Section 48 of the Income-tax Act, 1961 (“IT Act”) provides the computation mechanism for capital gains arising to a taxpayer pursuant to the transfer of a capital asset. The said provision, inter alia, permits non-resident taxpayers to account for foreign currency fluctuation while computing capital gains arising from the transfer of shares or debentures of an Indian company. However, where capital gains arise to a non-resident taxpayer pursuant to the transfer of unlisted securities or shares of a private company, section 112(1)(c)(iii) of the IT Act provides that such capital gains should be computed without giving effect to any foreign currency fluctuations. A concessional tax rate of 10% (plus applicable surcharge and cess) is available on such gains. Section 112(1)(c)(ii) of the IT Act, on the other hand, provides a higher tax rate of 20% (plus applicable surcharge and cess) on any other long-term capital gains arising to a non-resident (i.e., other than gains arising from transfer of unlisted securities or shares) while, inter alia, allowing foreign currency fluctuation benefits to such non-residents.
In this context, non-resident taxpayers often maintain that they are eligible to claim foreign currency fluctuation benefits on transfer of unlisted securities or shares as well, if they opt to pay tax at the higher rate provided under section 112(1)(c)(ii) of the IT Act. Thus, typically, the method of computation in such cases is deliberated among the parties at the time of negotiations and a decision is reached basis the commercial exigencies of the transaction. The issue of which provision shall be applied in such cases and the interplay between these two sections was recently adjudicatedbefore the Hon’ble Mumbai Income Tax Appellate Tribunal (“ITAT”) in the case of Legatum Ventures Limited.
Facts of the case
In Legatum Ventures Limited, the taxpayer was a company incorporated in the UAE and engaged in investment activities. For the year under review, the taxpayer sold unlisted shares of an Indian company and declared long-term capital loss in its return of income. The taxpayer computed the capital gains tax liability under section 48 of the IT Act after accounting for foreign currency fluctuations. On assessment, the tax officer contended that capital gains tax liability of the taxpayer should have been computed under section 112(1)(c)(iii) of the IT Act, without accounting for foreign currency fluctuations. Accordingly, the tax officer computed long-term capital gains and made a tax addition, which the taxpayer was liable to pay.
The taxpayer filed detailed objections before the Dispute Resolution Panel (“DRP”)against the addition made by the tax officer. However, the DRP, too, rejected the objections filed by the taxpayer and thus, the tax officer passed a final assessment order against the taxpayer.
Aggrieved, the taxpayer filed an appeal before the Hon’ble Mumbai ITAT.
ITAT Ruling in Legatum Ventures Limited
The Hon’ble Mumbai ITAT noted that the taxpayer was a non-resident company which had sold unlisted shares of an Indian company. Thus, section 112(1)(c)(iii) of the IT Act would be applicable for computation of capital gains in the hands of the taxpayer.
The Hon’ble ITAT held that while section 112 of the IT Act dealt with tax rates chargeable on transfer of long-term capital assets, it also provided the methodology for computing capital gains. Thus, section 112(1)(c)(iii) is akin to a special provision for computing capital gains in the hands of non-residents under specified circumstances, i.e., transfer of unlisted securities held as long-term capital assets. Accordingly, it would override section 48 of the IT Act, which is a general provision for computing capital gains on transfer of all capital assets. The taxpayer did not have a right to choose the manner of computation. Accordingly, capital gains could only be computed under section 112(1)(c)(iii) of the IT Act.
Thus, the Hon’ble ITAT confirmed the orders passed by the lower authorities and dismissed the appeal of the taxpayer.
Section 48 of the IT Act permits certain adjustments to protect non-resident investors against the impact of foreign exchange fluctuations, which may result in them paying tax on notional capital gains, which only arise due to change in forex rates. Due to this provision, if assets were purchased in foreign currency, then the taxpayer would have the option of computing capital gains by reconverting the sale consideration in the same foreign currency. Section 112(1)(c)(iii) was introduced as a beneficial tax regime for non-residents with the objective of incentivising foreign investment in private companies in India. Further, as discussed above, section 112(1)(c)(ii) is applicable to gains other than those arising from transfer of capital assets provided for under section 112(1)(c)(iii) of the IT Act. There is a difference of opinion on whether the idea is to exclude gains arising from the transfer of unlisted securities or shares in its entirety or only in situations where the concessional tax rate of 10% is claimed on such gains.
The Hon’ble Mumbai ITAT in Legatum Ventures Limited has excluded the benefit of foreign exchange fluctuations to capital gains arising on transfer of unlisted securities or shares in its entirety. While this issue is likely to be litigated further, until the matter is laid to rest by the higher courts, taxpayers will have to structure their transactions keeping in mind this decision of the Hon’ble ITAT.
It is also pertinent to note that the Hon’ble Mumbai ITAT order only applies to transfer of shares of unlisted private Indian companies and not to transfer of shares of listed Indian companies. Further, even in a non-resident to non-resident transaction, where the (listed or unlisted, as the case may be) shares of an Indian company are acquired and sold in foreign currency, foreign currency fluctuation benefits may continue to be available even without resorting to section 48 of the IT Act, since such non-resident may continue to compute their capital gains in foreign currency before making any conversion for tax payment.
This judgement may have a major impact on other ongoing assessments for non-resident taxpayers. It may also trigger reopening of assessments in other similar cases.
 As per this provision, capital gains are computed by deducting (i) expenditure incurred wholly and exclusively in connection with the transfer, (ii) the cost of acquisition of the asset, and (iii) any cost of improvement of the asset, from the full value of consideration received by or accrued to the taxpayer.
 Legatum Ventures Limited v. ACIT (ITA No. 1627/Mum/2022).