The Mumbai bench of the Income Tax Appellate Tribunal ( ITAT )  held that capital gain arising out of transfer of shares of an Indian entity cannot be taxed at hands of foreign entity in India when foreign entity has less than 10% shareholding in such an Indian entity. India Opportunity Fund I F.C.R DE REGIMEN COMUN,  the assessee, a VC Fund incorporated in Spain, and engaged in investing business, having no permanent establishment (PE) or any office in India, declared Nil return. The assessee has shown Long Term Capital Gain (LTCG) of Rs. 27 crores and Short-Term Capital Loss (STCL) of Rs. 65 lacs on sale of shares and claimed the same as exempt under section 90/91 of the Income tax Act and Article-14 of India-Spain DTAA.

The Assessing Officer (AO) found that the assessee has failed to provide any evidence in support of entitlement for the benefit of Article-14 of the Indo-Spain DTAA and brought to tax the net capital gain in the hands of assessee. The AO opined that if share of immovable property is more than 50% of the total assets of assessee company, then any gain from alienation of shares of the company whose property consists principally immovable property, is taxable in India. The assessee approached the ITAT. Get a Copy of Commercial’s Direct Taxes Law & Practice – Free E-Book Access, Click here Referring to Article-14(4) of the Indo Spain treaty, the Bench explained that gains from alienation of shares of the capital stock of a company the property of which consists, directly or indirectly principally of immovable property situated in a contracting state (India) may be taxed in that State (India). The Bench referred to the submission of the AO that the immovable property owned by assessee is more than 50% and therefore, the gain arising on the transfer of shares would result in capital gain in India. It was noted that the value of immovable property as a percentage of total assets of the assessee does not exceed 50% either based on book value or as per the Fair Market Value.Therefore, Article-14(4) of India-Spain DTAA cannot be applied in assessee’s case.

In light of the case of JCIT Vs. Merrill Lynch Capital Market Espana SA SV , the Bench reiterated that interpretation of Article 14(4) must essentially remain confined to the shares effectively leading to control of the company or which gives the right to enjoy the underlying immovable property owned by the company, and such property is what the company principally holds. Get a Copy of Commercial’s Direct Taxes Law & Practice – Free E-Book Access, Click here The two member Bench of Padmavathy S (Accountant Member) and Sunil Kumar Singh (Judicial Member) clarified that capital gain in hands of Spanish company (assessee/ appellant) from sale of shares of IMI Investments (Indian company) cannot be taxed in India, since assessee has no controlling interest in said Indian company. The Bench refused to accept that such holding is towards any controlling interest. While allowing the appeal, the ITAT directed the AO to delete the additions of capital gains, made in the hands of assessee.