By Arunabh Choudhary, Nikita Chawla and Arjun Rastogi
The taxation of indirect transfer of assets has been incessantly making headlines in the financial markets post the Supreme Court of India’s decision in the case of Vodafone International Holdings BV vs Union of India (2012) 6 SCC 613 (“Vodafone Case”).
The Indian Government introduced the indirect transfer provision by way of the Finance Act 2012. Accordingly Section 9(1)(i) of the Income Tax Act, 1961 (“Tax Act”) was amended and made applicable with retrospective effect from 1st April 1961 (following the Supreme Court ruling in Vodafone Case.)
Post the amendments introduced by the Finance Act, 2012, various stakeholders raised multiple concerns before the Government of India and requested clarity on the scope of the amendment. Considering the situation, an expert committee (hereinafter referred to as Shome Committee) under the chairmanship of Dr. Parthasarathi Shome was constituted to analyse various dimensions of the amendment carried out through the Finance Act 2012. The Shome Committee, in its report, suggested that Foreign Portfolio Investors (“FPIs”) should be kept outside the ambit of indirect transfer provisions under the Tax Act. Amendments brought in by Finance Act 2015 on indirect transfer of assets do not exempt FPIs.
Since then, the applicability of indirect transfer provisions to FPIs have become a matter of perpetual debate and are subject to multiple interpretations. The Central Board of Direct Taxes (“CBDT”) on June 15 last year constituted a working group to examine the issues raised by various stakeholders i.e. FPIs and its investors, in this regard. The working group has recently, on December 21 last year, issued clarifications in relation to the applicability of indirect transfer provisions to FPIs.
Indirect Transfer and regulatory tests to identify it:
As per Section 9(1)(i) of the Tax Act, all income arising (whether directly or indirectly), from any business connection in India, or from any property situated in India, or from any asset or source of income in India or through the transfer of a capital asset situated in India shall be deemed to arise in India.
Explanation 5 to Section 9(1)(i) further clarifies that, a share or interest in a company or entity registered or incorporated outside India shall be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.
Explanation 6 to Section 9(1)(i) provides that in order for Explanation 5 to hold good, the share or interest shall be deemed to derive its value substantially from the assets (tangible or intangible) located in India, if on a specified date, the value of such assets:
- exceeds Indian Rupee (“INR”) 100 million; and
- represents at least 50 percent of the value of all assets owned by the company or entity.
THE CARVE OUT:
Explanation 7 to section 9(1)(i) provides that Explanation 5 shall not be applicable to any transferor which, in the 12 month’s period preceding the date of transfer:
- has had no right of management or control over such company or entity; or
- has held less than 5 percent of the total voting power or share capital or interest of the company or entity has held that directly or indirectly owns the assets situated in India.
Some of the clarifications provided by the CBDT are as following
(a) Structures falling under the indirect transfer provisions: –
Will the indirect transfer provisions apply to the redemption of units in X?
Provisions of indirect transfer will apply as per Explanation 5 and 6 because the conditions stipulated under Explanation 6 are satisfied in case of X.
However investors covered under Explanation 7 will be exempted if they at any time in the twelve months period preceeding the date of transfer, do not have right of control or management in X or hold voting power or share capital or interest, directly or indirectly, exceeding 5 percent in X.
Will the indirect transfer provisions apply to X which is using a sub-fund for investments in India?
|Indirect transfer provisions will be applicable to fund X, on account of Explanation 5, since the value of units held by X the sub-fund derives its value substantially from assets located in India.|
(b) Structures not falling under the provisions of the indirect transfer provisions
Will indirect transfer provisions apply to investors in Fund I and Fund II which are used to only pool monies from investors?
|As per the provisions of Explanation 7, any income generated by the investors of Fund I or Fund II by transfer of their interest in such feeder funds would not be subject to the provisions of indirect transfer.|
Will indirect transfer provision apply to investors in A?
|As per the provisions of Explanation 7, investors in A will not be subject to the provisions of indirect transfer since they at any time in the twelve months period of preceeding the date of transfer, do not have right of control or management in B or hold voting power or share capital or interest, directly or indirectly, exceeding 5 percent in B.|
In addition to the above scenarios, the clarifications also set out other scenarios which at this stage lead to further questions such as, can there be situations of double taxation on account of such investments? Will carve outs apply to avoid such double taxation?
Additionally, queries surrounding newly introduced tax provisions in India. How would the effect of these tax provisions pan out and to what extent would they apply to structures involving FPIs, all these questions remain unanswered as of now, but what are the right answers, we need to wait and watch.
Arunabh Choudhary is a Principal Associate, Nikita Chawla is a Senior Associate and Arjun Rastogi is an Associate at the Mumbai office of Juriscorp.
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