India Tax Insights – eighth edition
India issues rules for taxing indirect transfers – a move toward greater clarity?
Geeta Jani, Partner – Tax & Regulatory Services, EY India
As a sequel to the Indian Supreme Court’s judgment in the case of Vodafone International BV1, indirect transfer provisions were introduced in the Income Tax Laws (ITL) in 2012, with retrospective effect from 1 April 1962, to tax gains arising from the transfer of shares/interest in foreign companies/entities (FCos/FEs) that substantially derive, either directly or indirectly, their value from assets in India.
Acknowledging the concerns of various stakeholders, the 2015 Budget’s proposals clarified that the fair market value (FMV) of assets located in India should represent ≥ 50% of the FMV of all the assets of an FCo/FE to constitute substantial value derived from India. Under a complex mechanism, FMV is determined with reference to a defined specified date (SD) by including the tangible and intangible assets of entities, but ignoring their liabilities. Taxation is contemplated on a proportionate basis, as is reasonably attributable to assets located in India, unless relieved by the tax treaty.
The 2015 amendments also provide certain exemptions in respect of overseas corporate reorganizations, small shareholders, etc. Additionally, for the purpose of determining income arising from indirect transfers, there is a mandatory reporting obligation on Indian concerns in which or through which an FCo/FE holds substantial assets. Failure to report attracts penal consequences.
Recently, the Central Board of Direct Taxes (CBDT) of India issued the much-awaited2 Rules and forms as required under the ITL (the Rules). The Rules provide for valuation mechanisms, forms for reporting compliance by Indian concerns and details of documents to be maintained by such Indian concerns.
The Rules provide much-needed clarity around certain significant aspects. It permits the adoption of market capitalization value based on the actual transfer price between non-connected persons3 as the basis for determining the FMV of share or interest in an FCo/FE. In case of listed entities, it permits valuation based on market capitalization. Other assets are directed to be valued by an expert in accordance with any internationally accepted valuation methodology.
For facilitating the calculation of chargeable gain, the Rules require the transferor to furnish a certificate from an accountant to the tax authority. Additionally, they permit one of the designated Indian concerns to undertake reporting compliance in lieu of all the Indian concerns through or in which an FCo/ FE derives its substantial value.
However, the Rules do still fail to address certain challenges and recommendations of the stakeholders. For example, the Rules continue to require that the FMV of assets should be determined by adding back the liabilities. This creates inconsistency with the commercial valuation. To illustrate, two companies A and B with equal net worth of 1m get valued at 1m and 10m, respectively, if A is debt-free while B has operating liabilities of 9m.
The determination of market capitalization (enterprise value) based on the transfer price between non-connected persons may not reflect a valid basis for the valuation of the interest of other stakeholders if the subject matter of transfer is shares with or without differential voting rights.
Another major challenge in respect of the Rules is with regard to their centricity around SD. According to the Rules, the chargeable income is determined based on the proportion of Indian assets vis-à-vis global assets of an FCo/FE as on the SD, which may not always coincide with the date of transfer and may relate to the preceding accounting year end. Thus, if the FMV of Indian assets as of the SD is 80%, the taxpayer may, as per the Rules, need to pay tax on 80% of the income even though commercially the India contribution as on date of transfer is lower. There can also be ambiguity on the scope of chargeability if the value contribution of the India assets as of the date of transfer is 45% but as of the SD is 55%.
The Rules impose onerous reporting obligation on Indian concerns. Apart from information relating to the corporate structure, the Rules also require Indian concerns to maintain valuation reports and information relating to the implementation process of the overall arrangement of transfer, business operation, personnel, properties of the FCo/FE and its subsidiaries that hold Indian concerns, etc. Such information/documents are required to be furnished within the prescribed timeframe. The requirement is far too detailed and may create near impossibility of performance in certain cases for the Indian concern. Notably, while a number of countries do tax indirect transfer, there is either no disclosure obligation at all or the obligation is far more limited (for instance, in countries such as Peru, Chile). The Rules appear to have followed the precedent in China where the context appears to be materially different. First, Chinese indirect transfer provisions apply to tax avoidant transactions alone. Second, compliance can be by the transferor, transferee or Chinese concern. Third, the compliance is voluntary and there is no penalty for non-compliance.
Since indirect transfer provisions have a material impact on foreign direct investment and corporate reorganization, they should be clear, simple and easy to implement. This is particularly so for the non-resident acquirer who triggers withholding obligation even in the absence of any presence in India.
- (2012) 341 ITR 1 (SC)
- Notification No. 55/2016 dated 28 June 2016
- Defined as per Indian General Anti-avoidance Rules (GAAR)