Snug cover for ‘indirect transfers’

The Finance Act 2012 was a bag of surprises, not all of them pleasant for the business community, especially multinationals. While the introduction of the General Anti-Avoidance Regulations (GAAR) caught most business organisations unawares, the ‘clarificatory’ amendment to tax ‘indirect transfers’ retrospectively, which effectively sought to reverse the Supreme Court decision in the case of Vodafone, left them stunned.

As the Government reeled under a backlash to these moves, the Prime Minister had to intervene and ‘take charge’ of the situation in order to assuage foreign investors’ concerns that the tax environment was becoming increasingly uncertain. Prime Minister Manmohan Singh constituted an expert committee, headed by Parthasarathi Shome, to suggest amendments to GAAR. The panel’s mandate was expanded to include recommendations on the widely criticised retrospective amendment to tax ‘indirect transfer’ of capital assets.

On October 1, 2012, the committee presented its draft report on the ‘indirect transfer’ provisions, seeking to align the policy with international best practices. There has been reference to global practices, recommendations of the Standing Committee of Finance (SCF) on the Direct Taxes Code provisions, as also extensive consultations with stakeholders.

At the general level, the committee suggested that retrospective amendments should be introduced only in the ‘rarest of rare’ cases in order to: Correct apparent anomalies in law; remove technical defects in procedure; or protect the ‘tax base’ from abusive tax planning schemes. It opined that the amendment to retrospectively tax indirect transfers aims to ‘expand’ the tax base, and is hence against the basic tenet of law as it affects certainty, apart from being unfair. Accordingly, it recommended that the amendment should only be applied prospectively.

The committee made several other recommendations, including some that would apply if the Government opts for retrospective taxation, and others that would apply in either case.

It stated that if the Government continues with retrospective taxation, such provisions should apply only to the person who has actually earned capital gains (the seller), and it would be unfair to impose a withholding tax obligation on the payer (the buyer), or even treat the buyer as a ‘representative assessee’ of the seller, as this would amount to imposition of a burden of performing an impossibility. If this recommendation is accepted, it would be interesting to see whether revenue authorities can effectively pursue the seller who has liquidated business interests in India. The committee has also suggested that no interest or penalty should be charged if income is charged to tax retrospectively.

Irrespective of whether the law is implemented prospectively or retrospectively, the committee noted the need for clarity, and removal of unintended consequences. While the provisions apply for transfer of shares or interest in an overseas company or entity, the committee has clarified that applicability of these rules should be restricted to ‘shares or interest’ that result in participation in the ownership, management, capital or control of the company. Any other form of economic interest should be outside the ambit of these provisions.

Furthermore, it suggested that the provisions should apply only to indirect transfers in which more than 50 per cent of the value of the overseas company or entity is derived from assets located in India. It has included guidelines for ‘valuation’ in such cases and recommended that taxation should be restricted to gains pertaining to the value of assets located in India.

There was concern among multinationals that the provisions may be extended to dividends paid by a foreign company that derives its value ‘substantially’ from assets in India. The committee has indicated that this leads to an unintended cascading effect on dividend taxation in a multi-tier overseas structure. It recommended clarifying that the dividend paid by a foreign company will not be covered.

Foreign institutional investors have reason to smile, as the panel’s suggestions would remove non-resident investors outside the purview of ‘indirect transfer’ tax, thereby allaying concerns that FII investments would become unattractive. The committee has taken into account concerns of small investors and suggested that a shareholder with less than 26 per cent holding (direct stake or effective indirect stake) in a foreign company that has substantial assets in India should be left out of this tax. It further recommended that shareholders in a listed foreign company that is frequently traded on a recognised overseas stock exchange and intra-group re-organisations should be exempt, under certain conditions.

Importantly, the expert committee has suggested that the provisions should not override any beneficial tax treatment available to a non-resident under the tax treaty. Its efforts to infuse certainty, predictability, and stability in tax law must be lauded. One hopes the Government will take appropriate steps to clear the air on the much-debated and criticised tax legislation.

Pranav Sayta is Tax Partner, Ernst & Young