ITAT confirms eligibility of resident for claiming indexation benefit while computing capital gains on sale of foreign shares

Introduction

The Hon’ble Mumbai Income Tax Appellate Tribunal (‘ITAT’), confirms eligibility of resident taxpayers to claim indexation benefits on capital gains from the sale of foreign shares. In the case of Aarav Fragrances and Flavors (P) Limited vs. Deputy Commissioner of Income Tax, Mumbai¹, the ITAT ruled that there was no distinction between assets held in India and those held abroad for entitlement to indexation benefit. This judgment establishes a critical precedent for interpreting indexation benefits on sale of foreign assets by residents.

Facts

• Aarav Fragrances and Flavors (P) Limited (‘Assessee’) is engaged in manufacturing and selling fragrance compounds and flavours in Maharashtra.
• The Assessee has two wholly owned subsidiaries: Aarav ITES Pvt. Ltd. and Aarav Suisse SA, with the latter being a foreign company.
• During the year under review, the Assessee sold shares of Aarav Suisse SA under a buyback scheme. The Assessee computed long-term capital gains by deducting the indexed cost of acquisition, applying the Cost Inflation Index (‘CII’), which resulted in a long-term capital loss of INR 22.93 crores.
• The Assessing Officer (‘AO’) argued that the Assessee could not avail the indexation benefit for foreign assets held and sold outside India. Consequently, the AO denied the benefit of CII, recalculating the capital gain, leading to a revised long-term capital loss of INR 11.53 crores.
• In the appellate proceedings, the Ld. Commissioner of Income Tax (‘CIT(A)’) ruled in favour of the Assessee, allowing the benefit of CII, and thereby, granting relief to the Assessee.
• Dissatisfied with the CIT(A) decision, the Revenue appealed the matter before the ITAT.

AO’s Contention

• The AO argued that the CII is based on the inflation data specific to India. Therefore, the Assessee shall not be entitled to claim the indexation benefit on the sale of foreign shares held outside India.
• The AO contended that since the indexation benefit is tied to domestic inflation, it shall not apply to assets located outside India.
• In light of the above contention, AO denied the benefit of indexation and recomputed the long-term capital loss, reducing it to INR 11.53 crores.

References made

• ICICI Bank Ltd. v. DCIT

Issues raised before the ITAT

1. Whether the first proviso to Section 48 of the Income Tax Act, 1961 (‘the Act’), which addresses the conversion of capital gains into foreign currency, apply to all assessees regardless of their residential status?
2. Whether the second proviso to Section 48 of the Act, which provides the indexation benefit, make a distinction between assets held within India and those held outside India?
   

Decision of the ITAT

• Whether the first proviso to Section 48 of the Act, which addresses the conversion of capital gains into foreign currency, apply to all assessees regardless of their residential status?
• Upon a detailed examination of the relevant provisions of the Act, the ITAT determined that the first proviso to Section 48 of the Act, which pertains to the conversion of capital gains into foreign currency, is specifically applicable only to non-resident assessees.
• The ITAT clarified that in the instant case, Assessee is a resident entity, and thus, the first proviso does not apply to it. Consequently, the ITAT ruled that Assessee was entitled to claim the indexation benefit without being impacted by the limitations set out in the first proviso to Section 48.
• Whether the second proviso to Section 48 of the Act, which provides the indexation benefit, make a distinction between assets held within India and those held outside India?
• The ITAT noted that the second proviso to Section 48 of the Act, which provides for indexation benefits, does not distinguish between assets held within India and those located abroad.
• Based on this observation, the ITAT held that the Assessee cannot be denied the benefit of the cost inflation index for assets situated outside India. Consequently, the ITAT determined that the AO erred in disallowing the indexation benefit on the sale of shares of the foreign company.

Conclusion

Basis this ruling, the ITAT has clarified that resident taxpayers are entitled to claim indexation benefits on capital gains arising from the sale of foreign shares, dismissing the AO’s contention that the CII applies solely to domestic assets. This decision underscores the principle of equitable tax treatment for residents and reinforces the consistency of indexation benefits for capital gains, regardless of whether assets are located within or outside India.