NRI’s Investments in Share Market

Whether ‘Capital Loss’ can be set off against Capital Gain’ arising in a Financial Year for TDS Purpose?

Background

Capital Market is always a fascinating investment option for NRIs and as part of trading in listed shares in a financial year (‘FY’), the investor sometimes makes profit in a month or sometimes incurs losses.

Post withdrawal of exemption under Section 10(38) of Income Tax Act, 1961 (‘IT Act’) on Long Term Capital Gain (‘LTCG’) arising from transfer of equity shares in a listed company, LTCG exceeding INR 1 lakh would become taxable in the hands of the NRI investor, at the rate of 10 percent and the same is subject to TDS.

For applying the TDS rate on such LTCG payable to NRIs, the question that arises from the Payer’s side is whether the TDS rates can be applied on the LTCG arrived at by setting off the capital loss arising on such share trading activity.

In the given background, we have analyzed Section 195 of the IT Act, being the section which casts the obligation on the payer to deduct tax at source on all payments made to a Non-resident Indian (NRIs) that are chargeable to tax in India.

I. Section 195(1) of the IT Act - Withholding tax requirement on non-resident payments:

Section 195(1) of the IT Act reads as under:

Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC) or section 194LD] or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries") shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force..

Section 195(1) of the IT Act casts an obligation on any person responsible for paying to a non-resident, any sum chargeable under the IT Act, to withhold tax on such sum at the rates in force as applicable, at the time of credit of such sum to the account of the payee or at the time of payment, whichever is earlier.

On analysis of Section 195 and various other provisions of the IT Act, we are of the view that withholding tax is applicable on the amount arrived at after setting off the long-term losses arising from trading activity against the long-term gains arising from such activity during a year

Our analysis in support of the afore mentioned view have been detailed below

1. “Sum chargeable under the provisions of the Act”

  • For applicability of Section 195, firstly it is important to determine whether the amount payable to non-resident would come under the purview of “sum chargeable to tax” under the provisions of the IT Act at the rates in force. Once the payment has been determined to be chargeable to tax, the next question that arises is what is the sum that is chargeable to tax in India.
  • Section 195 falls under Chapter XVII which deals with collection and recovery of tax. On analysis of various provisions of Chapter XVII, one finds use of different expressions, however, the expression “sum chargeable under the provisions of the Act” is used only in Section 195.
  • For this purpose, scope of Section 195 is to be read in conformity with the charging provisions, i.e. Sections 4, 5 and 9 of the IT Act.
  • Section 4 of the IT Act seeks to charge tax on the “total income” of an assessee during the previous year
  • As per Section 5 of the IT Act, the “total income” of a non-resident which shall be chargeable to tax in India shall comprise of:
    • Income received or deemed to be received in India; and
    • Income received or deemed to be received in India; and
  • Incomes which shall be “deemed to accrue or arise in India” has been defined in Section 9 of the IT Act to includes “income” accruing or arising, whether directly or indirectly, through the transfer of capital asset situated in India. Now, the next question to be answered is what is “income” in case of transfer of capital asset situated in India.
  • Section 2(24) of the IT Act defines the term ‘Income’ to include, inter-alia, any capital gains chargeable under section 45.
  • Section 45(1) of the IT Act, the charging section for capital gains, provides that “profits and gains” arising from the transfer of capital assets shall be chargeable to income tax under the head “Capital Gains”.
  • Accordingly, a combined reading of Sections 2(24) and 45 of the IT Act, only the profits and gains arising on transfer of capital assets are chargeable to tax and not the gross consideration received. The said profits and gains arising on transfer of capital assets are determined as follows:
  • Particulars Value
    Sale Consideration (A)
    Less: Cost of Acquisition (B)
    Profits / Gain (i.e., Capital Gains) chargeable to tax (A-B)
  • In summary, withholding requirement under Section 195 of the IT Act would be applicable where the sale consideration is more than the cost of acquisition and when the profit (gain) is chargeable to tax in India. In other words, where the sale consideration is less than or equal to the cost of acquisition, it results into ‘capital loss’ and thus there is no sum chargeable to tax and the provision of Section 195(1) shall not be applicable.

