Capital Gains On Transfer Of Rights & Interests Held In Capital Asset Are Not Taxable In India If The Capital Asset Is Located Outside India

Introduction

The Hon’ble Delhi Income Tax Appellate Tribunal (“ITAT”) upheld that the capital asset held by the Assessee, in the nature of rights and interests in respect of Compulsory Convertible Preference Shares (“CCPS”/ “Shares”) of two Indian companies, is located in Unites States of America (“USA”/ “US”) and not in India, as the source of such rights and interests was through an agreement which was executed in USA. Hence, the income derived from transfer or extinguishment of such rights/ interests is not taxable in India. The said decision was given in the case of Sh. Nikesh Arora Vs. DCIT, International Taxation, for the Assessment Year (“AY”) 2017-18.

Facts of the case

• The Assessee, Nikesh Arora, a Non-Resident Indian (“NRI”) and a resident of USA, was an employee of SB Internet and Media Inc., USA (“Employer”/ “SIMI US”) which is one of the group entities of Soft Bank Corp. a Japanese Co.
• The Assessee had entered into three employment agreements with his employer dated July 16, 2014, December 17, 2014 (“the second agreement”) along with an assignment deed dated December 29, 2014 and May 20, 2015 (“the third agreement”). The second agreement along with an assignment deed and the third agreement contained that along with salary, the employee would get the awards/ benefits including lump sum cash and created certain rights in favour of the Assessee to acquire the legal title of Shares of two Indian Companies Jasper Infotech Pvt. Ltd. (“Snapdeal”) and ANI Technologies Pvt. Ltd. (“Ola”).
• Further, the Assessee entered into a termination agreement dated February 01, 2017 with the employer for termination of his employment and extinguishment of all rights given to him as part of the above employment agreements and assignment deed. Upon termination, the Assessee received all employment compensation in lump sum cash.
• The Assessee offered the compensation received on extinguishment of his interest in the CCPS as long-term capital gain in the return of income filed in India for AY 2017-18.
• The Revenue passed an assessment order considering the capital gains as short-term in nature. Further, it also denied the cost of acquisition benefit to assessee. The DRP confirmed this order.
• Aggrieved by the above-mentioned order, Assessee filed an appeal against the said order.

Revenue’s Contention

• The Assessing Officer (“AO”) contended that the second employment agreement dated December 17, 2014 was mere a draft agreement and not the final one.
• Further, the employer company SIMI US itself did not have ownership of the Shares of the two Indian Companies as on December 17, 2014, as the Shares were transferred to SIMI US by its sister concerns SIMI Pacific Pte Ltd. and Starfish 1 Pte Ltd as on December 27, 2014 (i.e. post the second agreement date).
• Hence, the date of third agreement (i.e. May 20, 2015) shall be considered as date of acquisition for the rights to acquire the legal title of Shares.
• Further, the AO alleged that the assessee did not present any share certificate, and the Indian companies Snapdeal and Ola have confirmed that the assessee is not a registered shareholder of such companies. Thus, he submitted that the claim of the assessee that it had acquired the Shares is totally misconceived.
• Without prejudice to the above, Revenue submitted that the assessee had acquired certain rights to acquire the legal title of Shares, which stood extinguished as per the termination deed. Such right is a capital asset, however, it cannot be equated to share/security of a company.
• Since it should not be treated as an unlisted share, the period of holding of 36 months is to be considered and not 24 months. In light of the above, the capital asset shall be treated as short-term in nature.

Assessee’s Contention

• Legal counsel of the Assessee claimed that the employment agreements merely record the terms of the employment and do not record the acquisition of any asset by the Assessee. The agreements contain a promise for compensation but do not establish any transfer of any consideration either by cash or by Shares. The assignment deed dated December 29, 2017 creates certain rights in favour of the Assessee.
• Further, the legal counsel also claimed that the word ‘held’ used in section 2(42A) of the Act does not refer to legal ownership of capital asset. The date on which the assessee acquired the interest in the capital asset would be reckoned as the starting point for determining the period of holding.
• Hence, though the Shares were held in the name of SIMI USA, they could not have alienated the Shares to others as the Assessee was the beneficial owner and enjoyed complete bundle of rights attached to the Shares.
• Hence, the date of assignment deed i.e. December 29, 2014 shall be the date of acquisition of Shares, being categorised as long-term capital asset, notwithstanding that the Assessee may not have acquired prefect legal title over the capital asset.
• Without prejudice to the above, he highlighted that as per section 9(1) of the Act, income is deemed to accrue and arise in India in case of a capital asset which is situated in India.  The termination agreement clearly states that the Assessee had not acquired any ownership of the Shares or right to proceed against the Indian companies. He submitted that the Assessee has only acquired the rights to proceed against the non-resident US company, which arose out of agreements entered into outside India.
• Further, all the agreements pursuant to which Assessee’s right to acquire or right to obtain Shares arose were entered outside India and were subject to the US jurisdiction. Therefore, situs of Assessee’s interest or rights to acquire Shares, which is a capital asset, is outside India.
• The assessee has transferred his interest/rights over the Shares which are situated outside India, hence capital gain is not taxable in India.
• Further, he clarified that the assessee does not have any objection to suffer tax liability of long-term capital gain arising out of sale of Shares.

