Budget 2015 takes baby steps to put an end to Vodafone-like tax controversies

By Hemal Mehta –Senior Director and Urmi Rambhia –Manager, are from Deloitte Touche Tohmatsu India Private Limited. Views expressed are personal India, among many things, gained global attention on the high profile Vodafone tax issue on indirect transfer of capital asset situated in India. International investors prior to exploring investment opportunities in India were questioning the fate of the Vodafone litigation. Despite a favorable Supreme Court decision in the said case, the Finance Act 2012 introduced provisions on indirect transfer with retrospective effectfrom 1 April 1962. This kept international investors at arm’s length from India for a while which was evident from the amount of foreign investment that India got after the retrospective amendment.  Unfortunately, even with the retrospective amendment, there was lack of clarity on what will constitute indirect transfer deriving value “substantially” from assets located in India, methodology of valuation of assets, computation mechanism of tax basis, impact on such a transfer in case of a reorganisation like merger or demerger of overseas entities, etc. When the new government took charge in 2014, among other issues to address the said matter, the Finance Minister announced that all fresh cases coming to the notice of tax officers will be scrutinised by a High Level Committee to be constituted by the Central Board of Direct Taxes (CBDT) before any action is initiated retrospectively in such cases related to indirect transfer. In the Budget proposals of 2015, a major clarity which is provided is what constitutes “substantial” value derived from assets located in India. It is proposed that share or interest in a foreign company will be deemed to derive its value “substantially” from assets located in India where the value of Indian assets on the specified date exceeds Rs 10 crore and it represents at least 50% of the value of all the assets owned by such foreign company. However, the trite is that debt raised by such foreign company will not be allowed to be adjusted from the valuation. Examples on computing substantial value for invoking provisions of indirect transfer: If Foreign Company 1 (FCo1) transfer shares held in FCo2 to FCo3 where FCo2 holds 100% shares of an Indian Company (ICo), where the value exceeds Rs. 10 crore and FCo2 holds no other assets outside India, then, provisions of indirect share transfer will be triggered. However, in the above example, if FCo2 holds 49% of its assets in India and balance 51% outside India, despite the value of Indian assets exceeding Rs 10 crore, the provisions of indirect transfer will not be triggered. Another scenario is when FCo 1 holds 50% in FCo2 and balance 50% are held by say FCO X. Also, suppose FCo2 in turn derives 60% of value of its assets from Indian assets. If FCo1 proposes to divest its shareholding of 50% in Fco2, indirect transfer provisions shall be attracted as the value derived by FCo1 indirectly from Indian assets is 50% of the assets owned by FCo2 even though the value held in Indian assets is 30% (i.e. 50% of 60%). To continue with the surprises, the method of valuation of shares, whereby manner of determination of fair market value of such asset can be determined is not specified. It will be prescribed in due course. Thus, there is still more to come. Interestingly, amalgamation or demerger of foreign companies which could lead to indirect transfer of Indian assets is exempted from the ambit of Indian taxation subject to fulfilling the prescribed conditions. Exemptions have also been proposed in case of small shareholdings (i.e. less than 5% voting power and with no control and management). Further, reporting obligation has been cast on Indian companies whose indirect shareholding undergoes a change and penalties are proposed for non-compliances thereof. Though the budget proposal clarifies many issues related to indirect transfer, which certainly helps foreign investors to overcome undue hardship, certain questions like method of determining tax basis of shares, availability of tax cost basis for future divestments, etc are still outstanding. It may be useful to have these issues clarified in the tax law, so that there is no ambiguity for foreign investors looking at investing in India.