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Indirect Transfer of Shares / Assets Taxability in India ( A Change Post Famount Vodafone Income Tax Case)

Indirect Transfer of Shares - Vodafone Case

What is the Indirect Transfer of Shares or Securities


Let's take a simple example, there are below four companies :


  1. Company A Ltd. based in India has an annual turnover of Rs 1000 Crore and total assets worth Rs. 200 Crore in India. Company A is valued at Rs 2500 Crore.

  2. Company B Ltd. which is a shareholder/investor in Company A. Ltd. Company B Ltd is incorporated in Singapore and holds 30% in Company A Ltd..

  3. Company C Ltd, which is a holding company of Company B. Ltd and is based out in the UK.

  4. Company D Ltd. is a company incorporated and based out in the USA.


Now Company B Ltd.'s total value if Rs 800 Crore and out of this Rs 750 Crore is due to its investment in Company A Ltd. and the rest is due to its other investments.


Now, Company D Ltd (USA) wants to buy a stake in A Ltd (India) by purchasing shares that are held by Company B Ltd (Singapore).


But, Company D (USA) Ltd does not directly buy shares of Company A Ltd (India) from Company B Ltd (Singapore) that it holds instead what it does is it buys the Shares of Company B Ltd ( Singapore) from Company C Ltd ( UK).


Thus, by buying all shares of Company B Ltd., Company A Ltd. becomes the indirect owner of the company based out in India i.e. Company A.


Such transfers are called indirect transfers where even though shares of India Company are not sold but indirect stake/rights in India Company are obtained by buying a stake of any other entity/ company based outside India. Most importantly, the company based outside India ie Company B Ltd.'s value was mainly and majorly due to actual assets/investments from an Indian Company and standalone it has no other such valuable asset except shares in Indian Company i.e. A Ltd.


The above Transactions of Sale of Shares of B Ltd (Singapore)by C Ltd (UK) to D Ltd (USA) will attract Capital Gain in India as it falls under Indirect Transfer


What Was the Vodafone-Hutch Case Relating to Indirect Transfer?


This famous case also relates to transactions where in India Hutch Became Vodafone.


Below are transactions and facts that happened:


In 2007, Hong Kong's Hutchison Telecommunication Ltd sold its stake in Hutchison Essar Limited (HEL), an Indian co. to Vodafone International Holdings, a Netherlands entity. Hutchison had Telecom Operations spread over Indonesia, India & Sri Lanka.


However, Vodafone did not buy shares in Hutchison Essar Limited directly. It first bought CGP Investment Holding which was situated in the Cayman Islands (tax heaven country) and this CGP Investment owned a 67% stake in Hutch Essar Group.


So without buying shares in HEL (Indian Company), Vodafone bought Hutch's telecom business in India by buying shares of CGP Investment which was through various other subsidiaries stake in India's HEL (Indian Company). Thus, indirectly shares / assets/rights of Indian Company were bought without doing any direct transaction or transfer in India.


The major motive was because Cayman was a tax haven country, Hutchinson / CGP Investment could save a lot of tax on the sale of its shares indirectly instead of paying around 25% Approx. Capital Gain Tax in India.


However, unfortunately, as there was no specific provision in the Income Tax Law to tax such indirect transfers, the Supreme Court order decision was in Favour of Hutch and Vodafone and the Income Tax Department could not levy tax on the above transaction.


But, soon after the Supreme Court Judgement, the Income Tax Act was amended to tax indirect transfer of any Indian Assets / Shares / Rights, etc. and such transactions will be subject to tax in India.


The above amendment was first implemented retrospectively from 1962 but later government brought in the amendment prospectively and waived off any tax on transactions before amendments.


Indirect Transfer Taxability Provisions in Income Tax


When shares of any entity incorporated or registered outside India are transferred and if such shares or interest derive its substantial value from assets located in India directly or indirectly, then such transfer is commonly referred to as ‘Indirect Transfer’.


In case of such indirect transfer, the income shall be deemed to accrue or arise in India and would be taxable for all including non-residents.


Substantial Interest Meaning:

The share or interest would be regarded as deriving substantial value from assets located in India if on the specified date, if the fair market value of such Indian assets –

a. Exceeds INR 10 Crores, AND

b. Indian Asset comprises at least 50% of the fair market value of total assets owned by the foreign company/entity.


For the above purpose, the specified date shall be -

a. End date of the last accounting period preceding the date of transfer of share/interest of foreign company/entity; or

b. Date of transfer, if book value of total assets of foreign company/entity on date of transfer exceeds book value of total assets on end date of last accounting period as above by 15%.


Exemption from Applicability of Indirect Transfer Provisions


  •  Category I FPI under SEBI (FPI) Regulations, 2019

  • if the non-resident transferor, directly or indirectly, at any time in the 12 months preceding date of transfer individually or along with its Associated Enterprise –

  1. a. does not hold management or control rights

  2. b. does not have voting power or interest or share in capital exceeding 5% of total voting power or interest or share capital, as the case may be

  • income to the extent attributable to value dervied from assets held in India is only taxable as per Rule 11UC.


For Concepts of Place of Effective Management read here

For Concepts of Business Connection and Substantial Economic presence read here

For Concepts of Residential Status read here


 

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