Decoding Sub-Clause (vi) – Not of Underlying Assets Under Transfer in Relation to a Capital Asset under Income Tax

Understanding the nuances of capital gains tax can be complex, especially when dealing with intricate provisions. One such provision, Sub-clause (vi) of Section 47, relating to transfers not regarded as transfers in relation to a capital asset, often puzzles taxpayers. This article aims to demystify this sub-clause, providing a comprehensive understanding of its implications under Indian Income Tax law.

Understanding "Transfer" under the Income Tax Act

Before delving into Sub-clause (vi), it's crucial to understand the concept of "transfer" as defined under Section 2(47) of the Income Tax Act, 1961. This section provides an inclusive definition, encompassing various transactions beyond the conventional sale, exchange, or relinquishment of an asset. It includes:

• Sale
• Exchange
• Relinquishment of the asset
• Extinguishment of any rights therein
• Compulsory acquisition under any law
• Conversion of a capital asset into stock-in-trade
• Maturity or redemption of zero-coupon bonds
• Transactions allowing the possession of immovable property to be taken or retained in part performance of a contract
• Any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882); or
• Any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.

Any transaction falling under these categories would ordinarily attract capital gains tax if it involves a capital asset. However, certain transactions are specifically excluded from the definition of "transfer" under Section 47, and this is where Sub-clause (vi) comes into play.

Section 47 and Exemptions from "Transfer"

Section 47 lists specific transactions that are not considered as "transfers" for the purpose of capital gains tax. These exemptions are designed to facilitate certain types of restructuring, reorganization, or transfers between specific entities without triggering an immediate tax liability. It's crucial to remember that these exemptions only postpone the tax liability, and the capital gains tax may become applicable later when the ultimate transferee disposes of the asset.

Unveiling Sub-Clause (vi): A Deeper Dive

Sub-clause (vi) of Section 47 deals with the transfer of a capital asset between holding and subsidiary companies, subject to specific conditions. It states that any transfer of a capital asset by a company to its subsidiary company, or by a subsidiary company to its holding company, shall not be regarded as a transfer. However, this exemption is not absolute and is contingent upon the fulfillment of the following crucial conditions:

1. Holding-Subsidiary Relationship: The transfer must be between a holding company and its wholly-owned subsidiary company, or vice versa. The term "wholly-owned subsidiary company" means a company in which the holding company holds the entire share capital. There should not be any other shareholders.

2. Indian Residency: The subsidiary company must be an Indian company. This condition implies that the exemption is only available if the subsidiary is incorporated and registered in India. A foreign subsidiary would not qualify for this exemption.

3. No Subsequent Transfer (The Crux): The capital asset must not be transferred by the subsidiary company (in case of transfer from holding to subsidiary) or by the holding company (in case of transfer from subsidiary to holding) at any time after such transfer. This is the most critical condition. If the transferee company subsequently transfers the asset, the initial transfer, which was initially exempt under Section 47(vi), will be deemed a transfer, and capital gains tax will be applicable to the transferor.

Key Interpretation of "Not of Underlying Assets Under Transfer"

The phrase "not of underlying assets under transfer" highlights the fact that the exemption is conditional. The exemption is given on the condition that the underlying assets which are transferred from the holding to subsidiary or subsidiary to holding should not be transferred. If it is transferred subsequently, then it will be taxable.

Example:

Let's say Holding Co. Ltd. transfers a piece of land to its wholly-owned Indian subsidiary, Subsidiary Co. Ltd. The transfer is initially exempt under Section 47(vi). However, if Subsidiary Co. Ltd. sells the land five years later, the initial transfer from Holding Co. Ltd. to Subsidiary Co. Ltd. will now be considered a transfer, and Holding Co. Ltd. will be liable to pay capital gains tax on the transfer, calculated as if the transfer occurred at the time Holding Co. Ltd. transferred to Subsidiary Co. Ltd.