Judgements and Circulars referred

• CWT v. C. Rai [1979] 119 ITR 553 (Bombay High Court)
• Des Raj Nagpal Vs. ITO, 13 ITD 800 (special bench of Delhi Tribunal)
• Mysore Minerals Ltd. Vs. CIT, 239 ITR 775 (Supreme Court)
• Vodafone International Holding B.V. Vs. Union of India [2012] [17 taxmann.com 202] (Supreme Court)
• A & F Harvey Ltd. Vs. CWT (107 ITR 326) (Madras High Court)
• CWT Vs. O.M.M. Kinnison [1986] 161 ITR 824 (Supreme Court)
• A & F Harvey Ltd. Vs. Commissioner of Wealth-tax [1977] 107 ITR 326 (Madras)
• CWT Vs. Mrs. O.M.M. Kinnison, 161 ITR 824 (Supreme Court)
• Circular no. 704, dated April 28, 1995

Issues raised before the ITAT

1. What is the capital asset held by the Assessee and what is the nature of such capital asset, whether long term or short term?
2. Whether the capital gain is taxable in India?

Decision on issue raised

• What is the capital asset held by the Assessee and what is the nature of such capital asset, whether long term or short term?
• As per the circular no. 704, dated April 28, 1995 issued by the Central Board of Direct Taxes (CBDT), it has been clarified by the Board that the date of broker note or date of contract of sale shall be relevant for determining period of holding subject to actual delivery of Share subsequently. As the Shares were never delivered in the name of the assessee, it cannot be said that the assessee had held any capital asset in the nature of share or security of an Indian company.
• Hence, by virtue of assignment agreement dated December 29, 2014, the assessee had only acquired certain rights and interests in the CCPS’s of two Indian Companies and not the actual ownership of Shares.
• Since the capital asset is not ‘unlisted Shares’, the period of holding applicability would be based on 36 months and not 24 months as it does not fall under the exceptions provided under section 2(42A) of the Act. In light of the above, the gains shall be treated as short-term capital gains (from the date of assignment deed dated December 29, 2014 till date of termination agreement dated February 01, 2017).

• Whether the capital gain is taxable in India?
• The assessee had only acquired certain rights and interests in the CCPS’s of two Indian Companies and not the actual ownership of Shares.
• Since the assignment deed which assigned the capital asset to the assessee was executed in USA, i.e. outside India, the source of the capital asset is generated outside India.
• Further, the employment agreement dated July 16, 2014, specified that any legal action or suit related in any way to the agreement shall be brought exclusively in the Federal State Court of California, i.e. outside India.
• Hence, it was held that the situs of capital asset (rights and interests to acquire the legal title of Shares),which were subsequently transferred and subjected to capital gain, was in USA and not located in India.
• Therefore, in terms of section 9(1)(i)(a) of the Act, the income derived from transfer of such capital asset is not taxable in India.
• Further, the assessee had voluntarily offered the capital gains to tax in India as per the return of income. It was held by the tribunal that the alternate contention made by the assessee in the appeal related to capital gains not being taxable in India, would be available to assessee only as a defence to support the claims made by him through return of income. It will not be available for claiming any extra benefit beyond such return of income. Hence, the capital gains offered by assessee in the return of income were accepted.

Conclusion

The Hon’ble Delhi ITAT opines that the capital asset is the ‘rights or interests held by the assessee to acquire the legal ownership of Shares’, and not ‘Shares’.

Furthermore, the agreement through which such rights and interests (capital asset) were generated was executed outside India, and the assessee had the right to take legal action and proceed with respect to this agreement in the US jurisdiction before US courts, i.e. outside India.

Hence, it is upheld that the situs of the capital asset is outside India, and the income derived by the assessee on transfer of such capital asset is not taxable in India under section 9(1)(i)(a) of the Income Tax Act.