Section 115C — NRI Special Definitions

Case Laws & Commentary

Section 115C — Definitions

Chapter XII-A: Special Provisions Relating to Certain Incomes of Non-Residents

1. Statutory Snapshot

Section 115C is the definition clause that powers the whole of Chapter XII-A. Every concessional benefit in sections 115D to 115-I is triggered only if the income and the asset answer the descriptions given here. The defined expressions are:

• “convertible foreign exchange” [cl. (a)] — foreign exchange which is for the time being treated by the Reserve Bank of India as convertible foreign exchange for the purposes of FEMA, 1999 (originally FERA, 1973). This is the source test.
• “foreign exchange asset” [cl. (b)] — any specified asset which the assessee has acquired or purchased with, or subscribed to in, convertible foreign exchange. This is the asset test and the gateway to ss. 115E/115F.
• “investment income” [cl. (c)] — any income derived (other than dividends referred to in s. 115-O) from a foreign exchange asset.
• “long-term capital gains” [cl. (d)] — income chargeable under 'Capital gains' relating to a long-term capital asset.
• “non-resident Indian” (NRI) [cl. (e)] — an individual, being a citizen of India or a person of Indian origin, who is not a resident. By the Explanation, a person is deemed of Indian origin if he, or either of his parents or any of his grand-parents, was born in undivided India.
• “specified asset” [cl. (f)] — (i) shares in an Indian company; (ii) debentures issued by an Indian non-private company; (iii) deposits with an Indian non-private company; (iv) any Central Government security under s. 2(2) of the Public Debt Act, 1944; (v) such other assets as the Central Government may notify.

2. Commentary

2.1 Two cumulative tests: 'source' and 'asset'

An asset qualifies only if both limbs are satisfied — it must be a specified asset (cl. f) AND it must have been acquired/subscribed in convertible foreign exchange (cl. a, via cl. b). An identical share bought out of rupee funds or an NRO balance is not a foreign exchange asset; the same share bought out of NRE/FCNR/inward remittance is. The funding trail is the single most important piece of evidence in any 115C dispute.

2.2 'Investment income' excludes s. 115-O dividends

Because domestic-company dividends were, for long periods, subjected to dividend distribution tax under s. 115-O (and exempt in the shareholder's hands), they were carved out of 'investment income'. After abolition of DDT (Finance Act, 2020), dividends are again taxable in the shareholder's hands; for an NRI they are generally taxed under s. 115A (20%) or the DTAA rate. Do not reflexively push dividends into s. 115E.

2.3 NRI status and 'person of Indian origin'

NRI status borrows the negative of 'resident' from s. 6 and adds the PIO limb. The grand-parent test reaches back to undivided India — a deliberately wide net for the diaspora. Residence is tested year-by-year; an individual may be an NRI in the years of investment and accrual but cease to be one later — exactly the situation s. 115H addresses.

3. Key Issues / Practice Points

• Maintain a clean forex funding trail — NRE/FCNR statements, FIRCs, broker/DP contract notes — for every lot.
• Bonus and rights shares: the funding character of the original holding flows to them (Sanjay Gala).
• Private-company debentures/deposits are outside cl. (f); only non-private (public) company instruments qualify.
• Test NRI status afresh each year against s. 6; keep passport/stamp records and a day-count working.

4. Case Laws

Direct decision under Chapter XII-A:

Facts

• The assessee, a non-resident Indian, filed a return for AY 2006-07 declaring income of Rs. 60,000.
• He held shares in Indian companies. It was undisputed that the original shares had been acquired by investing convertible foreign exchange, making them foreign exchange assets. Bonus shares had subsequently been allotted to him on those original shares.
• On the transfer of shares, the assessee claimed Chapter XII-A benefit (s. 115F), treating the bonus shares also as foreign exchange assets.
• In the assessment under s. 143(3), the Assessing Officer refused to treat the bonus shares as foreign exchange assets, denied the s. 115C/115F benefit, and assessed the total income at Rs. 11,23,265.
• The CIT(A) upheld the AO, reasoning that s. 115C(b) defines a 'foreign exchange asset' as one acquired or purchased with, or subscribed to in, convertible foreign exchange, whereas bonus shares were issued free and were neither acquired, purchased nor subscribed for by the assessee. The assessee appealed to the Tribunal.

Question(s) for determination

Whether bonus shares received in respect of original shares (admittedly acquired in convertible foreign exchange) are themselves a 'foreign exchange asset' within s. 115C(b), so as to be eligible for the s. 115F exemption.

