribed conditions) and hence any income arising from such transactions will not be taxable under the Act.

One such type of transaction is “transfer of capital asset by a company to its subsidiary company” [Section 47(iv) of the Act].  While the transaction between a company and its immediate subsidiary is covered by the said specific exclusion, a question arises as to whether the said exclusion also covers transactions between a holding company/ parent company and its step down subsidiary.  As the Act does not explicitly define the word “subsidiary company”, the inclusion of a step down subsidiary in the definition of a “subsidiary company” has been a matter of contention.  

Recently, the Kolkata Bench of the Income-tax Appellate Tribunal (“Tribunal”) in the case of Emami Infrastructure Ltd. v. ITO, Ward 12 (1), Kolkata, [TS-101-ITAT-2018(Kol)] held that the benefit of section 47(iv) of the Act will also be available to a company on the transfer of capital asset to its wholly owned step down subsidiary. 

Facts of the case

1. During the year under consideration, Emami Infrastructure Ltd (hereinafter referred to as “Assessee”), sold certain number of shares of Zandu Realty Ltd (“ZRL”), a listed company, through an off market transaction to its wholly owned step down subsidiary, Emami Rainbow Niketan Pvt. Ltd. and claimed a long-term capital loss in relation to the said transaction in its Return of Income (“ROI”).

2. The sale price of the shares for the said transaction was determined based on a valuation report obtained from an independent valuer.

3. During the course of assessment proceedings, the claim of long term capital loss was denied by the Income-tax officer (“ITO”) on the grounds that the shares sold by the Assessee were of a “listed company” and that the sale price of the shares was required to be computed based on the price quoted at the stock exchange and not as per the valuation report.  Also, the ITO held that as the transaction was with an associated enterprise/ related party that the same should be at arm’s length price.

4. In light of the above and considering the huge difference between the quoted price on the stock exchange and the sale price as computed on the basis of the said valuation report, the ITO adopted the average selling price of ZRL on the stock exchange to arrive at the fair market value of the shares that were sold by the Assessee and accordingly computed capital gains in relation to the said transaction.

5. During the course of assessment proceedings, the Assessee also put forth a claim of benefit of Sec.47(iv) to the said transaction.  However, the ITO did not accept Assessee’s claim u/s. 47(iv) on the ground that the shares were sold to a step down subsidiary.

6. Further, during the course of the first appellate proceedings, the Commissioner of Income tax (Appeal) [“CIT(A)”] confirmed the action of the ITO and denied the Assessee’s claim of benefit of Sec.47(iv) on the grounds that the claim was not made in the return of income and any claim during the assessment proceedings as such cannot be accepted. In doing so, the CIT(A) relied on the Supreme Court (“SC”) ruling in the case of Goetze (India) Ltd. vs CIT [TS-21-SC-2006-O] wherein it was held that an assessee cannot make a claim for deduction in relation to the return filed by him other than by filing a revised return and the claim for deduction cannot be made by way of a letter before the AO during the course of the assessment proceedings.

Issues before the Tribunal

1. Whether there is a transfer of shares in view of the specific exclusion provisions of Sec.47(iv)?

2. If the transaction in question is not covered u/s. 47(iv), then whether the computation of capital gains as made by ITO and confirmed by CIT(A) was correct or not, and whether the ITO could substitute the sale consideration of the shares sold with the fair market value determined by him?

Provisions of Sec. 47(iv) of the Act

Sec. 47(iv) provides that transfer of a capital asset held by a company to its subsidiary company is not to be regarded as a 'transfer' for the purpose of income chargeable to income-tax under the head “Capital Gains” provided:

(i) the parent company or its nominees hold whole of the share capital of the subsidiary company; and

(ii) the subsidiary company is an Indian company.

The Tribunal’s Decision

The Tribunal arrived at its conclusion by analysing whether Sec. 47(iv) is applicable to a step down subsidiary.  

As there were divergent views on the said issue, the Tribunal deliberated the judgement of the Bombay HC in Petrosil Oil Company Ltd vs CIT [TS-5676-HC-1998(BOMBAY)-O] and the ruling of the Gujarat High Court in Kalindi Investment Private Limited vs CIT [TS-2-HC-2001(GUJ)-O].

The Tribunal held that the transfer of shares of ZRL by the Assessee to its wholly owned step down subsidiary would fall within the ambit of Sec. 47(iv) and therefore would not be taxable under the Act.

In doing so, the Tribunal relied on the judgment of the Bombay HC in Petrosil Oil Company Ltd (supra) wherein it was held that since the term “subsidiary company” was not explicitly defined in the Act, the definition of “subsidiary company” under the Companies Act, 1956, which includes a step down subsidiary, could be imported for the purpose of Sec. 47(iv).

