After almost 3 years of
ambiguity, the Indian government finally proposed to clarify how it intends to
tax the income arising on indirect share / interest transfers. It may be
recalled that the Explanation, introduced in 2012 but made applicable retrospectively
from 1961, sought to tax in India any income arising from transfer of shares in
a foreign company if those shares derived their value substantially from assets
located in India. This was to counter the Vodafone type cases in which no tax
was paid in India on some mega acquisitions as the shares changed hands outside
India at a holding company level. The Government having lost its case before the
Supreme Court had decided to change the rules of the game with
retrospective effect. What it did not do was to clarify what it meant by
‘substantial value’.
To illustrate, if shares in a
company M in Mauritius (which is a holding company of Company I in India) are
sold, will this sale be taxable in India even if M derived only 25% of its
value from the Indian holding and the rest from its investments in other
countries?
In view of the ambiguity,
investors and their advisors involved in an M&A deal were often forced to
take a conservative stand and considered a transaction to be taxable in India
even when the foreign holding company derived as little as 20% of its
total value from Indian holdings. This meant protracted negotiations when it
came to withholding of tax arising upon transactions, onerous indemnities given
by the sellers and a general feeling of a tax sword hanging on everyone’s head.
Now Finance Bill 2015 proposes
to define ‘foreign company / entity shares / interest deriving substantial
value directly or indirectly from assets located in India’ as only those where
the fair value of such Indian assets -
1. Is valued at Rs. 10 crore or more;
and
2. Represents at least 50% of the total
assets owned by the foreign shares / entity
The value for this purpose will
be a fair value of the Indian assets, without reducing liabilities, as on the
end of the accounting year concluded just before the date of the transaction.
If however, the book value of assets of the foreign company / entity on the
date of transfer exceeds the book value at the accounting year end by 15%, then
the fair value on the date of the transaction will have to be considered.
To illustrate, Company M in
Mauritius holds assets in India and China and their respective fair values are
8 crore and 42 crore on 31 March 2015. There are no other assets held by M. If shares
in Mauritius company were sold on 1 April 2015, there would not be any India
tax arising as the value of India assets is less than 10 crore and they also do
not represent 50% or more of the total assets of M, which add up to 50 crore.
Further, even if the above
thresholds were breached, i.e., Indian assets amounted to more than 10 crore
and represented more than 50% of value of all assets held by M, the selling
shareholder of M would still not have to bother about Indian tax, as long as
they do not, and did not hold at any time in last 12 months preceding the date
of transfer:
a) the right of management or control
in M; or
b) voting power or share capital or
interest exceeding five per cent in M.
The proposed explanations would
bring a much awaited solace to the M&A scene in India, in cases where deals involve indirect transfer of shares / interest in Indian companies.
