25 July 2014 | Volume 7 Issue 5
Chennai ITAT holds that a 'company' can make 'gifts' and transfer of shares without consideration is not taxable

This tax alert summarises the ruling delivered by the Chennai Income Tax Appellate Tribunal (ITAT) in the case of Redington India Limited (RGIL) on the issue of taxability of transfer of shares of one subsidiary company to another step-down subsidiary company.

Facts
  • RGIL provides end-to-end supply chain solutions for all categories of information technology (IT) products such as personal peripherals, PC building blocks, etc.
  • RGIL has a wholly owned subsidiary (WOS) M/s Redington Gulf FZE, Dubai (RGF) engaged in the same line of business mainly focusing its operations in the Middle East and African countries.
  • In order to attract investments to expand its business operations and also for listing its shares in stock exchanges abroad, RGIL set up a WOS in Mauritius in July 2008 by  the name M/s Redington International Mauritius Ltd (RIML).
  • A PE fund was interested in the overseas operation (i.e. in RGF) of RGIL. However, RGF had set up a Free Zone Enterprise (FZE) in Dubai. The regulations governing FZE did not permit more than one shareholder. Therefore, it was not possible for the PE fund to invest directly in RGF.
  • Furthermore, the PE fund preferred an entity set up in Cayman Islands to invest its funds. As such, RIML int urn set up its WOS in Cayman Islands by the name, M/s Redignton International (Holdings) Limited (RIHLC) in November 2008.
  • RGIL transferred its entire shareholding in RGF to RHILC without any consideration to facilitate the PE investment in its business.
  • As the transfer was without any consideration, RGIL took a stand that it is not an 'international transaction'. It also took a stand that the transfer was in the nature of a 'gift' and relied on section 47(iii) of the Indian Income Tax Act (ITA), which excludes transfer of gifts from the purview of capital gains taxation.
The Transfer Pricing Officer's observations/findings
  • In light of the retrospective amendment brought by the Finance Act 2012, the TPO held that the transfer of shares is an international transaction.
  • The TPO also made certain other Transfer Pricing (TP) adjustments in connection with corporate guarantees, trademarks, etc. which are not the subject matter of this alert.
  • The Assessing Officer (AO) passed his draft order considering the TP adjustments and also made an addition on account of long term capital gains on the transfer of shares, holding that a corporate entity cannot make a gift. He considered the arm's length price (ALP) suggested by the TPO as the sale consideration for computing capital gains.
  • The AO made the above addition holding that there was no business rationale in setting up overseas subsidiaries and that the only motive was to avoid tax. 
The Dispute Resolution Panel's (DRP) observations
  • The DRP upheld all the adjustments except that it directed a marginal relief of 10% in capital gains.
Issues before the ITAT
The aggrieved taxpayer approached the ITAT for decisions on the following questions:
  1. Whether the transaction of gift of shares is a valid gift and exempt from capital gains in light of exemption under section 47(iii) of the ITA. If not, whether the computation mechanism fails to operate in view of the fact that the transaction is without consideration.
  2. Whether, transfer pricing provisions would be applicable if the transaction is not chargeable to tax in India.
The Taxpayer and Revenue's contentions
The contentions taken by RGIL and the revenue authorities on various issues/grounds are:
  1. Whether a corporate body can make a 'gift':
          RGIL's contentions
  • The learned counsel for RGIL relied on the provisions of the erstwhile Gift Tax Act, 1958 which defines a gift as a voluntary transfer of property by one person to another without consideration. 'Person' includes a company as well, as provided in section 2(xviii) of that Act.
  • He also pointed out certain provisions under the ITA itself, which provided that a corporate body can make gifts.
  • He then referred to the provisions of the Transfer of Property Act, 1882. As per section 5 of the said Act, 'Transfer of property' means an act by which a living person conveys property ... to another living person..." The section further provides that a 'living person' includes, among other things, 'a company'. 
  • Further, as per section 122 of the said Act, essential ingredients of a valid gift are the existence of property, no consideration, voluntary transfer by donor to the donee and acceptance by the donee.
  • He also relied on the ruling of the Authority for Advance Rulings (AAR) in the case of Deere and Company[1] wherein it was held that 'love and affection' are not required to make gifts.
  • Reference was also made to the judgement of Mumbai Tribunal in the case of DP World (P) Ltd[2] wherein the Tribunal held that as long as the donor company is permitted by its Articles of Association, it can make gifts under section 82 of the Companies Act, 1956. It also held that transfer without consideration has to be treated as a gift within the meaning of section 47(iii) of the ITA.
          Revenue's contentions
  • The CIT contended that RGIL itself has stated in its notes to accounts that the transfer has not diminished the asset base of the group. The transaction was from one company to another company of the same group. The asset base of the group as a whole is steady.
  • If that is the case, there was no gift at all; and, therefore, the question of exclusion under section 47(iii) does not arise.
  1. In absence of consideration, the capital gains computation mechanism would fail:
          RGIL's contentions
  • The DRP had confirmed that the transfer of shares was voluntary and without consideration, hence even if the transfer is not considered as gift, it will not be chargeable to tax as the computation provisions would fail in absence of consideration.
  • He placed reliance on decision of the Supreme Court in the case of CIT vs BC Srinivasa Setty[3], wherein the court had held that the charging provisions and the computation provisions form an integral code. Even if one of them fails, there is no capital gain.
  • He also argued that where there is no consideration, it is not permissible in law to substitute the same with fair value or estimated value of the property. He quoted several judgements[4] in support of this.
          Revenue's contentions
  • The CIT contended that the computation mechanism fails only if there is absolutely no means to compute the value of the asset transferred.
  • In the present case, the shares transferred to RHILC do have a defined value. The asset and business base of the assessee company are the strength of that value.
ITAT's ruling
 The ITAT considered the submissions of both the parties and ruled as under:
  • It also held that there is nothing anywhere in law, which prescribes that only natural persons can make gifts on the ground of 'love and affection'. The ITAT referred to the provisions of the erstwhile Gift Tax Act, the Transfer of Property Act, and the judgements quoted by the counsel of RGIL while ruling so.
  • Accordingly, the ITAT accepted the legal capacity of RGIL to make gifts.
  • The ITAT further ruled that there is no restriction provided under the ITA, which prohibits a company from claiming exemption under section 47(iii). Accordingly, it held that no capital gains tax is imputable to the said transfer of shares.
  • The ITAT also agreed with the contentions of RGIL that the computation mechanism fails in case of transfers without consideration.
  • With respect to the applicability of transfer pricing provisions, the ITAT observed that section 92 provides that "any income arising from an international transaction shall be computed having regard to the ALP". It therefore held that the computation of the ALP is dependent on the income arising to an assessee from an international transaction. In the present case, as the shares were transferred by way of gift and no income arose to RGIL, ALP determination does not extend to this transaction.
 
