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In a significant move, Finance Minister Arun Jaitley clarified in his Budget speech that capital gains tax will be applied to all transactions involving indirect transfer of a foreign company's assets, if 50 per cent or more of the company's assets are based in India. This was one of the key recommendations of a committee led by Parthasarathi Shome.
"There are two aspects in retrospective taxes. First, it's the threshold of 50 per cent, as laid down by the Delhi High Court. This is a significant asset test. After determining a taxpayer is not exempt under the significant rule, only that part of the income will be tax that pertains to India (on a pro rata basis)," says BMR Legal's Mukesh Bhutani.
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The clarification will help avoid tax litigation, like the one involving Vodafone, where the Indian government raised a massive Rs 11,000-crore demand on the company for buying India-based wireless telephony operations of Hutchison in 2007. Though the British telecom giant received a favourable judgment from the Supreme Court, the previous government, under Manmohan Singh, taxed the company retrospectively.
"This definitely provides greater certainty to determine applicability of indirect transfer taxation in global merger & acquisition transactions involving Indian assets. Also, the prescribed threshold of 50 per cent is in line with the recent Delhi HC ruling in the case of Copal Research Ltd. Certain other aspects like valuation of assets (to be implemented from next financial year) will be guided by rules to be prescribed by CBDT (Central Board of Direct Taxes)," says Nitesh Mehta, executive director, Walker Chandiok & Co LLP.
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Since 2012, two questions plagued indirect transfers: First, what is considered 'substantial'; and second, how this 'substantial value' is to be calculated for tax purposes.
"It has now been clarified that substantial means "at least 50 per cent" of the value of all assets owned by the company whose shares are being alienated. There is also clarity on the specified date for calculation of the value of assets. There is also guidance on the extent to be offered to tax in India, as the Bill now reads that such 'part of the income as is reasonably attributable to assets located in India and determined in such a manner as may be prescribed'," says Pallavi Bakhru, director, Grant Thornton.
There are two notable exceptions to triggering tax implications on indirect transfers - if the value of assets in India does not exceed Rs 10 crore, and if the shareholder directly or indirectly holds five per cent or less in the transferor company and does not have a right to management or control.
"This clarity will bring welcome relief for foreign investors, though there was an expectation such transactions, when undertaken as part of a group restructuring, would not be taxable. That has not been addressed," adds Bakhru.
The Budget also raised the threshold limit for application of domestic transfer pricing from Rs 5 crore to Rs 20 crore, to clarify on taxation of indirect transfers. Industry experts say this clarity will go a long way in boosting companies' sentiment.
Shell companies to be taxed in India
An important measure announced by the Finance Minister was the clarification of the incorporation of the Place of Effective Management (POEM test) into the Income Tax Act to determine residential status in case of companies. This is a significant move to ensure the shell companies incorporated in tax havens of Mauritius or Singapore but "effectively managed" in India will have to pay tax in India.
The introduction of POEM test for residential status determination would curtail the practice of opening of shell companies by Indian companies in tax havens. "The shell companies outside India, easily bypass the condition of 'controlled and managed' as even holding one board meeting outside India puts it outside the purview of being Resident in India," said tax expert Suresh Surana.
