If there is one Indian tax provision that has been critically discussed and debated in almost every international business and tax forum in the last two years, it is the retrospective tax on indirect transfer of shares. Also, questions have been raised about its pragmatism and constitutional validity. This has eroded the foreign investor’s confidence in India as a stable tax regime and has been one of the key factors in foreign investments getting stalled and expansion plans of global companies being put on hold.
Though the government had clarified its position in its first budget last year (2014) that, in general, it would not make any retrospective changes in tax law and that any new case to be picked by the Indian revenue under the current provisions will have to be first vetted by an expert committee constituted for this purpose. Still, the uncertainty surrounding the existing structures/transactions is a big concern for the global investors. Thus, it does require to be re-evaluated.
First and foremost, there is a strong view that the tax on indirect transfers is a new levy and should therefore have prospective application. There is a firm view that this provision is not merely clarificatory in nature, but it widens the tax base. This view is also supported by the Shome Committee report. Therefore, this provision should be made applicable only prospectively. This will put an end to the ambiguity and uncertainty surrounding many cases which are or are likely to come under the Indian revenue’s scanner and undergo multiple years of litigation, to be contested in Indian courts and international forums.
A practical challenge for a foreign company in case of taxation on indirect transfer of shares is to avail tax credit in its respective overseas tax jurisdiction. The situation becomes even more complex when the immediate investment into India is via a tax-treaty, where direct transfer of shares per se is not taxable. Thus, it would not be easy for a foreign company to convince its home country tax authorities to avail tax credit and this may result in tax being paid twice, i.e., the transaction being taxed in the home country as a direct transfer, subject to the home country tax laws, and also being taxed in India, as indirect transfer without any tax credit being available in the home country.
Even when made prospective, one key concern for global companies is that it is still not clear as to what constitutes ‘substantial value of assets situated in India’. Foreign companies engaged in any international transaction like merger, demerger, sale of business, etc, and having a subsidiary company or other assets in India, are sceptical as to how India will treat such transactions from a tax perspective once they are consummated. At present, each such transaction is to be evaluated on the basis of the facts and circumstances of such a case. This leads to uncertainty in the minds of foreign companies, as to whether 20% or 50% or 75% or more of the value of the transaction would constitute substantial value in a particular case.
The Shome Committee had recommended that only those transactions where 50% or more value of the assets is situated in India should be covered under these provisions. The Direct Tax Code Bill of 2010 had also suggested 50% as the threshold, while Direct Tax Code Bill of 2013 had lowered this limit to 20%. Interestingly, in a recent ruling of the Delhi High Court in the case of Copal Research, it has been held that ‘substantial’ should be read as ‘principally’ or ‘mainly’ or at least ‘majority’ and that 50% is a reasonable threshold. In the international context, the OECD Model Tax Convention and UN Model Tax Convention also emphasise that for the source country to exercise taxing rights, the shares of the company should derive 50% or more of its value from the immovable property situated in the source country. Therefore, keeping in view so much uncertainty surrounding this issue in the Indian tax provisions, it is necessary to clarify India’s position on this point.
A plain reading of the current tax provision leads to an impression that the entire value of the gains in respect of a particular transaction may be subject to tax in India, if it is held by the Indian revenue that the substantial value of assets is based in India. Though logically speaking it should not be the case and probably may not even have been the intent when this provision was introduced. Therefore, only such portion of the gains should be taxable in India as is relatable to Indian assets; in case it is determined that a foreign entity has substantial value of assets in India. An appropriate computation mechanism should be prescribed to remove the huge uncertainty.
Global companies undertake internal or group re-structuring for various commercial reasons like; aligning product verticals, geographical synergies, integrating operations to avail benefits of scale, etc. These are normal commercial transactions, not necessarily to avail any tax benefits and are quite common in the global business world. In such cases, there is no change in the overall parent entity or the effective shareholders owning these companies or underlying assets. Further, such restructuring transactions may not be taxable in the respective overseas tax jurisdictions, subject to fulfilment of certain conditions. By virtue of the provisions relating to indirect transfer, however, such transactions may fall within the tax net in India. The Shome Committee had also recommended that such transactions i.e. group restructuring done outside India should be kept outside the ambit of these provisions. Therefore, internal reorganisation or restructuring within the group where ultimate parent entity remains the same, should be carved out as an exception to the general rule.
No tax should be imposed where shares of a foreign company are listed and traded on a recognised stock exchange outside India, like New York Stock Exchange, London Stock Exchange, etc. The transactions in such stock exchanges are well-regulated and subject to tax as per the tax law in the respective country. Else, there could be situations where genuine transactions on recognised stock exchanges overseas would be subject to double taxation.
It should be clarified that dividends distributed by a foreign company which derives its value substantially from assets located in India would not be covered by the ‘indirect transfer’ provisions to avoid any interpretation issue and remove ambiguity, especially in view of the litigious trend on tax issues in India.
India’s ranking in the recent World Bank Report on the ease of doing business has been abysmally low—142 out of the 189 economies. If the retro-tax provisions are repealed and other points addressed, then surely this will be a topic of discussion at international business and tax forums, however, this time it may help India improve its perception—and ultimately, its ranking—in the world order, besides giving a strong assurance to the global investors about India aiming to provide a non-adversarial tax regime. Therefore, it is time for a bold move via Budget FY16.
The author is Partner (Tax), KPMG in India. Views are personal