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India: Ruling on taxation of indirect transfer



Rajendra Nayak

Aastha Jain

Under the Indian Tax Law (ITL), any income arising from the transfer of a capital asset situated in India would be taxable in India. In 2012, the ITL was retroactively amended to introduce an indirect transfer taxation rule (the rule), to tax the transfer of shares of a foreign company, if such shares directly or indirectly derived 'substantial' value from assets located in India. The ITL does not provide any guidance on what constitutes 'substantial'. Recently, the Delhi High Court (HC) adjudicated on the issue of determining what constitutes 'substantial' when applying the rule. In the facts of the case, a UK incorporated company (UK Co) wanted to acquire the participation in a company located in Jersey (Jersey Co) and its subsidiaries situated in Mauritius, India and the US. Consequently, the following share purchase agreements (SPA) were entered into:

  • SPA-I: Transfer of 100% stake in an Indian company (I Co) by its parent company in Mauritius to UK Co.

  • SPA-II: Transfer of 100% stake in a US company (which in turn held an Indian company) by its parent company in Mauritius to UK Co.

  • SPA-III: Transfer of 67% stake in Jersey Co which was held by individual residents of UK.

Following a ruling of the Authority for Advance Ruling on the non-taxability of the transaction, the HC was approached by the tax authority, which claimed that the arrangement was for the transfer of business and interest of Jersey Co which should be taxable in India under the rule as shares of Jersey Co derived their substantial value from India, through its (direct or indirect) subsidiaries. Further, routing the transactions through Mauritius (in SPA I, SPA II) was done with the object to avoid taxation and it should be disregarded.

The HC observed the following on the rule:

  • Legal fiction in the rule should be limited to income that has nexus with India;

  • 'Substantial' should be read as synonymous to 'principally', 'mainly', or at least 'majority'. For this purpose, 50% can be treated as reasonable threshold; and

  • Therefore, the rule can be invoked to tax transfers of overseas assets which derive 50% of their value from India.

In the present facts, HC held that each SPA has commercial rationale and is independent. It cannot be considered as a transaction structured to avoid taxes. Assuming SPA-I and SPA-II were not executed and if only shares of Jersey Co were transferred, the value of Jersey Co shares derived from India assets would only be 30.5% and it may not be regarded as 'substantial' in terms of the rule. Hence, it was held not taxable under the ITL.

Rajendra Nayak ( & Aastha Jain (


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