[1] 337 ITR 227
[2] 140 ITD 694
[3] 128 ITR 294
[4] CIT vs George Henderson and Co. Ltd, 66 ITR 622(SC), CIT vs Smt Nilofer I Singh, 309 ITR 233 (Delhi)
CIT vs Gillanders Arbuthnot & Co., 87 ITR 407(SC), Tej Pratap Singh vs ACIT, 307 ITR (AT) 244(ITAT Delhi)
SKP's Comments
This ruling is certainly a very favourable ruling that several companies can rely upon to defend their pending cases on similar matters. However, the Finance Act, 2010 has inserted section 56(viia) in the ITA taxing such transfers as gifts in the hands of the recipients (being closely held companies).  The value to be adopted for this purpose is as per the Rules prescribed.
 
Also, with the rapid developments on the transfer pricing front, it will be interesting to see the stand the department adopts with respect to the applicability of the transfer pricing provisions on transactions that are not chargeable to tax. Furthermore, there are conflicting decisions[1] on this issue of whether chargeable income is a prerequisite for transfer pricing to apply.
 
Of course, it is essential on the part of the taxpayers to demonstrate that the transactions are genuine and not a tool to evade taxes.
 
[1] See the Ruling of the Authority for Advance Rulings in Re Castleton Investment, AAR 999 of 2010, and in the case of Orient Green Power Pte Ltd AAR No. 973 of 2010 

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