Capital Gains Tax – Article 13 – Double Taxation Avoidance Agreement

Capital Gains to Non Residents Tax in India – Article 13 – Double Taxation Avoidance Agreement

Article 13 – Capital Gains – Double Taxation Avoidance Agreement

This is the most commonly used Article.  It provides for the taxation of income arising from transfer of a capital asset, including transfer of shares. The right to tax income from capital gains may be exclusively with the country of residence, or shared between both the countries.

WHAT COULD BE POTENTIAL SITUATIONS OF CAPITAL GAINS ?

TAXATION OF CAPITAL GAINS

OECD Model Tax Convention on Income and on Capital 2017	UN Model Convention 2017
CAPITAL GAINS	CAPITAL GAINS
Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.	Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in article 6 and situated in the other Contracting State may be taxed in that other State.
Article 13(1) provides the right to tax capital gains arising from transfer of immovable property to the State where the property is situated. ARTICLE 13 – Capital gain Since the word is used is ‘may’, both the Contracting countries, have the right to tax Capital Gains. Where income is taxable in both countries, State of Residence will either grant credit for taxes paid in Source State, or exempt such income in accordance with Article 23 of DTAA. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of , or the right to work, mineral deposits, sources and other natural resources; Ships, boats and aircraft shall not be regarded as immovable property.
Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise), may be taxed in that other State.	2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State.
ARTICLE 13 – Capital gain Article 13(2) of the OECD Model Convention is akin to Article 13(2) of the UN Model Convention, except that it does not provide for taxation of movable property forming part of fixed base available to a resident of a Contracting State in the other Contracting State. Gains arising from transfer of business property (not immovable property), associated with PE would be taxable in the Country in which the PE is located. Even if the PE has ceased to exist at the time of transfer of the asset, such provision would apply. Elimination of double taxation will be under the tax credit mechanism of both the countries. Example: M Limited, is a tax resident of Country A, has a PE in Country B, which has certain movable property, immovable property and stock in Country B. On transfer of movable property, gains would be taxable under Article 13(2) while gains from immovable property would be taxable under Article 13(1) . Further gains on transfer of stock-in-trade, would be taxable under Article 7 dealing with Business Profits.
Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that Other State.	Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that other State.
Article 13(3) of the OECD and UN Models specifically covers alienation of boats engaged in inland waterways transport, which is not covered in Article 13(4) of the US Model.  Article 13(3) of the OECD and UN Model applies to : – •        Alienation of ships, aircrafts, boats and •        movable property pertaining to operation of such ships, aircrafts, boats, etc. Under this Article, the Country where the place of effective management of the enterprise is situated has the exclusive right of taxation of such income. X Limited owns and operates a ship from Country A to Country B . X Limited has a place of effective management in Country B. In such a case, capital gains from transfer of ship would be taxable in Country B.
Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that Other State.	Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that other State.
	5. Gains, other than those to which paragraph 4 applies, derived by a resident of a Contracting State from the alienation of shares of a company, or comparable interests such as interest in partnership or Trust, which is a resident of the other Contracting State, may be taxed in that other State if the alienator, at any time during the 365 days preceding such alienation, held directly or indirectly at least __ per cent (the percentage is to be established through bilateral negotiations) of the capital of that company.
Article 13(5) of the UN Model is absent in the OECD. This Article provides that gains from shares or other comparable interest such as interest in partnership or Trust other than those covered under para 4 would be taxable in Source State only when the transferor owned at least a given percentage for 12 months before the alienation.
Gains from the alienation of any property, other than that referred to in paragraphs 1, 2, 3 and 4, shall be taxable only in the Contracting State of which the alienator is a resident.	6. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3, 4 and 5 shall be taxable only in the Contracting State of which the alienator is a resident.

WHAT COULD BE POTENTIAL SITUATIONS WHEN CAPITAL GAINS WOULD ARISE

Transfer of Shares by NR to resident

Transfer of Shares by NR to NR

What is the Meaning of “capital gains” ?

1. Term “Capital Gains “ defined under Article 13 ?

2. Article – 3 “General Definitions” requires application of domestic laws to ascertain meaning of terms not defined in Treaty

3. Income assessable under Section 45 of IT Act, 1961, may be considered as Capital gains

4.Subject matter of transfer should be a “Capital assets” and not “stock-in-trade”

5.What if a particular Capital Gains is not taxable under IT Act at all ?

6.Capital gains may be Long-term or Short-term capital gain, and may be chargeable to tax at special or normal rates

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“CAPITAL ASSETS” COVERED UNDER ARTICLE 13 ?