2. Manner of computation of ‘Capital Gain’ and Meaning of ‘rates in force’ under Section 195

  • Section 195 provides that the tax shall be deducted as per the rates in force. As per Section 2(37A) read with Section 90 of the IT Act, for the purpose of TDS as per Section 195 of the IT Act, “rates in force” means the most beneficial of the following:
    • the rate or rates of Income-tax specified in Part II of First Schedule of the Finance Act; or
    • the rate or rates of Income-tax specified in the Double Taxation Avoidance Agreements (DTAA)).
  • Once the capital gains are determined to be taxable in India, whether as per the IT Act or the DTAA, computation of such capital gains would be determined as per the provisions of the IT Act. Sections 48 to 55 provide the mechanism to compute capital gains earned in India
  • Therefore, it can be inferred that “any sum chargeable to tax under the Act” refers to capital gains computed in accordance with Section 48 to 55 of the IT Act and the tax rates in case of capital gains arising on listed securities have been prescribed in Section 112A (for long-term capital gains) and 111A of the IT Act (for short-term capital gains).
  • Section 112A(1)(i) of the IT Act provides that the section applies only if ‘the total income includes any income chargeable under the heads “capital gains”
  • The term capital gain has not been defined in the IT Act; however, Section 45 covers any profits or gain arising from transfer of a capital asset effected in the previous year as chargeable to tax under the head ‘capital gain’. Further, capital gain has been classified into two categories as ‘Long Term Capital Gain’ (‘LTCG’) and ‘Short Term Capital Gain’ (‘STCG’) which has been specifically defined under the IT Act. LTCG means capital gain arising from transfer of long-term capital asset and STCG means capital gain arising from transfer of short-term capital asset.
  • The computation mechanism for determining ‘taxable capital gain’ is provided in Sections 48 to 55 of the IT Act, and only if the net result of computation under the head capital gains of all long-term share trading transactions during a year is ‘positive’, it would become ‘taxable LTCG ’ on which the rate provided in Section 112A shall be applicable
  • In other words, if the net result of computation under the head capital gain is ‘negative’, then the rates prescribed under Section 112A of the IT shall not be relevant and in turn the withholding tax provisions stated in Section 195 shall not be applicable.

3. Set off and Carry Forward of losses

  • Setting off of losses under the head ‘capital gain’ falls under Chapter VI of the IT Act, which governs the provisions for intra-head and inter-head set off of profits / losses.
  • Sections 70(3) of the IT Act, which deals with intra head adjustment of long-term capital losses, provides that:

    ‘Where the result of the computation made for any assessment year under sections 48 to 55 in respect of any capital asset (other than a short-term capital asset) is a loss, the assessee shall be entitled to have the amount of such loss set off against the income, if any, as arrived at under a similar computation made for the assessment year in respect of any other capital asset not being a short-term capital asset.’

  • Further, Section 74 of the IT Act dealing with carry forward of losses, reads as under:

    ‘Where in respect of any assessment year, the net result of the computation under the head ‘Capital gains’ is a loss, such loss shall, subject to the other provisions of this Chapter, be dealt with as follows….’.

