The issue of tax planning through partnerships can be illustrated by an example based on a recent case decided by Authority for Advance Rulings
A Foreign Company is engaged in India in a profitable venture by holding participating interest in oil blocks. The value of Company’s interest in the Oil Blocks is far more than the actual investment made by it. The company is interested to sell its interest in oil blocks without paying any capital gains tax.
If the Foreign Company sells its participating interest, it will be liable to pay tax u/s 45 of the Income Tax Act. Therefore the company goes in for a scheme of restructuring its business in India by transferring its participating interest in the oil block to a partnership firm outside India between the foreign company and other persons who are interested to buy the participating interest from the foreign company.
The Foreign Company transfers its interest to the partnership firm at its actual cost. In this manner there is no Capital gain in the hands of the Foreign company because sub-section (3) of section 45 comes to the rescue of the foreign company. The effect of the amendment in Sec.45 (3) as explained by CBDT Circular No. 495 dated 22.9.1987 is: “profits and gains arising from the transfer of a capital asset by a partner to a firm shall be chargeable as the partner's income of the previous year in which the transfer took place. For purposes of computing the capital gains, the value of the asset recorded in the books of the firm on the date of the transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of the capital asset”.
Curiously, the above issue in the oil block was raised before the Authority for Advance Ruling in case of “Canoro Resources Ltd. vs. DIT. The authority decided the issue on 23 April 2009 and observed that the provisions of Sec. 45(3) may save the Foreign Company from the charge of Capital Gains Tax in India because this provision does not distinguish between Residents and Non-Residents.
But in case of Non-Residents this type of transaction will be hit by the provisions of Sec.92 because such a transfer of interest will fall in the category of “International Transaction”.
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As per Sec.92(3) the income relating to International Transaction is to be computed having regard to Arms Length Price .In the instant case the participating interest has obviously been transferred at a value which may be lower than the Arms Length Price. The difference between the Arms Length Price and the value of actual transfer could be brought to tax.
“The authority took notice of the fact that in the instant case whereas Sec. 45(3) saves the Foreign Company from the tax, Sec.92 will enrope the Foreign Company in the tax liability.”
In the aforesaid case, the Authority took a view that “the provisions of sub-section(3) of section 45 and the relevant transfer pricing provisions, when read in harmony, would lead to the inference that sub-section(3) would not apply to international transactions, which should be dealt with in accordance with the transfer pricing provisions. As such, when a transaction referred to in section 45(3) is in the nature of international transaction, the value of consideration shall not be the value as recorded in the firm's account books, but the same shall be determined on the basis of arm's length price in accordance with transfer pricing provisions.”
It is unfortunate a legitimate tax planning scheme has been reduced to a “naught” by Authority for Advance Rulings just because there are conflicting provisions in the Indian Income Tax Act. Why should the benefit of doubt arising due to contradictory provisions in law go to the ex-chequer and not to the tax payer?
(Author is a Partner in S.S. Kothari Mehta & Co.)