Indirect Transfer-Simplified

Indirect  transfers  in  the  context  of capital  gain  covers  the  transfer  of shares   of   an   Indian   entity/assets situated in India, where the transaction occurs   outside   India   among   the foreign entities . Since India has source based   taxation,   i.e. any   income accruing or  arising,  or  deemed  to accrue or  arise,  in  India  to  a  non – resident is taxable in India. In case of sale of shares of an Indian company, the situs of shares is in India. Hence, income accrues and arises in India.

The Finance Act, 2012, introduced tax on indirect transfers with retrospective effect from 1962.

The  Income  Tax Act,  1961  (the Act) was  accordingly amended  to  provide  that  transfer  of shares  or  interest  in  a  company  or entity registered/incorporated outside India  shall  be  chargeable  to  tax      in India  if  the  value  of  such  shares  is substantially   derived   from   assets located in India. Though an amendment  was  made to the Act, still there were a number of practical issues in interpretation of the same. The word ‘substantially’ which was  the  benchmark  for  deciding  the taxability  had not been defined. This not only  created  uncertainty  in  its interpretation   but  also   resulted   in challenges in global restructurings . Thus  the finance bill left two pivotal questions unanswered:

  • What is considered ‘substantial’
  • How this ‘substantial value’ is to be calculated for tax purposes .

Clarification   proposed in   Budget 2015

To   avoid   ambiguity on such an important concept and based upon the

Exemption available on transfer of shares in case of merger and de-merger subject to fulfilment of certain conditions

Recommendations of the committee and the concerns raised by various stake holders , the Finance Bill, 2015 has proposed certain amendments to the existing provisions related to indirect transfer, namely:

1. Defining Substantial Value

Share of foreign company shall be deemed to derive substantial value from Indian assets if on the specified date, the fair value of the Indian assets

  • Exceed INR 10 crores ; and
  • Represents at least 50% of the value of all the assets owned by the company or entity

 2. Manner of computing the value

  • Value of an asset shall mean the fair market value of such asset without reduction of liabilities , if any, in respect of the asset.
  • The manner of determination of fair market value of the Indian assets vis -a vis  global assets of the foreign company shall be prescribed by the rules .
  • The specified date of valuation shall be the date on which the accounting period of the company or entity, as the case may be, ends preceding the date of transfer.
  • However, if the book value of the assets of the company 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 instead of the date mentioned as above, the date of transfer shall be the specified date of valuation.


 3. Taxation

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.

4. Exemptions

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 or indirectly 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.

Further, in case of a merger or de-merger, where shares  of foreign company or entity which derive their value  substantially from Indian assets are transferred will not be regarded as transfer provided that:

In case of merger, at least 25% of shareholders of the transferor company become shareholders of transferee company

  • In case of de-merger, shareholders holding at least  75% in value of shares  of transferor company become shareholders of transferee company and
  • The transaction is tax neutral in the country of origin of the transferor company.

5Reporting requirements

The Indian entity shall be obligated 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 or entity. In case of any failure on the part of Indian concern in this regard a penalty shall be leviable. The proposed penalty shall be:

  •  A sum equal to 2% of the transaction value where such transaction had the effect of directly or Indirectly transferring the right of management and control in relation to the Indian concern.
  • A sum of INR 500,000 in any other case

Parting Thoughts

This is  a very positive move by the Hon’ble Finance Minister as this will provide greater clarity to investors on the taxability of merger and acquisition transactions in India where shares are transferred outside the country, though the underlying asset is within the country. Foreign investors should be pleased with the budget as it tries to address many of their concerns and looks to alleviate their concerns . Further, this amendment is in line with the judgment of Delhi High Court in the case of DIT v. Copal Research Ltd., Mauritius in which it was held that the gains arising from sale of a shares of a company incorporated overseas , which derive less than 50 per cent of its value from assets situated in India would not be taxable under section 9(1)(i) read with Explanation  5 thereto.

However as a budget critic, I still have few unanswered questions from this introduction, namely on the following points , firstly since this is a prospective clarification it leaves doubts about open cases Secondly, the CBDT has not come out with rules to determine the valuation of shares which is of great essence in this . Lastly it will be interesting to see what rules are prescribed  by  CBDT  regarding  the  reporting  of  transactions  and  whether  they  would  have  any  inherent  practical challenges .