1. Capital Assets

2. Immovable property referred to in Article 6 – Article 13(1)

3. Movable property forming part of Business property of a PE / Fixed Base – 13(2)

4.Ships, Aircrafts, Boats, etc. operated in international traffic/ movable property pertaining to such operations – 13(3)

5. Shares of Real Estate company – 13(4)

6. Any other property – 13(5)

RIGHT TO TAX OF SOURCE &/OR RESIDENT STATE

Right to tax

1. Only India – (No Treaty like Cayman Island)
2. Only Treaty Partner (India-Singapore Treaty)
3. Both India & Treaty partner (India – USA Treaty)

RIGHT TO TAX WITH TREATY PARTNER – INDIA SINGAPORE TREATY

1. Gains derived by a resident of a Contracting State from the alienation of immovable property …..
2. Gains from the alienation of movable property forming part of the business property of a permanent establishment …….
3. Gains from the alienation of ships or aircraft …….
4. Gains derived by a resident of a Contracting State from the alienation of any property other than those mentioned in paragraphs 1, 2 and 3 of this Article shall be taxable only in that State.

RIGHT TO TAX WITH BOTH COUNTRIES – INDIA US TREATY

Except as provided in Article 8 (Shipping and Air Transport) of this Convention

each Contracting State may tax capital gains

in accordance with the provisions of its domestic law.

TAXATION OF CAPITAL GAINS

ALIENATION VS TRANSFER IN CAPITAL GAINS TAX

ALIENATION AS PER INDIA – MAURITIUS TREATY

Alienation means the

sale,

exchange,

transfer, or

relinquishment of the property, or

the extinguishment of any rights therein, or

the compulsory acquisition thereof under any law in force in the respective Contracting States.

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ALIENATION OF PROPERTY

1. Sale of a property
2. Exchange of a property
3. Extinguishment of rights in a property
4. Transfer of a property
5. Gift

EXISTENCE OF PE AND CAPITAL GAINS TAX – LUFTHANSA GERMAN AIRLINES CASE

Facts:

• Lufthansa airlines provided handling services to other airlines in India, as per the International Airline Technical Pool, as per IATP manual
• It also availed services from other Airlines
• Taxpayer claimed that income from various airline was not taxable in India in terms of Article 8 (4), which covered profits from the participation in a pool.

Issue:

• Whether profits earned by Lufthansa airlines was taxable under Article 8(4) or Article 7 & 5 ?

Held:

• Profits will be taxable under Article 8(4) which specifically covered profit from participation in pool.

ARTICLE 8 AS PER INDIA – GERMANY TREATY

1. Profits from the operation of ships or aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.
2. If the place of effective management of a shipping enterprise is aboard a ship, then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship is situated, or, if there is no such home harbour, in the Contracting State of which the operator of the ship is a resident.
3. For the purposes of this Article, interest on funds connected with the operation of ships or aircraft in international traffic shall be regarded as profits derived from the operation of such ships or aircraft, and the provisions of Article 11 shall not apply in relation to such interest.
4. The provisions of paragraph 1 shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

MAT ON SALE OF SHARES OF INDIAN COMPANY

Facts:

• FCO 1 is an Foreign Co. engaged in the manufacturing business
• ICO is a WOS of FCO 1;
• FCO 1 sold shares of ICO to FCO 2, a Mauritius Co.

Issue:

• Whether MAT is applicable on Capital Gain?

Position :

• Explanation 4 to Section 115JB(1) provides that MAT shall not apply to a foreign company if : –
  • India has entered into a DTAA (Section 90(1))/relief from double taxation u/s 90A(1) with the country of whom the NR is a resident
  • NR does not have a PE in India as per said agreement

AMENDMENT BY FINANCE ACT 2016

ARTICLE 13(1) – INDIA – AUSTRIA IMMOVABLE PROPERTY

Gains

derived  by a resident of Contracting State

from the alienation of a immovable property referred to in Article 6

and

situated in the Other Contracting State

may be taxed in that Other State.

Article 13(1) – Transfer of Immovable Property

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Article 13(1) – Issues For Consideration

What should be derived ?
Gains (shall include losses)

Who should derive ?
Resident of the other Contracting State

What is the subject matter of transfer ?
Immovable property which is situated in India and referred to in Article 6

Who has the right to tax ?
 India also has the right to tax such gains

Article 6 – Immovable Property

“Immovable property” shall have the meaning which it has under the law of Contracting State in which the property in question is situated.

The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of , or the right to work, mineral deposits, sources and other natural resources;

Ships, boats and aircraft shall not be regarded as immovable property.

