Section 45 of the Income Tax Act, 1961 (IT Act) taxes any profits or gains arising from transfer of a capital asset under the head "Capital Gains". However, section 47 of the IT Act lists down certain transactions which shall not be regarded as transfer for the purpose of section 45 of the IT Act and thereby not liable to tax. One of the specified transactions is transfer of capital asset by a subsidiary company to its holding company subject to fulfilment of following conditions:
- the whole of the share capital of the subsidiary company is held by the holding company; and
- the holding company is Indian Company
The provisions of the Companies Act, 2013 (as well as erstwhile Companies Act, 1956) provides that for a company to be considered as Public Limited company, there should be minimum 7 shareholders. Thus, an individual company (as a shareholder) cannot own entire share capital of a Public Limited company. Hence, a question arises whether in case of transfer of capital asset by a Public Limited company to its 99.99 percent Indian holding company would satisfy the above conditions and therefore such transfer shall not be regarded as transfer for the purpose of section 45 of the IT Act?
Recently, the Hon'ble Madras High Court1 had an occasion to examine the aforesaid issue. We, at BDO in India, have summarised the ruling of the High Court and provided our comments on the impact of this decision.
Facts of the case
Taxpayer, a public limited company, transferred some portion of its land (being regarded a capital assets) to its Indian holding company for INR 37.5 Mn and thereafter treated the said transaction to be covered by section 47(v)2 of the IT Act. Accordingly, taxpayer did not offer the gains arising from sale of land to tax. The tax authorities reopened the matter under section 148 of the IT Act on the basis that the taxpayer had wrongly claimed the benefit of section 47(v) of the IT Act. The Tax authorities observed that out of 80 lakh shares of the taxpayer, 25 shares were held by the nominees of the holding company. Accordingly, the tax authorities denied the benefit of section 47(v) of the IT Act and brought the entire gains to tax. While the First Appellate Authority concurred with the action of Tax authorities, the Tax Tribunal granted relief to the taxpayer by observing that the six individuals were not holding 25 shares in their individual capacity but as nominees of taxpayer; these shares were held to comply with the provisions of Companies Act, 1956. Hence, the Tax authorities filed an appeal before the Madras High Court (Madras HC).
High Court ruling
Madras HC at the time of delivering its verdict, observed that following facts are not disputed:
- Out of 80 lakh shares of the taxpayer, 25 shares were held by six individuals who were nominated by the holding company of taxpayer.
- These six individuals had no right as a shareholder and that their holding was for and on behalf of the holding company.
The taxpayer contended that it being a public limited company should have a minimum of seven shareholders as required under the Companies Act. However, the Tax authorities contended that the language used in the provisions of section 47(iv)2 and section 47(v) of the IT Act are distinct. The expression 'or its nominees' is not present in section 47(v) of the IT Act and thus the taxpayer cannot claim the transfer of land as not liable to capital gains tax though the said transfer was between the subsidiary and its holding company.
Madras HC observed that section 47 of the IT Act deals with transaction not regarded as transfer and hence it requires purposive interpretation otherwise the said provision shall become redundant. The total number of shares of taxpayer are 80 lakhs, out of which, 79,99,975 shares were held by the Indian holding company. The remaining 25 shares were held by six individuals. The explanation offered by the taxpayer was that under the Companies Act, a public limited company ought to have a minimum of seven shareholders. These individuals were nominees of the Indian holding company and they had no right, these facts were also not disputed by the Tax authorities. Hence, HC held that whole of the share capital of the taxpayer was held by the holding company in the instant case. Accordingly, the HC held that the exemption contained in section 47(v) of the IT Act would be available to the taxpayer.
The HC also placed reliance on the Hon'ble Bombay High Court decision in the case of Papilion Investments Private Limited3 wherein Bombay Hight Court held that:
"As a matter of fact, there cannot be any company in India which has less than two members i.e. shareholders. Now the requirement of Section 47(v) is that the whole of the share capital of the subsidiary company should be held by the holding company. The whole of the share capital being held by the holding company is certainly not the same thing as whole of the share capital being held in the name of the holding company. In fact, that situation is a legal impossibility in India. In case one is to proceed on the basis that entire share capital of the subsidiary company should be held in the name of the holding company, there cannot be any situation in which section 47(v) can apply. That is certainly not an interpretation which can be termed as ut res magis valeat quam pereat, i.e. to make the statute effective rather than making it redundant. As held by Hon'ble Supreme court, in the case of CIT Vs. Teja Singh (35 ITR 408), a construction which results in rendering a provision redundant must be avoided. For this reason alone, the interpretation canvassed by the revenue is to be rejected."
Keeping in mind the purposive interpretation and following the decision of the Hon'ble Bombay High Court, the Hon'ble Madras High Court has delivered a welcoming decision in the favour of the taxpayer. While the provision of section 47(v) of the IT Act does not contain the expression 'or its nominees', in India, it is legally impossible to directly own entire share capital of a subsidiary company (being a Public Limited or a Private Limited company). Hence, if an Indian holding company appoints persons (who generally are their key employees) to own minimal capital of its subsidiary company (being a Public Limited or Private Limited company) as a nominee (without having any control) then, this decision would support taxpayer's position where the tax authorities are inclined to levy capital gains tax merely on the ground that the entire share capital of such subsidiary is not directly hold by the Indian holding company.
1 CIT vs. Shardlow India Ltd [Tax Case No. 485 of 2018]
2 Section 47: Nothing contained in section 45 shall apply to the following transfers :—
(iv) any transfer of a capital asset by a company to its subsidiary company, if—
(a) the parent company or its nominees hold the whole of the share capital of the subsidiary company, and
(b) the subsidiary company is an Indian company;
(v) any transfer of a capital asset by a subsidiary company to the holding company, if—
(a) the whole of the share capital of the subsidiary company is held by the holding company, and
(b) the holding company is an Indian company :
Provided that nothing contained in clause (iv) or clause (v) shall apply to the transfer of a capital asset made after the 29th day of February, 1988, as stock-in-trade.
3 CIT vs M/s Papilion Investments Private Limited [2009-TIOL-491-HC-Mum-IT]
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