Foreign investors likely to be relieved by Budget fixing a value threshold for taxation of indirect transfers
If there is one clear message in Budget FY16 for the foreign investors, then it is that the government is listening to their concerns and moving fast to provide certainty and clarity. Some of the key concerns of the global investors have been addressed, including clarifications on taxation on indirect transfer of shares, non-levy of minimum alternative tax on foreign institutional investors, ironing out some of the issues relating to tax concessions for Real Estate Investment Trusts, etc.
There was an expectation that government will take a bold step to repeal retrospective tax on indirect transfer of shares this year; however, the Budget has shied away from that step. For past transactions, the only solace is that in last year’s Budget, it had been clarified that new cases, if any, will have to be first referred to a Committee which would decide on merits, whether a particular requires detailed examination. One can hope that a more pragmatic approach will be adopted in selecting the cases for further examination, ensuring that investor’s confidence is not hurt. In respect of any tax changes with retrospective effect in the future, the government has reassured the investors that, ordinarily, retrospective tax provisions that adversely impact the stability and predictability of the taxation regime shall be avoided.
After more than two years, since the introduction of these provisions, it has been clarified as to what constitutes substantial value of assets in India. It has been specified that this provision will get triggered only if the value of assets, whether tangible or intangible, located in India on the specified date, represents at least 50% of the value of the global assets. Further, it has been specified that this provision will be applicable only if the value of the assets located in India exceeds R10 crore, thereby, providing relief to small transactions. This is a move in the right direction, which will calm the frayed nerves of foreign investors, as they have always been worried about the position that Indian revenue may adopt in the absence of clear guidance on this subject.
Another big concern that has been addressed now is on the taxability on proportional basis. Hitherto, if it is determined that the substantial value of the assets is situated in India, then the entire value of the global transaction could be subject to tax in India. This may not have been the intent of the legislature when the provision was introduced or may be the provision was drafted keeping in mind transactions where almost the entire value of the assets was located in India. Nevertheless, this was an issue which has been addressed now. It has been specified that only the proportionate value of assets linked to India would be subject to tax. The computation mechanism for determining the proportionality will be prescribed in the tax rules to be notified subsequently.
The proposed changes in the Budget have been carefully thought through to end the ambiguity surrounding these provisions. Accordingly, it has been specified that the value of an asset shall mean the fair market value (FMV) without reduction of liabilities. The computation mechanism for determination of the FMV of the Indian assets vis-à-vis global assets of the foreign company shall be prescribed in the rules. It would be good to follow international best practices while laying out the computation mechanism.
The date for the determination of FMV shall be the date on which the accounting period of the company ends preceding the date of transfer of shares. This is to reduce the administrative burden by placing reliance on the last available financial statements. If, however, the book value of the assets on the date of transfer exceeds by at least 15% of the book value of the assets as on the last balance sheet date preceding the date of transfer, then valuation is to be determined on the date of transfer itself.
Certain exceptions have been carved out to provide relief to small transfers, like in the case of a transfer by a non-resident outside India of any shares in a foreign company that directly owns the assets situated in India and where the non-resident neither holds the right of management or control nor holds voting power or share capital or interest exceeding 5% in such foreign company. Similar exemption has been provided in case of transfer by non-residents in a foreign company that indirectly owns the assets situated in India.
This issue of overseas internal group restructurings falling into the tax net in India has also been addressed. Now, they can enjoy the tax exemption, subject to certain conditions. It has been provided that any transfer, in a scheme of amalgamation, where foreign company derives its value substantially from the shares of an Indian company, shall not be subject to tax, subject to fulfilment of specified conditions which inter alia include non-taxability of such amalgamation in the foreign country. Similar exemption has been carved out for a foreign demerger.
In the case of indirect transfer of shares, an onerous reporting obligation has been cast on the Indian company, 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.
Stringent penal provisions have been prescribed for non-compliance like penalty of 2% of the value of the transaction where such transaction has the effect of transferring the right of management or control in relation to the Indian company, etc. More clarity is required on this issue in respect of reporting and computation mechanism.
To address the concern relating to applicability of indirect transfer provisions to dividends paid by the foreign company to its shareholders, it has been clarified that a circular will be issued by the Central Board of Direct Taxes on the same.
Few other aspects require some reconsideration and clarity. Transfer of shares on a recognised stock exchange outside India should also be exempt from these provisions. Also, when a foreign company has been taxed in India on indirect transfer of shares, then it may be allowed a cost step-up for any such future transaction to avoid double taxation.
On the issues relating to taxation of indirect transfer of shares, the Budget has clarified most of the major concerns and removed ambiguities. It will go a long way in re-building the confidence of global investors in India as a stable tax regime where their issues are addressed upfront, while also protecting the interests of the Indian revenue.
By Vikas Vasal
The author is partner (Tax), KPMG in India. Views are personal