Rival contentions

• Assessee: bonus shares cannot be divorced from the original forex-funded shares; on issue of bonus shares the cost of the original shares is spread over the enlarged holding, so the forex character of the original investment flows to the bonus shares.
• Revenue: the words of s. 115C(b) require acquisition/purchase/subscription in convertible foreign exchange; bonus shares involve no such payment and therefore fail the statutory test.

Decision & reasoning

The Tribunal held that the assessee had acquired the original shares by investing convertible foreign exchange, and the bonus shares cannot be considered in isolation from those original shares.

It noted that the Supreme Court and various High Courts have settled the valuation of bonus shares: the cost of acquisition of the original shares is to be spread over both the original and the bonus shares (the averaging method), because on issue of bonus shares the value of the original shares is proportionately diminished — the holding is, in effect, 'split up'. The cost and value of the original and bonus shares are therefore closely interlinked and interdependent, and once bonus shares are issued the averaging formula applies to the whole holding.

Applying that principle, the bonus shares partake of the character of the original (forex-funded) shares and are covered by s. 115C(b) as a foreign exchange asset; they are accordingly eligible for benefit under s. 115F.

The appeal of the assessee was allowed.

Ratio decidendi

The forex character of an original foreign-currency-funded shareholding flows through to bonus shares issued on it; bonus shares are a 'foreign exchange asset' under s. 115C(b) and qualify for s. 115F.

The cost-averaging principle for bonus shares (the Dalmia Investment line of authority) governs both the characterisation of the bonus shares and the quantification of the qualifying gain.

Application to this section

This is the foundational authority on what is a 'foreign exchange asset' under s. 115C(b). It establishes that the statutory words 'acquired or purchased with, or subscribed to in, convertible foreign exchange' are read to include accretions (bonus shares) that derive from a forex-funded original holding.

Practice note: The leading authority to defend Chapter XII-A claims on accreted/derivative securities. Retain the original FIRC / contract notes to anchor the forex 'flow-through'.

Allied / foundational authorities relied upon (verify before citing):

Facts

• The assessee company held shares and was allotted bonus shares ranking pari passu with the originals. On a subsequent sale, the question arose as to the cost at which the bonus shares should be taken in computing the profit/gain.

Question(s) for determination

What is the correct method of determining the cost of acquisition of bonus shares?

Decision & reasoning

The Supreme Court examined the competing methods — taking the cost of bonus shares as nil, at face value, at market price on the date of issue, or by spreading the original cost — and held that, where the bonus shares rank pari passu with the original shares, the correct method is to spread the cost of the original shares over the whole holding (original + bonus) and take the average.

The Court reasoned that the issue of bonus shares depresses the market value of the original shares, so the cost must be re-distributed over the enlarged holding to reflect economic reality.

Ratio decidendi

Cost of bonus shares is to be computed by averaging the original cost over original and bonus shares; the two are interdependent.

Application to this section

Supplies the cost-averaging logic expressly applied in Sanjay Gala to characterise bonus shares as forex assets under s. 115C(b).

Practice note: This is the precise principle the Mumbai Tribunal applied in Sanjay Gala to characterise bonus shares as a foreign exchange asset and to quantify the s. 115F-eligible gain.

Facts

• The assessee, an existing shareholder, became entitled to rights shares and sold the right entitlement. In computing the gain, she sought to account for the fall in the market value of her original shares caused by the rights issue.

Question(s) for determination

Whether, in computing capital gains on the sale of a rights entitlement, the diminution in the value of the original shares (attributable to the rights issue) is to be taken into account.

Decision & reasoning

The Supreme Court held that the value of the right must be measured against the depreciation in the market value of the original shares brought about by the rights issue; the original holding and the accretion are interlinked and the real gain must reflect that diminution.

Ratio decidendi

Accretions (rights/bonus) and the original holding are economically interdependent and must be valued together — the accretion is not a stand-alone, cost-free asset.

Application to this section

Reinforces that an accretion (rights/bonus) is not a stand-alone, cost-free asset but is interlinked with the original forex-funded holding — supporting the 115C(b) characterisation.

Practice note: Reinforces the 'interdependence / flow-through' reasoning applied to bonus shares in the Chapter XII-A context (Sanjay Gala).

5. Cross-references

s. 6 (residence) • s. 2(2) Public Debt Act, 1944 • FEMA, 1999 / RBI convertibility • s. 115D (computation) • s. 115E (rates) • s. 115F (exemption) • s. 115A (NRI dividend/interest outside the Chapter).

Standing Disclaimer & Verification Note