SKP Tax Alert
Volume 9 Issue 17 |
AAR allows benefit of section 47 (vi) on transfer of Indian branch in a foreign company amalgamation by applying non-discrimination clause of the DTAA

Recently, the Authority for Advance Ruling (AAR)[1] held that there is no tax liability in India either in the hands of the company or shareholders of the transferor company on the amalgamation of two foreign companies having assets based in India pursuant to the India-Italy tax treaty. Since the amalgamation of two Indian companies is not a taxable event, in view of the non-discrimination clause of India-Italy tax treaty, the amalgamation of two foreign companies shall also not be taxable in India.

Facts of the case

Banca Sella SPA (BSS or the applicant), Italy is a banking company, wholly owned by Banca Sella Holding S.P.A. Sella Servizi Bancari S.C.P.A., Italy (SSBS) was one of the group companies of the Banca Sella Group where BSS held 15% and the balance was held by other group companies.
Banca Sella Group had been carrying out business in India through Sella Synergy India Private Limited (SSIPL). SSBS incorporated a branch office in India which took over the information technology business of SSIPL on a slump sale basis and due taxes were paid by SSIPL.

After the transaction, SSBS was merged into BSS. As a result of amalgamation, shareholders of SSBS (except BSS) were allotted shares of BSS. The company SSBS ceased to exist and all assets and liabilities of SSBS were vested with BSS. Post amalgamation, the branch continued to carry on IT services.

Matter before AAR
  1. Taxability in the hands of SSBS on the transfer of Indian branch
  1. Whether the amalgamation involves the transfer of capital assets (being a branch) under section 2(47) of the Income Tax Act, 1961 (the Act)? If yes, is such a transfer chargeable to tax under section 45 of the Act for SSBS?
  2. If SSBS is chargeable to tax in India, then is the exemption under 47(vi) available by virtue of the Non-Discrimination clause (Article 25) of the Indo-Italian Double Taxation Avoidance Agreement (DTAA)?
  1. Taxability in the hands of shareholders of SSBS on amalgamation
  1. Would BSS be subject to capital gains tax in India on extinguishment of its 15% shareholding in SSBS?
  2. Would the other shareholders of SSBS be subject to capital gains tax in India upon transferring their shareholding in SSBS for shares of BSS?
  1.  Applicability of transfer pricing provisions
  1. Whether the amalgamation attracts transfer pricing provisions of Section 92 to 92F of the Act?
Applicant’s Contentions
  1. Taxability in the hands of SSBS on the transfer of the Indian branch
  • The applicant contended that there is no transfer on amalgamation as a transfer postulates a change of ownership of property from one person to another where both the parties and the property is existing[2]. On amalgamation, the transferor ceases to exist and no independent transfer of the right, title and interest in or transfer of the branch of SSBS took place on amalgamation as it was only as a consequence of the amalgamation that all the assets of SSBS stood vested in the applicant which does not tantamount to a transfer.
  • Even assuming there is a transfer, there is no consideration which accrues to SSBS[3] and, therefore, there can be no question of levy of capital gains as the computation mechanism fails[4].
  • Furthermore, the applicant relied on the non-discrimination clause in Article 25(1) of India-Italy DTAA and contended that the charge would fail as there is no taxability on amalgamation of two Indian companies according to Section 47(vi) and hence, as per the non-discrimination clause the benefit should also be available to a foreign company.
  1. Taxability in the hands of shareholders of SSBS on amalgamation
  • For taxability in the hands of BSS, the applicant argued that since SSBS was amalgamated with BSS, no consideration was received by it (as shares cannot be issued to oneself) and therefore, in the absence of any consideration there cannot be any tax liability.
  • Furthermore, for taxability in the hands of BSS as well as other shareholders, the applicant represented the following:
  • In cases of indirect transfer, according to the explanation 5 to section 9(1)(i), taxability will arise in India only if the share or interest transferred derives its value substantially from assets located in India. The assets of SSBS located in India constituted about 5.75% of the total cost of the assets of SSBS and hence, it cannot be said that the shares of SSBS derive its value substantially from Indian assets.
  • Furthermore, as per Article 14(5) of the DTAA gains from the alienation of shares of a company which is a resident of Italy may be taxed in Italy and hence, India does not have the taxing rights in case of transfer of shares of SSBS.
  1. Applicability of transfer pricing provisions
  • Relying on a previous ruling[5] of the AAR, the applicant submitted that transfer pricing provisions are not applicable if there is no taxability
Tax authority’s contentions
  1. Taxability in the hands of SSBS on transfer of Indian branch
  • The Revenue contended that the argument that the transferor has ceased to exist is misplaced because on the effective date of amalgamation both the transferor as well as the transferee were in existence. Also, the fact, that this case of the applicant is not covered under section 47, it falls within the ambit of section 45 of the Act.
  • The Revenue argued that the market value of SSBS is the amount of consideration for SSBS and the net asset value can be considered as cost of consideration.
  • Furthermore, the Revenue made a reference to the non-discrimination clause as per Article 25(3) which excludes granting benefit of personal allowances, reliefs and reductions for taxation purposes which are available only to residents. The Revenue argued that the words ‘reductions  for tax purposes’ has a much wider meaning and cannot be restricted to rebate, relief or similar other phrases.
  1. Taxability in the hands of  shareholders of SSBS on amalgamation
  • With respect to the tax liability of BSS, the Revenue argued that on amalgamation, the 15% shareholding in SSBS will no longer appear in the books of BSS as the shares are extinguished and hence, there is a transfer. Moreover, BSS has issued shares only to the other shareholders (to the extent of 85%) and hence, 15% of the valuation of SSBS as per the valuation report should be considered as sales consideration for computing capital gain.
  • Furthermore, referring to the treaty provisions the Revenue argued that the case will fall under Article 14(2) which deals with taxability in case of gains from alienation of movable property which forms a part of business property of a permanent establishment. Furthermore, according to this clause, the taxing rights on such gains shall be with India. Since the amalgamation involved transfer of all assets of the branch (PE of SSBS in India) together with the enterprise, according to Revenue it would be taxable in India.
  1. Applicability of transfer pricing provisions
  • The Revenue argued that the transfer pricing provisions are applicable whether or not there is any liability to tax.
Authority for Advance Ruling (AAR)
  1. Taxability in the hands of SSBS on the transfer of an Indian branch
  • Drawing a reference from the explanatory notes to Finance Act 1967 which clarifies that tax liabilities are attracted in the case of both transferor company and shareholders on amalgamation, the AAR held that there is ‘transfer’ in the case of amalgamation. However, relying on the ruling of the Apex Court in the case of B.C. Srinivasa Shetty[6], it ruled that in the absence of consideration, there cannot be any capital gains tax liability.
  • With respect to the exception in non-discrimination clause, the AAR observed that the exception is only in the context of individuals and not companies as the word 'personal' denotes. Furthermore, the AAR clarified that the clause seeks to ensure that both countries do not decline any allowance or exemption only on the ground of taxpayer’s nationality.
  • The AAR ruled that if a case of amalgamation results in special benefits to a local company and its shareholder, there is no reason for denying similar benefits to a foreign company and its shareholders. Therefore, the exemption under section 47 should be available to SSBS also.
  1. Taxability in the hands of shareholders of SSBS on amalgamation