The Tribunal preferred not to follow the Gujarat HC ruling in Kalindi Investment Private Limited (supra) wherein the Gujarat High Court expressed a contrary view on the said issue stating that the definition of “holding company” under the Companies Act could not be adopted for the purpose of Sec. 47  since the language used in Sec. 47(iv) does not use the wider definition of holding company based on control and requires the parent or its nominees to hold whole of the share capital of the subsidiary company.

The Tribunal also held that since the said transaction was not taxable applying the exclusion of Sec. 47(iv), the gain/ loss arising from such transfer was held to be irrelevant from an income tax perspective and accordingly, the claim of the Assessee for carry forward of the capital losses arising from the transfer of shares could not be allowed.  Further, the issue as to whether the ITO can substitute the sale consideration of shares with the fair market value as computed was also considered as irrelevant based on the exemption being applied per above.

Analysis

As there is limited jurisprudence with regard to the exemption u/s. 47(iv) for transfer of capital assets to a wholly owned step down subsidiary, this ruling of the Tribunal supports a taxpayer’s claim to avail an exemption from capital gains tax on transfer of capital asset by a parent company to a wholly owned step down subsidiary u/s. 47(iv).  

This ruling seeks to reiterate few principles which were laid down in the past by several jurisprudence.

Illustratively -  

1. This ruling reiterates the principle that for terms which are not specifically defined under the provisions of the Act, definitions given under other statutes (such as in the Companies Act) can also be imported into the Act.

2. The Tribunal, by choosing to follow the ratio laid down by the Bombay HC instead of following the ratio of Gujarat HC re-emphasises the principle that if two reasonable constructions of a taxing provision are possible, that construction which favours & is more beneficial to the taxpayer must be adopted.

3. Also, the Tribunal by first analysing whether the transaction is covered within the meaning of Sec.47(iv), a claim which was made by the Assessee at the time of assessment proceedings seeks to suggest that the Tribunal had admitted the claim of the Assessee in relation to the benefit of Sec. 47(iv) to the said transaction.  In this regard, the action of the ITAT appears consistent with the Circular (Circular No. 14 (XL-35) of 1955, dated 11 April 1955) issued by the Central Board of Direct Taxes (previously known as Central Board of Revenue) and the principles under Article 265 of the Constitution of India along with the varied jurisprudence that have observed that tax officers were entitled to entertain fresh claims of the assessee (i.e, which are in line with the provisions of the Act) even though a revised return was not filed by the assessee for such claims (and particularly that such claims be given due cognizance to during the course of appellate proceedings).

Interestingly, the ruling of the Tribunal has not delved upon certain key aspects that are subject to contention, namely:

1. The aspect of computation of sale consideration for an off market transaction using the average share price on the stock exchange

The existing provisions of Sec. 50CA of the Act seek to tax a taxpayer on deemed fair value basis on a transfer of unquoted shares.  On the other hand, there is no such enabling provision in the Act to determine the fair market value of 'quoted shares' transferred in off market sale.

2. General Anti-Avoidance Rules (GAAR)

The ITO had contended that since the transaction was between associated enterprises/ related parties, the same is required to be at arm’s length price.  In this regard, it may be noted that for the year under consideration (i.e, AY 2010-11) the provisions governing specified domestic transactions were not applicable.  The same were inserted by the Finance Act, 2012 with effect from 1 April 2012. The existing provisions governing the specified domestic transactions are applicable only to a limited set of transactions and the same do not include transactions that are taxable under the head “Capital Gains”. In the absence of any specific provisions empowering the tax officer to challenge the transaction price adopted, the position adopted by the ITO may be questionable.  It is probable that the ITO may have been influenced by the GAAR regime.  Though the provisions of GAAR regime as contained in the Act provide wide powers to the tax authorities to deal with impermissible tax avoidance arrangements, the GAAR provisions are effective from 1 April 2017 and do not apply to the year under consideration.

While the above ruling could be evaluated by taxpayers for claiming a tax exempt status for similar transactions within a group, it may be noted that the exemption provision is also subject to continuity of shareholding in the subsidiary for a period of eight years (as required within the scope of section 47A of the Act).  In addition, depending on the manner in which such transactions occur, the eligibility of the subsidiary to carry-forward any business losses u/s. 79 of the Act may also require evaluation.

Further, with the insertion of Sec. 56(2)(x) with effect from 1 April 2017, the scope has expanded to include quoted shares that are transferred at a value below fair market value and tax the difference in the hands of the recipient.  In this regard, one may need to evaluate the interplay between Sec. 47(iv) (i.e., which seeks to exempt the transferor) and Sec. 56(2)(x) (i.e., which seeks to tax the recipient).

(Inputs from Ruvina Monteiro, Senior Consultant, Tax &  Regulatory Services at EY India)