Understanding of Capital Gain
When it comes to the transfer of shares or debentures by non-residents, understanding the implications of capital gain is crucial. Capital gain refers to the profit or gain that arises from the sale or transfer of a capital asset. In the case of non-residents, the provisions of Proviso 1 to Section 4 and Rule 115A of the Income Tax Act, 1961, come into play.
Proviso 1 to Section 4
Proviso 1 to Section 4 of the Income Tax Act states that any income arising from the transfer of a capital asset situated in India shall be deemed to accrue or arise in India. This means that even if the non-resident is not physically present in India, any gains from the transfer of shares or debentures of an Indian company will be taxable in India.
Section 4 Proviso:
Section 4 of the Income Tax Act, 1961, is the charging section that determines the scope of total income. The proviso to Section 4 clarifies that in the case of a non-resident, only income that is received in India or accrues or arises in India shall be deemed to be their total income in India and is therefore subject to taxation in India.
This proviso has implications for non-residents who earn capital gains from the transfer of shares or debentures in India. If the gains are not deemed to have accrued or arisen in India under this provision, they may not be subject to Indian taxation.
Rule 115A of the Income Tax Rules, 1962, provides specific provisions for the taxation of capital gains earned by non-residents from the transfer of shares or debentures in an Indian company. These rules were introduced to provide a clear framework for the taxation of such capital gains.
Key points related to Rule 115A include:
- Tax Rate: Rule 115A prescribes a special tax rate for capital gains arising from the transfer of unlisted shares or debentures of an Indian company. The tax rate may vary depending on the nature of the asset and the holding period.
- Computation of Capital Gains: The rule provides guidance on how to compute the capital gains, taking into account various factors such as the sale consideration, cost of acquisition, and any indexed cost of acquisition.
- Tax Deduction at Source (TDS): In most cases, the purchaser of shares or debentures is required to deduct tax at source (TDS) at the applicable rates while making the payment to the non-resident seller.
- Tax Treaty Benefits: Non-residents may also benefit from provisions in tax treaties between India and their home countries. Tax treaties can influence the taxation of capital gains and may provide for reduced tax rates or exemptions.
- Exemptions and Deductions: Rule 115A includes provisions for certain exemptions and deductions, such as the benefit of indexation, which allows the adjustment of the cost of acquisition for inflation.
Taxation of Capital Gain
The capital gain derived from the transfer of shares or debentures by non-residents is taxed differently based on the holding period:
If the shares or debentures are held for less than 24 months, the gains are considered short-term capital gains and are taxed at the applicable slab rate.
If the shares or debentures are held for 24 months or more, the gains are considered long-term capital gains and are taxed at a flat rate of 20%.
India has entered into tax treaties with various countries to avoid double taxation. Under these tax treaties, non-residents may be entitled to certain exemptions or reduced tax rates on their capital gains. It is important for non-residents to review the tax treaty between their country of residence and India to understand the applicable provisions.
Understanding the provisions of Proviso 1 to Section 4 and Rule 115A is essential for non-residents who are considering the transfer of shares or debentures of an Indian company. Being aware of the tax implications and the available exemptions or reduced tax rates under tax treaties can help non-residents make informed decisions. Consulting with a tax advisor or expert is recommended to ensure compliance with the tax laws and optimize tax planning.
Manner of Computation of Capital Gain
As already discussed, in the case of long-term capital gain, the cost of acquisition and cost of improvement thereto are both indexed. However, in the case of an assessee who is a non-resident, any capital gain, whether short-term or long-term, arising from the transfer of a capital asset being shares/debentures of an Indian company, bought in foreign currency, shall be computed in the following manner and no indexation of cost will be done, even if it is a long-term capital gain:
(a) Cost Of Acquisitionshall be converted into the foreign currency, which was initially utilised in the purchase of such shares/debentures. For the purpose of such a conversion, average rate of TT buying and TT selling, on the date of acquisition of such shares/debentures, shall be taken;
(b) Expenses Of Transferwill also be converted into the same foreign currency, which was initially utilised for acquisition of such shares/debentures. For the purpose of conversion average rate of TT buying and TT selling, on the date of transfer, shall be taken;
(c) Full Value Of Consideration shall also be converted into the same foreign currency which was initially utilised for purchase of such shares/debentures. Here also the average rate of IT’ buying and TT selling rate of the foreign currency, on the date of sale, shall he taken;
(d) Capital Gain will now be computed as under:
full value of consideration (converted into foreign currency at average TT buying and TT selling rate on date of sale)
Less: (i) expenses on transfer (converted into foreign currency at average TT buying and TT selling rate on the date of sale)
(ii) cost of acquisition (converted into foreign currency at average TT buying and — TT selling rate on the date of acquisition)
Capital gain in foreign currency
(e) the capital gain in foreign currency, which may be long-term or short-term, shall be converted into Indian rupees at the IT buying rate only (not the average rate) on the date of transfer of the capital asset.
1. Telegraphic transfer buying/selling rates in relation to a foreign currency is the rate of exchange adopted by the State Bank of India for purchasing or selling such currency, where such currency is made available by that bank through telegraphic transfer.
2. The transferor should be a non-resident at the time of transfer. Non-resident includes a foreign company who is non-resident.
3. This proviso is not applicable to units of UTI and mutual funds.
4. The shares and debentures (whether listed or non-listed) of Indian companies only are covered under this proviso. Indian company shall include Government company. However, bonds of Central Government/State Government and RBI are not covered for this purpose.
5. The first proviso to section 48 is mandatory. Hence the non-resident covered by this proviso is not allowed to opt for indexation of cost (i.e., 2nd proviso to section 48).
6. If the shares and debentures are acquired by the non-resident in Indian currency, the second proviso to section 48 relating to indexation will apply only to shares as debentures are not eligible for indexation.
7. It may be noted that long-term capital gain on equity shares sold through a recognised stock exchange on or after 1.10.2004 shall be exempt.
R, a non-resident Indian, remits US $40,000 to India on 16.9.1989. The amount is partly utilised on 3.10.1989 for purchasing 10,000 shares in A Ltd., an indian company at the rate of Rs.12 per share. These shares are sold for Rs. 75 per share on 30.3.2022.
The telegraphic transfer buying and selling rate of US dollars adopted by the State Bank of India is as follows:
(1 US $)
(1 US $)
Compute capital gain chargeable to tax for the assessment year 2022-23 on the assumption that these shares have not been sold through a recognised stock exchange.
Sale consideration (Rs. 7,50,000/75)
Less: Cost of acquisition (Rs. 1,20,000/20)
Long-Term Capital Gain
Capital Gain Converted into Rupees (Rs. 4,000 x 74)