  • In this relation, the Supreme Court in the case of Hariprasad & Co. (P.) Ltd. [1975] 99 ITR 118 has observed that " "From the charging provisions of the Act, it is discernible that the words 'income' or 'profits and gains' should be understood as including losses also, so that, in one sense 'profits and gains' represent 'plus income' whereas losses represent 'minus income'. In other words, loss is negative profit. Both positive and negative profits are of a revenue character. Both must enter into computation, wherever it becomes material, in the same mode of the taxable income of the assessee. Although Section 6 classifies income under six heads, the main charging provision is Section 3 which levies income-tax, as only one tax, on the 'total income ' of the assessee as defined in Section 2(15). An income in order to come within the purview of that definition must satisfy two conditions. Firstly, it must comprise the ' total amount of income, profits and gains referred to in Section 4(1)'. Secondly, it must be 'computed in the manner laid down in the Act'. If either of these conditions fails, the income will not be a part of the total income that can be brought to charge
  • It was further observed that "it may be remembered that the concept of carry forward of loss does not stand in vacuo. It involves the notion of set- off. Its sole purpose is to set off the loss against the profits of a subsequent year. It pre-supposes the permissibility and possibility of the carried-forward loss being absorbed or set off against the profits and gains, if any, of the subsequent year. Set off implies that the tax is eligible and the assessee wants to adjust the loss against profit to reduce the tax demand. It follows that if such set-off is not permissible or possible owing to the income or profits of the subsequent year being from a non-taxable source, there would be no point in allowing the loss to be "carried forward".
  • Accordingly, drawing principles from the above, it can be inferred that income includes losses, and therefore the setting off of long term capital loss is to be considered against long term capital gain for determining a ‘net taxable long term capital gain’, which would be chargeable to tax as “such sum” under Section 195 of the IT Act and effectively would be subject to withholding tax on “such long term capital gain (in other words, such sum)” as stated in Section 112A of the IT Act.
  • Therefore, it is evident that if the net result of the computation mechanism as provided in Section 48 of the IT Act turns out negative then such loss is termed as capital loss, then Section 195 of the IT Act shall not be applicable for withholding tax purpose.
  • Following judicial precedents supports the above view
    1. In the case of Raptakos Brett & Co. Ltd v DCIT [2015] 58 taxmann.com 115, Mumbai Tribunal has allowed the claim of set off of Long-term capital loss on sale of shares, (gains if any which was earlier exempt under Section 10(38) of the IT Act), against the Long-term capital gain arising on sale of land . This was in a scenario wherein the capital gains arising from the sale of shares was not taxable.
    2. Further, in the case of DCIT vs. Kamineni Hospitals (P.) Ltd. [2020] 117 taxmann.com 642 , the Hyderabad Tribunal remanded back to the AO with a direction to assessee to establish that NRI vendor had deposited sale consideration of residential property in LTCG scheme within stipulated time period in compliance with first proviso to Section 201(1A) and, thus, assessee was not required to deduct tax at source under Section 195 while making payment in question to said NRI vendor.
  • Also, attention is drawn to the Frequently Asked Tax Questions for Qualified Foreign Investors (‘QFIs’) issued on 26 December 2012, wherein it has been clarified as follows:

    Question: For the purpose of computing tax deducted at source (withholding tax) Can Qualified Depository Participants (‘QDP’) set off in the case of QFIs, the profits earned in one security against losses earned in another security during a given year?

    Ans: Yes. For computing tax deducted at source (withholding tax) QDPs can set off profits earned by the QFI in one security against losses earned in another security as long as these securities are subject to Securities Transaction Tax (STT). Therefore, this would not be applicable in case of QFI investments in bonds as bond transaction are not subject to Securities Transaction Tax Such setting off for computing tax deduction at source would therefore be permissible only in the case of listed securities and mutual fund Units and redemption by mutual funds as these are subject to STT. The set off would again be subject to the general principle that an earlier loss of current year can be set off against subsequent profit which is credited or paid to the QFI. However, if tax deduction at source (TDS) has already been effected for a particular credit or payment, it cannot be reduced by subsequent loss. A QFI is, however, eligible to claim refund of excess amount of tax deducted at source (withholding) by filing a return of income for the relevant year

  • In a subsequent question to the FAQ, it has been further clarified that the QDPs cannot set off losses of previous years against income of current year for computing the withholding tax liability and such option is only available to the QFI at the time of filing of return of income.
  • In light of the above, it becomes amply clear that the losses can be set off against gains during the financial year, in computing the withholding tax liability. Although, the above clarification was issued in the case of QFI, similar approach can be adopted on withholding tax liabilities for all non-resident investors.

