There is a view that when the Direct Taxes Code kicks in, hopefully from the Assessment Year 2013-14 as promised by the Finance Minister, the Income Tax department would not be stymied in its efforts to recover tax from overseas deals between two non-residents that effectively confers them control of an Indian company, which in fact L'affaire Vodafone was all about.

What has given rise to this optimism is the proposed section 5 (1) (d) which says “the income shall be deemed to accrue in India, if it accrues, whether directly or indirectly, through or from the transfer of a capital asset situated in India.”

This begs the question whether the transfer of shares of a foreign company consummated abroad tantamounts to transfer of the underlying capital assets situated in India.

Unintended results

The DTC smugly assumes that its intention is borne out by the above provision but the Courts may not be convinced in the absence of an express provision to this effect which should create an explicit legal fiction for the purpose of taxing such overseas deals. Be that as it may, section 5(4 (g) goes on to say that the capital gains would not be deemed to arise in India from such transactions “unless at any time in twelve months preceding the transfer, the fair market value of the assets in India, owned, directly or indirectly, by the company, represent at least fifty per cent of the fair market value of all assets owned by the company”.

This might produce results that were not intended. The intention obviously is to tax such foreign deals only if the acquirer i.e. the transferee comes to control at least 50 per cent equity of the company whereas the italicised words convey the impression that if the transferor controlled at least 50 per cent during the last twelve months, the deal would be liable to income-tax even if the transferee acquires from him a minuscule share out of the holdings of the transferor.

Herculean task

And the real difficulty in calculating what is taxable in India would arise in working the formula — capital gains earned abroad by the transferor non-resident would be taxable in India in proportion to the fair value of the assets of the Indian company directly or indirectly controlled by the foreign company vis-à-vis its fair value of all its assets.

To wit, suppose, Hutch had made a profit of Rs 50,000 crore from Vodafone by selling the Camay island company to it, the amount taxable in India out of this amount would depend upon the composition of assets of this company. Assuming its purpose was only to invest in an Indian telecom company and therefore its only assets were investment in such Indian company, obviously the entire amount would be taxable in India.

But if it had other assets which, let us say, represented 50 per cent of the fair value of its total assets, then only 50 per cent of the capital gains, namely, Rs 25,000 crore would be taxable in India. Fair enough.

But determining the fair value of all the assets would be a herculean task with reliance willy-nilly having to be placed on the certificates given by friendly accountants. Accounts of companies incorporated in tax havens cannot be expected to be very transparent.

It is entirely possible for the foreign company in the event to jack up the share of other assets vis-à-vis the value of the shares only to hoodwink the Indian exchequer.

Tax incidence

A non-resident is not going to take the trouble of complying with the tax laws of another country, much less pay the taxes due to it meticulously, which is why the income-tax law of India provides for deeming an agent of a non-resident as his representative assessee.

Such agents cannot be arbitrarily chosen. They must be the ones who come into possession of a non-resident's money in India in the course of their dealings. In fact, the income tax department had to cut a sorry figure in the Vodafone case precisely for this reason.

It wanted to make Vodafone India responsible for the tax liabilities of Hutchison, oblivious of the obvious reality that it never came in possession of assets or moneys belonging to Hutchison.

Same problem under DTC

The same problem would arise under the DTC dispensation as well because the issue has not been addressed adequately and satisfactorily as would be apparent from the following provisions extracted from section 164 of the proposed code:

“(2) The “agent” in relation to a non-resident includes —

(a) any person in India — (i) who is employed by, or on behalf of, the non-resident ;(ii) who has any business connection with the non-resident;(iii) from, or through, whom the non-resident is in receipt of any income, whether directly or indirectly; or (iv) who is the trustee of the non-resident; and

(b) any other person who has acquired, by means of transfer, a capital asset in India from the non-resident”

It would be apparent that (b) is qualitatively different from (a) — all the persons mentioned in (a) are in India whereas the person mentioned in (b) whom the Code wants to hold liable for discharge of capital gains tax liability arising in Vodafone-type deals consummated abroad would never be available in India. In the event, the department would have the smug satisfaction of having determined the quantum of capital gains taxable in India all right but without the wherewithal to recover the same.

In other words, the DTC, after all, would not make life easier for the department as is being believed even in knowledgeable quarters.

The problem is likely to continue unless the Indian government makes bold to initiate legal proceedings abroad to attach the properties of the foreign company controlling the Indian company. This won't be easy.

Making Vodafone India responsible for the tax liabilities of Hutchison was the easiest for the department but the move would never stand legal scrutiny inasmuch as it never came in possession of money belonging to Hutchison.

(The author is a New Delhi based chartered accountant.)

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