Loss of the tax shield is something Walmart, as the buyer, has to worry about and this also makes the case stronger for a delay in sale of stake by SoftBank.
SoftBank Vision Fund, which is selling its 22% stake in Flipkart to Walmart, may need to pay close to Rs 2,000 crore to Indian tax authorities as capital gains tax. While all other major investors in Flipkart are based in treaty-protected jurisdictions, Indian tax authorities could still seek taxes from them invoking the limitation of benefit clause under the tax treaties. Also, there is the possibility of Walmart losing Flipkart’s tax shield from the facility to carry-forward losses. Based in the US, the SoftBank arm doesn’t have the treaty cover to claim tax exemption in India, unlike most other large investors in the Indian e-commerce firm. Since it acquired the Flipkart stake in August last year, it is also liable for a steeper short-term capital gains tax (rather than long-term) on the proceeds. Given that SoftBank bought the Flipkart shares for $2.5 billion and is getting $4.5 billion for the asset now, the capital gains are around $2 billion (~`13,000 crore); so the capital gains tax liability works out to be close to Rs 2,000 crore.
Currently, India taxes short-term (held for less than two years) capital gains from unlisted shares at 15%, while similar long-term (over two years) is taxed at 20% with indexation. As the buyer, Walmart has the onus of withholding the tax before it pays the sellers, while the final tax liability is on the seller. As FE had reported earlier this week, most of the large investors in Flipkart — Tiger Global, Naspers, Tencent and e-Bay — are protected by treaties that give waiver from capital gains tax in India for investors based in Cyprus, Mauritius, Singapore and the Netherlands. All these investors are based in one of these jurisdictions. However, Indian tax authorities could still seek tax payment in India invoking the limitation of benefit clause under the tax treaties. An entity claiming residency in Singapore/Mauritius needs to prove “substance” in the claim by passing the motive and expenditure tests.
The motive test is to prove that the primary purpose of the deal (via the treaty-protected country) is not to obtain the tax exemption. The expenditure caveat (investment threshold) is relatively easy to surmount. Flipkart (and hence Walmart, the buyer) will lose the “tax shield” on account of its accumulated losses owing to the proposed deal. Under Section 79 of Income Tax Act, carry-forward and set-off of losses in a closely held company is allowed only if there is a continuity in the beneficial owner of the shares carrying not less than 51% of the voting power, on the last day of the year or years in which the loss was incurred. As the proposed transaction involves acquisition of 77% of Flipkart, in essence, more than 51% of shareholding shall not be beneficially held by same persons.
Loss of the tax shield is something Walmart, as the buyer, has to worry about and this also makes the case stronger for a delay in sale of stake by SoftBank. In FY16, Flipkart’s loss was Rs 5,223 crore and rose to Rs 8,771 crore in the subsequent year. “Walmart may perhaps decide to claim the continuance of tax shield thereby opening up litigation at various levels,” said Amit Agarwal, partner, Nangia & Co. As Tiger Global arms are registered in Mauritius/Singapore and acquired their combined 21% stake in Flipkart before April 1, 2017, they could seek protection under a grandfathering clause in New Delhi’s double taxation avoidance agreements with the two countries (the tax waiver is not available to shares purchased post the cut-off date, thanks to amendments to treaties at New Delhi’s behest in 2016).
Under Section 9 (1)(i) of the I-T Act, “all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through 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 accrue or arise in India and is liable for tax. This piece of law was amplified in 2012, after Vodafone episode where the government was caught on the wrong foot by attempting retrospective taxation (the Supreme Court in January 2012 ruled in the telecom giant’s favour, saying it was not liable to pay any tax over the acquisition of assets in India from the Hong Kong-based Hutchison).
Naveen Wadhwa, DGM, Taxmann.com, said: “Flipkart.com has both resident and non-resident shareholders. As far as resident shareholders are concerned, the capital gains arising to them from this deal shall be taxable in India. However, the overseas shareholders shall be liable to pay tax in India if the resultant capital gain is taxable in India as per tax treaties. Both India-US and India-Mauritius tax treaties provide the taxing rights to India if capital gains accrue in India as per Section 9 of the Income Tax Act. The India-Mauritius treaty grandfathers the capital gains arising from sale of shares which were acquired before April 1, 2017, accordingly, no tax shall be levied on it.”