[Opinion] Indirect Transfers – A Circumlocutory Concept

Jaya Krishna Kapoor – [2023] 151 taxmann.com 31 (Article)

Introduction

India’s tryst with the taxation of indirect transfers has been full of jolts.

Prior to the insertion of provisions of indirect transfer, Indian Government was losing on its taxes. The following illustration will help understand the concept and need for the introduction of provisions of indirect transfer.

• A, a resident of United Kingdom (‘UK’), holds 100% shares in A Ltd registered in UK.
• A Ltd has a wholly owned subsidiary, B Ltd in India.
• Now, A sells his shares in A Ltd to another company in UK, say C Ltd.

In this case, while the shareholding of the Indian company, B Ltd, remains unchanged but in effect the transfer of shares of A Ltd ultimately leads to transfer of shares in B Ltd. However, in the absence of the provisions to tax the gains on such transfer, the Indian Government was losing tax on the gains arising on the indirect transfer of shares of B Ltd.

Genesis of the provisions of Indirect Transfer

The evolution of the provisions of tax on indirect transfers in the Income Tax Act, 1961 (‘the Act’) lies in the famous, rather infamous case of Vodafone International Holdings B.V. v. Union of India [2012] 17 taxmann.com 202/204 Taxman 408/341 ITR 1 (SC).

The Revenue, in the said case advocated the application of a ‘look through’ approach and contended that if there is a transfer of a capital asset situated in India ‘in consequence of’ an action taken overseas, then all income derived from such transfer should be taxable in India. The Hon’ble Apex Court, however, held that the transfer of shares of a foreign company which had an Indian Company as its subsidiary does not amount to transfer of any capital asset situated in India.

Accordingly, the efforts of the Income Tax Department of taxing the transfer of Indian shares through lifting the corporate veil went in vain. Therefore, as a reaction to the Supreme Court decision, plethora of amendments were introduced in Income Tax Act, to tax the indirect transfer directly by creating a deeming fiction vide section 9 of the Act.

Finance Act 2012 introduced provisions of indirect transfer by amending the provisions of section 9(1)(i) of the Act.

Since 2012, the provisions of indirect transfer have been meandering and have faced lots of curves to sail through.

Section 9(1)(i) of the Act provides that any income accruing or arising, directly or indirectly, through transfer of a capital asset situated in India shall be deemed to accrue and arise in India and consequently be taxable in India.

Finance Act 2012 inserted Explanation 4 and 5 to section 9 and the words used in the clause (i) of section 9(1), namely, “through”, “transfer”, “capital asset” and “situated in India” were assigned additional meaning to cover cases of indirect transfers. The verbatim reproduction of the Explanations is as under:

[Explanation 4.—For the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of”, “in consequence of” or “by reason of”.

Explanation 5.—For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India;

The amendment in the tax laws provided that a share or interest in a company or entity, registered or incorporated outside India, would be deemed to be situated in India if such share or interest derives directly or indirectly, its value substantially from assets located in India.

These amendments established territorial nexus and provided that the situs of shares of a foreign company shall be deemed to be in India if the share derives, directly or indirectly, its value substantially from the assets located in India. These provisions were introduced with a retrospective effect from 01 April 1962 onwards.

Although, the aforementioned provisions were brought were brought into effect retrospectively, however there was not much clarity with respect to the intent and extent of the provisions.

Such an ambiguity posed a significant commercial challenge for those multi-national corporations which were under continuous requirement of restructuring their operations, thus, resulting in withdrawal of investment plans in India. Therefore, there was a dire need for a clarification from the Income Tax Department to clear the air around the Explanations inserted in the Income Tax Act.

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