Punnika Parikh – Case Study

Facts:

• Applicant, a citizen of Netherlands, had interest in tenancy rights of a flat in India and ownership of shares in a company having ownership rights in immovable property;
• She wanted to release the tenancy rights and sell shares of the Co.

Issue:

• Whether gains realised from release of tenancy rights & sale of shares are taxable in India ?

Held:

• Gains realised are taxable in India as per DTAA between India & Netherlands, as the property is situated in India.

Article 13(2) – India – Austria Treaty – Movable Property of PE Business

Gains from the alienation of movable property

forming part of the business property of a permanent establishment

which an enterprise of a Contracting State has in the other Contracting State or

of movable property pertaining to a fixed base available to a resident of Contracting State in the other Contracting State

for the purpose of performing independent personal services

including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base

may be taxed in that other State.

Movable property not forming part of the business property of a permanent establishment shall be taxable as per Article 13 (6)

Application of Article – 13(2)

• Alienation of movable property forming part of business property of a PE
• Alienation of the PE along with such movable property
• Alienation of the whole Enterprise along with the movable property forming part of business property of a PE

What is Movable Property ?

Sale of Capital Asset after Cessation of PE

Cartier shipping co. – Alienation of PE

Facts:

• FCO 1 owned a cantilever type jack up rig and the said rig was used for drilling, prospecting and production of hydrocarbons in offshore oil fields;
• FCO 1 sold the said rig to FCO 2 during the relevant assessment year;
• FCO 1 did not disclose the gains realised from sale of said rig.

Issue:

• Whether Capital Gain will be taxable in India ?

Held:

• Gains realised from sale of rig will be taxable in India as per Article 13(2) of India-Mauritius tax treaty.

Since the assessee claimed depreciation on the rig in the past, it was an asset of the PE.

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Article 13(3) – India – Netherlands Treaty

Gains from the alienation of ships or aircraft

operated in international traffic

or

movable property pertaining to the operation to such ships, aircraft

shall be taxable only in the Contracting State

in which the place of effective management of the enterprise is situated.

Article 13(3) – Analysis

Taxable in the Contracting State in which the Place of effective Management (POEM) of the enterprise is situated

POEM Explanation to Section 6(3)

Place of Effective Management  – Ship – Article 8(3)

Article 14(4) as per INDIA – Malaysia Treaty

Gains derived by a resident of a Contracting State

from the alienation of shares deriving more than 50% of their value

“directly or indirectly” from immovable property

situated in the Other Contracting state

or

any other right pertaining to such immovable property

may be taxed in that Other State.

Article 13(4) – Value from Immovable Property

Article 13(4) – Less than 50% Value from IP

Article 13(4)

Liabilities	Amount (Rs.)	Assets	Amount (Rs.)
Share Capital	100	Immovable property	300
Reserve & Surplus	200	Other Assets	200
Loan for immovable property	200
Total	500	Total	500

 

Facts:

• Mr. X owns entire Share capital of Rs. 100 in ICO;
• ICO owns immovable property of Rs. 300 & other assets of Rs. 200;
• ICO has taken loan for immovable property of Rs. 200;
• Mr. X sells shares of ICO to a NR for Rs. 400, and derives Capital Gain of Rs. 300.

Issue:

• Whether Capital Gain will be taxable in India ?

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Certain Possible Exceptions

• Transfer of shares of Listed companies owning immovable property
• Transfer of shares as a part of corporate reorganizations
• Where business is carried on in the property
• Pension funds, REIT cases

Article 13(5) – India – Netherlands Treaty – Alienation of any other property

Gains from the

alienation of

any property other than that referred to in paragraphs 1, 2, 3 & 4

shall be taxable

only in the State of which the alienator is a resident.

Assets whose transfer could be covered under Residuary Clause

• Shares of an Indian company – Other than Real Estate company covered earlier
• Bonds, Debentures (Convertible/ Non convertible)
• Options and Futures (Stock or Index)
• Movable property not forming part of business
• Trademark & Technology
• Forward cover contracts
• Other financial instruments

Factors not considered to be relevant while applying Article 13(5)

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COMPUTATION OF INCOME IN SOURCE STATE

• Article 13 does not provide methodology of computing income in Source  State
• Taxable income should be computed as per Domestic law of Source State  – Nature and extent of any deductions for expenses, exemption etc to be governed by provision of IT Act
• Proviso 2 to Section 48 – Indexation not available for long term capital asset being shares or Debentures in an Indian company

Capital gains Tax on Transfer of Ship ?

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