A recent ruling given by the Authority for Advance Rulings (AAR) has cleared the path for the application of the Indo-UAE tax treaty.

In its ruling, the AAR has firmly held that merely because there is no tax incidence in the other country (the UAE, in this particular case), it does not imply that such income can be taxed in India. The AAR has emphasised that tax treaties override domestic tax laws.

The AAR held, “It is clear that under the tax treaty, capital gains arising from alienation of shares in Indian companies in the hands of a UAE resident are taxable only in the UAE and not in India.”

In this case, Emirates Fertilizer Trading, which was a UAE resident partnership firm, filed an application with the AAR. In its application, it submitted that as per the Indo-UAE tax treaty there would be no liability to pay tax in India on capital gains arising on sale of shares in an Indian company. It held 4 mn shares in Indo-Gulf Corporation valued at around $0.89 mln that it wished to dispose of.

However, the tax department in its submissions to the AAR, pointed out that the UAE firm is not subject to tax in the UAE. Thus, if it were not subject to any tax in India either, it would lead to a situation of double non-taxation. The plea was that the UAE firm should be subject to tax in India on the capital gains earned by it on sale of its investments in an Indian company.

Based on the provisions of the Income-Tax (I-T) Act and also several judgments of the Supreme Court, the AAR held that “The tax treaty has an overriding effect over the provisions of the I-T Act. Thus, the capital gains arising to the UAE resident on sale of shares of an Indian company cannot be taxed in India.”

In the past, divergent views have been adopted, especially in the case of assessments of individuals resident in the UAE. At times, assessing officers have held that as individuals are not subject to tax in the UAE, they cannot avail of the benefits of the Indo-UAE tax treaty. A similar view was also taken on occasion by the AAR, which digressed from its earlier judgments with this recent one.

Currently, India exempts long-term capital gains arising from the sale of shares on recognised stock exchanges in India. However, short-term capital gains continue to be taxable in India. Moreover, domestic tax laws are subject to frequent changes. In such a scenario tax treaties provide greater stability.