After a number of controversial court hearings, in particular for Vodafone and Shell, but also for many other companies including Copal, taxpayers have their fingers crossed that the government will make decisions about indirect share transfers including specific threshold limits.
The provision for the taxation of indirect transfers is already part of India’s Income Tax Law. However, after last year’s budget, the finance minister said the provision should only be applied in rare cases.
“[That] explanation did not please the industry enough,” said Jitendra Grover, global head of tax for Aricent. “Hence there is this expectation of roll-back in the upcoming budget. So far no clear statement has surfaced from the government but generally there is expectation of a lot of tax reliefs for both corporate and individual taxpayers.”
While there is no certainty that the government will address indirect share transfers in the 2015 budget, taxpayers hope that any mention of the issue will look forward rather than back.
“It is expected that amendment, if any, on indirect transfers will be clarified to be prospective,” said Navin Jain of Cairn India.
Jain added that the amended provisions do not address a number of critical aspects, such as:
· when it can be said that shares derive value substantially from assets located in India;
· how to compute the cost of acquisition;
· that capital gains taxation, if any, should be restricted to gains from substantial assets in India;
· that group reorganisations are not taxable; and
· the impossibility of withholding tax due to retrospective amendment.
“Thus an amendment, even if prospective, needs to be comprehensive, clear and not [contentious].”
A large part of the contention with indirect share transfers in India relates to the government’s attempt to undo the Supreme Court’s ruling in the Vodafone case with retrospective amendments, which stated that the share or interest in a company shall be deemed to always be situated in India, if the share or interest derives, directly or indirectly, its value substantially from assets located in India.
However, specific thresholds do not clarify what “substantially” means.
“While various lawmakers and consultants had their own views as to the meaning of the term substantially, for instance, some advisers interpreted the word substantial in line with the recommendation of the Shome Committee report (therefore 20%), some related it to the reference in Section 40A of the Income Tax Act, wherein the threshold limit of substantial interest is prescribed at 20% shareholding,” said Amit Agarwal of Nangia & Co.
“The Shome committee did a remarkable job in considering the concerns of all stakeholders and coming up with comprehensive recommendations,” Amit Rana of GE added. “The entire report should be considered and adopted; at least on all the administrative or machinery points which make the law clear and workable.”
The Delhi High Court provided clarity in its decision in, DIT v. Copal Research Mauritius Limited, Moody’s Analytics, USA & Ors, where it held the term “substantially”, as used in Explanation 5 to Section 9 of the Income Tax Act, should be interpreted to mean “principally”, “mainly” or at least “majority”.
“The [Copal ruling] stated that a restrictive approach should be employed while interpreting a legal fiction, such as Explanation 5, and concluded that, for the indirect transfer tax provisions to apply, the overseas company should derive at least 50% of its value from Indian assets. What follows from the judgment of Copal Research, is that a transaction of indirect transfer would be considered taxable in India, where at least 50% of the value of the transferee entity is from the assets located in India,” said Agarwal.
If the budget does not provide it, advisers hope clarity will come from the courts.
“I heard that the revenue may take the ruling of the High Court to the Supreme Court [in the case of Copal],” said Rahul Garg of PwC. “This shows that the revenue seeks to apply a threshold lower than 50%.”
However, if the threshold is to be applied at less than 50%, Rana does not think this will be sufficient.
“For instance, even with the threshold defined, there is no provision in law to proportionate the tax to the value in India, or to define how the cost of acquisition will be computed in such cases or to clarify whether the tax will trigger if the overseas share transfers are by retail investors in an overseas listed entity etcetera,” said Rana.
Recommended government approach
The budget should therefore add useful, detailed guidelines to the effect that an offshore entity should be regarded as deriving its value substantially from India if at least 50% or more of the value of all the assets owned directly or indirectly by such offshore entity are located in India. The mechanism of valuation of assets should also be appropriately prescribed in the rules to avoid any uncertainty on the computational matters.
“The controversial amendment for taxing indirect transfers does not provide any clarity on meaning of the term “Assets located in India”. It would be a welcome move, if the budget document clarifies that the phrase means assets which are recorded in the books of the Indian subsidiary, and does not include unrecorded assets like intangibles,” said Agarwal.
Foreign investors are also likely to be relieved if the government also provides certain procedural checks for taxation of indirect transfers.
“For instance, it may be provided that no tax officer would be permitted to issue any notice, alleging taxation on indirect transfers, unless the particular case has been approved by the Commissioner and reasons of such approval are recorded,” said Agarwal. “This shall prevent arbitrary notices being issued by Indian tax officers to foreign companies, when notices are purely based on news reports.”
If the government succeeds in making this situation clearer for taxpayers it could bring in much-needed revenue for India.
“Clarifying the ambiguity in the indirect transfer law is a low hanging fruit and can go some way in sending a positive message to investors that the government is serious about providing a certain law,” said Rana. “I am not even arguing on the merits of the law itself, which probably gets into the arena of India having a sovereign right to tax such transactions, and any change - even if warranted to make India more attractive for investors - will probably entail significant political manoeuvring, but merely making it workable.”
We will also be running a web eminar on the India budget on March 1, with two times to suit those people listening in the Americas and in Asia:
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