Implications and Considerations

• Tax Planning: This provision is often used for internal restructuring within corporate groups. Companies can transfer assets between entities without immediate tax consequences, allowing for better asset management and operational efficiency.

• Due Diligence: Before undertaking such a transfer, companies must conduct thorough due diligence to ensure that all conditions are met. Failure to comply with even one condition can result in significant tax liabilities.

• Record Keeping: Accurate and detailed records of the transfer, including the date, value of the asset, and relationship between the companies, must be maintained. This is crucial for substantiating the claim for exemption and for calculating capital gains tax if the asset is subsequently transferred.

• Valuation: While the initial transfer may be exempt, the value of the asset at the time of the original transfer is critical. This value will be used to calculate the capital gains tax when the asset is eventually sold by the transferee company. A fair market valuation is therefore recommended.

• Business Restructuring and Mergers: This clause facilitates business restructuring and mergers where assets need to be moved between entities within the group without immediate tax implications.

Points to Note

• The exemption is only available for transfers between a holding company and its wholly-owned subsidiary. If the subsidiary has even a single minority shareholder, the exemption is not applicable.

• The subsequent transfer that triggers the capital gains tax on the initial transfer does not necessarily have to be a sale. It can be any form of transfer as defined under Section 2(47), including exchange, relinquishment, etc.

• The holding-subsidiary relationship must exist at the time of the initial transfer.

• The provision is meant to facilitate internal restructuring and not tax avoidance. The Income Tax Department may scrutinize transactions that appear to be designed solely to avoid paying capital gains tax.

Legal Precedents and Case Laws

While a comprehensive list of case laws is beyond the scope of this article, it's important to note that the interpretation and application of Section 47(vi) have been the subject of several court decisions. These cases often revolve around the interpretation of "wholly-owned subsidiary," the nature of the subsequent transfer, and the purpose of the transaction. Taxpayers should consult with legal professionals to understand how these precedents might apply to their specific circumstances.

Practical Examples

Scenario 1: Restructuring for Operational Efficiency

Holding Co. Ltd., a manufacturing company, wants to consolidate its production facilities. It transfers a manufacturing plant to its wholly-owned Indian subsidiary, Subsidiary Co. Ltd. This transfer is exempt under Section 47(vi). Subsidiary Co. Ltd. then manages the entire manufacturing process. If Subsidiary Co. Ltd. continues to operate the plant and does not transfer it, the exemption remains valid.

Scenario 2: Subsequent Sale of Transferred Asset

Holding Co. Ltd. transfers a commercial property to its wholly-owned Indian subsidiary, Subsidiary Co. Ltd. A few years later, Subsidiary Co. Ltd. decides to sell the property. In this case, the initial transfer from Holding Co. Ltd. to Subsidiary Co. Ltd. will be considered a transfer, and Holding Co. Ltd. will be liable for capital gains tax based on the fair market value of the property at the time of the initial transfer to the subsidiary.

Scenario 3: Transfer to a Non-Wholly Owned Subsidiary

Holding Co. Ltd. transfers shares of another company to Subsidiary Co. Ltd. However, Holding Co. Ltd. owns only 90% of Subsidiary Co. Ltd.; the remaining 10% is owned by another investor. In this scenario, the transfer is not exempt under Section 47(vi) because Subsidiary Co. Ltd. is not a wholly-owned subsidiary. The transfer will be subject to capital gains tax at the time of the transfer.

Conclusion

Sub-clause (vi) of Section 47 provides a valuable exemption for transfers between holding and wholly-owned Indian subsidiary companies, facilitating internal restructuring and operational efficiency. However, the exemption is conditional and subject to stringent requirements. The key condition is that the underlying asset should not be subsequently transferred. Companies must carefully evaluate their transactions, conduct thorough due diligence, and maintain accurate records to ensure compliance with the law and avoid unexpected tax liabilities. Understanding this sub-clause is crucial for effective tax planning and ensuring compliance within corporate groups in India. Consulting with a tax professional is always recommended for specific guidance tailored to individual circumstances.