Indirect Transfer

[Section 9(1)(i)]

• Section 9(1)(i) was amended vide Finance Act, 2012 w.r.e.f. 01.04.1962, by inserting Explanation 4 and Explanation 5, to ‘clarify’ that the gains made through direct and indirect transfer of capital assets situated in India, shall be deemed to accrue or arise in India.

• Explanation 5 to section 9(1)(i) clarified that an asset or capital asset, being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India

• The CBDT issued Circular No. 4 of 2015 dated 26.03.2015 which stated that Explanation 5 reiterates the source rule of taxation in respect of income arising from indirect transfer of assets situated in India, as explicitly mentioned in the Explanatory Memorandum to the Finance Bill 2012.

• The following explanations have been inserted vide Finance Act, 2016, relating to indirect transfer:

Explanation 6 to section 9(1)(i):

• the share or interest of a foreign company or entity shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India, if on the specified date, the value of Indian assets-
  • exceeds the amount of ten crore rupees; and
  • represents at least fifty per cent of the value of all the assets owned by the company or entity

• value of an asset shall be the fair market value of such asset without reduction of any liabilities as on a specified date

Explanation 6 to section 9(1)(i) (contd.)

Specified date means:

• the date on which the accounting period of the company or entity ends (i.e. last day of accounting period) preceding the date of transfer of a share/ entity or

• the date of transfer, if the book value of the assets of the company or entity on the date of transfer exceeds book value of the assets by 15 per cent as compared to value as per date mentioned in point no. (i) above

Clarification: [Question no. 8 and 16]

      Example:

• If a company closes accounts on 30^th June every year ( last date of accounting period) and its date of transfer of share/ entity outside India is 30^th September i.e. after the last date of accounting period then:

• Situation 1:

If book value does not exceed by more than 15 per cent between the 2 dates, then the specified date would be 30^th June i.e. last date of accounting period [Explanation 6(d)(i) to section 9(1)(i) of the Act]

• Situation 2:

If book value exceeds by more than 15 per cent between the 2 dates, then the specified date would be 30^th September i.e. date of transfer of share/ entity outside India [Explanation 6(d)(ii) to section 9(1)(i) of the Act]

Explanation 7 to section 9(1)(i)

      Explanation 7 to section 9(1)(i) (i.e. Exception to the above):

• However, the aforesaid provision will not apply and no income shall be deemed to accrue or arise to the non-resident if the transferor (individually or along with its associated enterprises) neither holds the right to management or control in relation to such company or entity, nor holds voting power or share capital or interest exceeding 5 percent of the total voting power or total share capital or total interest of such company or entity, directly or indirectly

• Further, any income on transfer of a share or interest deriving, directly or indirectly, its value substantially from assets located in India will be on proportional basis, when all of the underlying assets of such company or entity are not located in India

Clarification:

[Question no. 1, 2, 3, 4, 5]

• The CBDT has clarified on various foreign portfolio investment structures namely covering master-feeder structure, nominee/distributor, offshore fund, sub-fund, etc. wherein a foreign portfolio investor (FPI) invests in shares of Indian listed companies.

• In the case of various investors who invest through different means in the FPI and have indirect interest in the Indian equity market, through the FPI, then, if the conditions mentioned in Explanation 6 and 7 are satisfied, then various consequences follow:

Condition 1 - value of  Indian assets -

• exceeds the amount of ten crore rupees; and
• represents at least fifty per cent of the value of all the assets owned by the company or entity

Condition 2 - voting power or share capital or interest of such investor does not exceed 5 percent of the total voting power or total share capital or total interest, directly or indirectly of such FPI

Conclusion: Then the investors will not be covered under the provisions of section 9(1)(i) i.e. no income shall be deemed to accrue or arise in India from transfer of capital asset situated in India.

Impact 1: The CBDT has clarified, by way of 5 different structures, that any investor requesting for redemption of the units of FPI / Offshore fund, etc., shall be governed by the provisions of section 9(1)(i) and unless exception under Condition 2 stated above (i.e. for small shareholders / investors) is satisfied, income shall be deemed to be accrued and arisen in India for the capital asset situated in India.

Impact 2: The sale of shares of Indian companies by FPI / Offshore fund, etc., would attract income-tax considering the provisions of section 115AD or applicable tax treaty rates.

Clarification:

[Question no. 11]

The CBDT has clarified that threshold of 5 per cent for excluding small shareholders is reasonable and the definition of ‘associated enterprises’ should be as referred in the Act (i.e. section 92A) and not in line with the definition as provided by SEBI.

Transactions not considered as transfer

[Section 47(viab)]

Any transfer of share of a foreign company in a scheme of amalgamation, subject to compliance of certain conditions, shall not be regarded as a transfer

Clarification:

[Question no. 6, 7 and 14]

The CBDT has clarified that exemption provided under Section 47(viab) of the Act, extends only to amalgamating foreign company or entity and not to shareholders/ investors of the amalgamating foreign company; and neither to non-corporate entities. Further, no income would deemed to accrue or arise in India in case of small investors/ shareholders satisfying Condition 2 (supra)

Reporting requirement [Section 285A]

Penalty [Section 271GA]

• The Indian entity is obligated to furnish information relating to the off-shore transaction having the effect of directly or indirectly modifying the ownership structure or control of the Indian company or entity. In case of any failure on the part of Indian concern in this regard a penalty shall be leviable.

• The proposed penalty shall be-

• a sum equal to two percent of the value of the transaction; or
• a sum of five hundred thousand rupees;

as the case may be

Clarification:

[Question no. 9]

• Recently, the CBDT has inserted Rule 114DB w.e.f. 28.06.2016 which specifies the information and documents to be maintained and furnished by every Indian concern referred to in section 285A.

• However, the CBDT is silent on the challenges in the reporting requirement by a company whose shares are bought and sold by an FPI investor frequently.

 COMMENTS

• The CBDT has tried to resolve various issues / queries raised by the stakeholders by way of a clarificatory circular. However, there are various practical issues which still remain unanswered and which would evolve over a period of time. Some of these issues are enumerated below:

• Determination of cost of acquisition, availability of indexation, potential double taxation in multi-layer structures, etc.
• Onerous withholding tax requirements on FPIs and foreign buyers of listed securities of FPIs, etc.

• The above clarifications are reflective of CBDT’s strict interpretation of the law, but it has not delved into the finer nuances of the methodology of investment carried on through offshore structures, and hence, whether there is a requirement for some exceptions, especially as there is a difference in the economic activity of investing in Indian equity markets and foreign direct investment (FDI).

• It may still be debatable whether the new regime of taxing gains accruing to non-residents indirectly is within the law, and probably jurisprudence will evolve on this.