4.Reporting of income in ITR Form

  • It is also relevant to note the manner in which taxable capital gain are required to be reported in the return of income in Income Tax Return (ITR) as prescribed by the Income Tax Rule, 1962. The Forms notified by the Central Board of Direct Taxes for filing return of income also supports the contention that the losses to be set off against profits in line with the provisions of the IT Act before applying the tax rates.
  • The ITR 2 provides a separate Schedule for Section 112A of the IT Act for determining long term capital gain. In the said schedule, the details in relation to each particular transaction is to be keyed in separately and only the amount, net of all losses is given as part of the Capital Gains Schedule (Item 4(a)).
  • Therefore, it can be inferred that, capital gains arising on transfer of listed securities need be considered net of the long-term capital loss on transfer of similar securities.
  • Further, it is pertinent to note that the term ‘capital loss’ is not specifically defined under the IT Act. In ITR 2, the following words are given ‘Income chargeable under the head “CAPITAL GAINS” (A9+ B13) >(take B13 as nil, if loss)’, wherein the gains are taken as Nil in the event of net computation being a loss.
  • It is important note the Supreme Court ruling in the case of CIT vs PK Kochammu Ammu Peroke [1980] 125 ITR 624 , wherein it has laid down the principle that forms prescribed by the department cannot be ignored, and the interpretation of law contained therein reflects the executive opinion on the matter.
  • In light of the above, we are of the view that the capital losses can be set off against capital gains during the financial year, in computing the withholding tax liability

II. Whether payer should approach the Assessing Officer under Section 195(2) of the IT Act

  • Under Section 195(2), where the person responsible for paying any such sum chargeable under this Act (other than salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application in such form and manner to the AO, to determine in such manner as may be prescribed, the appropriate proportion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that proportion of the sum which is so chargeable.
  • A practical issue that arises is whether gross receipt (i.e. sales consideration) or net consideration received (i.e. Sales Consideration less purchase cost) is the sum chargeable to tax for the applicability of Section 195 of the IT Act.
  • Given the above, now let us analyse whether an application would be required to be made to the Tax Department under Section 195(2), for determining the withholding tax liability in the event of remittance of capital gains.
  • In this relation, the Supreme Court in case of GE India Technology Centre (P) Ltd. v. CIT [2010] 327 ITR 456 (SC) has observed that the provisions of Section 195(2) is just a safeguard and where a person responsible for deduction is fairly certain then he can make his own determination as to whether the tax was deductible at source and, if so, what should be the amount thereof
  • It was also further observed that Section 195 covers not only pure income payments but also composite payments which has an element of income embedded in it and obligation to deduct TDS in case of composite payment is limited to such income chargeable to tax forming the part of gross sum.
  • The Supreme Court noted as follows, ‘the words "such sum" clearly indicates that the observation refers to a case of composite payment where the payer has a doubt regarding the inclusion of an amount in such payment which is eligible to tax in India’.
  • From the above, it can be inferred that, the application under Section 195(2) is only applicable in the case of composite payments wherein there is doubts regarding the chargeability of an income component.
  • In the instant scenario, there is no doubt as to whether long term capital gains are liable to tax in India. Accordingly, it can be inferred that there is no requirement for making an application under Section 195(2) at the time of remittance of capital gains.
  • This seems to be the Tax Department's stand too, which has in the FAQs prepared for QFIs mentioned that the payer need not approach the tax department in every case of deduction of tax under Section 195.

III. Summary

  • For the purpose of withholding tax rate specified under Section 112A on payment of LTCG to NRIs, requirement of tax deduction shall be applicable only when the net result become ‘positive’ or ‘income’ after adjusting with the losses, which is permitted to be set off under Section 70 of the IT Act.

    In a scenario, where TDS is considered only on the LTCG without giving the set off effect to the losses, the actual tax liability would be much lesser than the taxes withheld and it would result into a refund scenario in the hands of NRIs.

    This will cause undue hardship to the NRIs, in terms of excess TDS in India and would impact their cash flows.

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