PE and VC Firms Are Troubled by the ITAT Ruling
Following the ITAT Mumbai order stating that the forex neutrality provision would not be applicable to non-resident investors when calculating capital gains on the sale of assets, including shares or debentures, private equity and venture capital firms have contacted tax advisers to gauge the potential impact on their exits.
Strategic and PE/VC investors may now need to rethink their investment plans and examine the tax consequences before engaging in transactions involving shares or debentures as a result of the decision. Additionally, because the decision establishes a new precedent that may potentially contradict with these stances, these corporations are seeking the examination of tax experts to see whether they need to reevaluate their previously adopted positions.
In 2022, India had total outflows of $24 billion.
In the Legatum case, the Dubai-based fund reported having no revenue for the assessment year 2018–19 in a tax return that was submitted on October 19, 2018. The tax authorities chose to examine the return, nevertheless, and subsequently sent a notification to the company. The entire income of Legatum’s appellant was estimated by the Assistant Commissioner of Income Tax (International Taxation), Mumbai, to be z17.136 crore. The fund subsequently filed a complaint with the tribunal, which rendered a decision on March 15, 2023.
For non-resident investors, the first proviso to Section 48 protects non-residents from changes in the rupee value when calculating capital ga-ins on the -sale of assets such as shares or debentures. But in the Legatum case, the tax authorities applied Section 112(1)(c)(iii) of the Act, which requires a different computa-tion of capital gains.
According to the technical terminology, the Mumbai Tribunal appears to have ruled, but the government should still consider changing the statute. Over the last few decades, the rupee has regularly fallen versus the dollar; this tendency will likely continue for the foreseeable future. It is understandable that non-residents measure their success in dollars rather than rupees, thus action must be taken to solve this issue before it hinders FDI, according to Ketan Da-lal, MD of Katalyst Advisors.
“The ruling would result in higher tax payments in respect of capital gains arising on trans-fer of shares in unlisted companies, even if the non-resident taxpayer has incurred losses in dollar terms,” said Paras Savla, partner at the accounting firm KPB & Associates. On the transfer of such shares, withholding tax must also be calculated, and rupee profits must be taken into account in rupee terms.
The problem may be stated simply as follows: When the ex-Indian corporation theequiva-change rate was Z60 and a VC firm invested $1 million, the resulting investment in rupee terms would have been f6 crore. The rupee gain would be V2.2 crore if the shares were recently sold for V8.2 crore at an exchange rate of z82.However, because the dollar-to-exchange rate has now decreased to 82 to 1, the non-resident fund would receive the same $1 million back, negating any currency gains.The forex neutrality rule may cause the fund to report no gain in their returns, but tax authorities may calculate it differently since the gain must be calculated in rupee values rather than in forex terms.
According to section 112(1)(c)(iii), an assessee who does not take advantage of the neutralisation of exchange rate fluctuation under the first proviso to section 48 will have their long-term gains from unlisted shares of the company in which the public is not substantially interested calculated at a lower rate of 10%. Initially, not all non-residents could profit from currency rate neutralisation. Later on, though, it was broadened to incorporate more businesses. Section 112(1)(c) was altered to exempt non-residents from a higher tax on the transfer of shares of unlisted firms, neutralising the effect of court pronouncements.
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