Positive changes in retrospective taxation of indirect transfer of shares should be continued in Union Budget 2016
One of the most globally debated changes in the Indian tax law has been retrospective taxation on indirect transfer of shares. Last year saw several positive changes were made to address the concerns of foreign investors, and to bring in the much required clarity on this subject.
It has been clarified that share or interest in a foreign company shall be deemed to derive its value substantially from assets located in India, only if the value of such assets, whether tangible or intangible, exceeds INR 10 crore and represents at least 50 per cent of the value of all assets owned by the foreign company.
Few exceptions have also been provided to protect small shareholders from the rigor of these provisions. For instance, the provisions may not trigger where the transferor neither holds the right to management or control, nor the voting power or share capital, or interest exceeding 5 per cent, as specified.
Although these changes are a welcome move, there are few aspects that require further consideration. Since the provisions have significant impact on past transactions and are not merely clarificatory in nature, they should ideally have only prospective implications. Nevertheless, at least the interest on tax demand should be levied prospectively. Further, the withholding tax obligations should also be applied prospectively, for impossibility of performance otherwise. Also, no penalty should be levied in such cases.
The provisions state that an asset, or a capital asset, being any share or interest in a company incorporated outside India shall be deemed to be situated in India if the share or interest derives, directly or indirectly, its value substantially from assets located in the country. This could lead to certain doubt as to whether all and any type of assets, e.g. stock-in-trade, other non-capital assets, etc., could be covered or the provisions would be restricted to only capital assets, in the nature of share or interest in an entity. This should be clarified to avoid any dispute at a later date.
It has been clarified that the value of assets shall be the Fair Market Value (FMV) without reduction of liabilities, as on the specified date. It is pertinent to note that in any commercial transaction, both assets and liabilities are taken into consideration. Therefore, the comparison between Indian assets and target entity assets should be based on commercial principles after taking into account the liabilities. Otherwise, it may distort the comparative value substantially.
The companies listed in recognised foreign exchanges are subject to the tax and regulatory regime of respective foreign countries. Therefore, an exception should be carved out for foreign listed companies. To safeguard Indian Revenue’s interest, overseas stock exchanges that may be covered under this exception may be specified.
There are various commercial reasons and methods through which global companies restructure and realign their businesses. Intragroup transfers, as part of group reorganisations other than amalgamation and demerger, should also be exempt from the indirect transfer provisions, so far as the ultimate holding company structure remains the same.
The onus of reporting the transactions has been cast on the Indian entity, which should not be the case. It is important to note that these provisions have been introduced to cover indirect transfer of shares, therefore, it is possible that the Indian entity may not have timely information relating to overseas indirect transfer, which may take place a few levels above that of the same.
The Participatory Note (P-Note) holders should also be exempt from the applicability of the provisions of indirect transfer to provide certainty to foreign investors. Foreign Institutional Investors (FIIs) are in any case subject to the tax and regulatory regime in India, and are liable to tax on their income earned in the country.
A more pragmatic approach is required to determine the valuation of Indian and foreign assets. Otherwise, it could lead to hardship and put unnecessary administrative burden on foreign investors. In case of Indian assets being listed shares, the market price of such shares on the specified date may be considered, and in case of unlisted shares the Discounted Cash Flow (DCF) method, or any internationally accepted method, may be adopted for determining the value.
In general, the foreign company may have a large number of diverse assets, which may pose a practical challenge in valuation. A better approach may be to adopt the transaction value, i.e. the price at which the shares of the foreign company are transferred. Also, in case of listed foreign companies, the market capitalisation value may be considered for valuation purposes.
The government has taken several positive measures in the recent past to placate fear of foreign investors by providing clarifications on various contentious issues, and also by easing some of the procedural aspects. This has boosted investor confidence, which is visible in the increased foreign investment commitments being made by global companies in India. Some of the issues highlighted above merit consideration in this year’s Union Budget, to convey a message that India not only provides a tax regime that is non-adversarial, but is also business friendly.
The views and opinions expressed herein are those of the author and do not necessarily represent the views or opinions of KPMG in India.
Author is partner-tax, KPMG in IndiaThe Great Diwali Discount!
Unlock 75% more savings this festive season. Get Moneycontrol Pro for a year for Rs 289 only.
Coupon code: DIWALI. Offer valid till 10th November, 2019 .
First Published on Feb 19, 2016 03:26 pm