    With respect to taxability in the hands of the BSS, the AAR ruled that
  • It is a settled law that there is transfer of shares on amalgamation. However, the Revenue gave a strange mechanism of calculating consideration on transfer. The AAR mentioned that the capital gains have to be calculated on real gains and not on the basis of some notional value and since no consideration was received by the BSS, there will not be any taxability.
  • The AAR followed the quantum settled by the Delhi High Court[7] that the word ‘substantial’ in relation to explanation 5 to section 9(1)(i) means more than 50%.
  • Also, the AAR held that for deciding the applicability of Article 14(2) or Article 14(5) what is important is to see what has been parted with by shareholders. In this case, the shareholders have parted with their shares in SSBS and not the assets of the branch. Therefore, though capital gains accrue to shareholders as per the provisions of the ITA, it is not chargeable to tax in India, in view of Article 14(5).

    Similarly, with respect to taxability in the hands of the other shareholder, applying the provisions of Article 14(5) of the tax treaty, the AAR held that the gain is not chargeable to tax in India.
  1. Applicability of transfer pricing provisions
  • Relying on its earlier ruling[8] the AAR held that transfer pricing provisions are inapplicable if there is no taxability.

[1] Banca Sella S.p.A [AAR No. 1130 of 2011]
[2] CIT vs. Texspin Engineering and Manufacturing Works (263 ITR 345); Shaw Wallace & Co.Ltd. vs CIT (119 ITR 399)
[3] CIT vs Texspin Engineering and Manufacturing Works (263 ITR 345); Shaw Wallace & Co.Ltd. vs CIT (119 ITR 399); Hoechst GmBH 289 ITR 312; Amiantit International Holding Limited, in re: 322 ITR 678
[4] B. C. Srinivasa Shetty (1981) 128 ITR 294; PNB Finance Ltd. vs. CIT 307 ITR 75
[5] Amiantit International Holding Limited, in re: 322 ITR 678
[6]  (1981) 128 ITR 294
[7] DIT (International Tax) vs Copal Research 371 ITR 114
[8] Amiantit International Holding Limited in re 322 ITR 678
SKP's comments
It is a settled principle of law that although, with respect to other parties the AAR ruling is merely of a persuasive nature, yet, the principles of law laid by the AAR can be followed. Hence, the principles laid by the AAR in this
ruling, mentioned below, will certainly have a far-reaching impact.
  • The benefit of a non-discrimination clause can be availed in cases where a particular transaction is not taxable in the hands of a resident, except for certain benefits available to individuals. Similar non-discrimination clauses may find place in treaties signed by India with UK, USA, Germany, etc. and hence this ruling could have a very high impact in the case of overseas M&A transactions resulting in the transfer of assets based in India.
  • Transfer pricing provisions shall not apply in cases where there is no taxability.
  • Although the meaning of the term ‘substantial’ is now specifically provided in the Act (w.e.f. 1 April 2015), the interpretation adopted by the AAR shall be useful for the assessee’s covered by the period prior to the amendment.
  • It further reaffirms the position that if there is no consideration received, the computation mechanism fails and there is no chargeability on capital gains. 
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