The Finance Act 2012 has retrospectively amended the ?source rule? tax principle enshrined in section 9 of the Income Tax Act, 1961. Retrospective amendments are intended to clarify and re-state the legislative intent for removal of doubts that transfer of shares or interest in an off-shore company will be liable to capital gains tax in India if the share or interest being transferred derives (directly or indirectly) its value ?substantially? from the assets located in India. Consequently, buyers who have already paid purchase consideration for acquiring shares in off-shore companies could be asked to pay the tax not withheld, interest and penalties as an assessee-in-default.
These amendments were made after the Supreme Court?s judgment in favour of Vodafone on an indirect transfer issue. Constitutional validity of the retrospective amendments has been challenged in the Calcutta and Bombay High Courts. In view of the controversy and its adverse impact on investor sentiments, the Shome Committee was tasked with carrying out consultations with stakeholders and to provide its recommendations. It has made useful recommendations by way of a draft report and has invited public comments.
Prospective application, not retrospective: As a matter of policy, the government should avoid anything that comes as a surprise to the taxpayers. In several countries such as Brazil, Greece, Mexico and Sweden, there is constitutional or statutory protection against retrospective application. Retrospective amendments of tax laws should occur in exceptional and rarest-of-rare case to address apparent mistakes, anomalies, technical defects and to ?protect? the tax base rather than ?expand? the tax base. Further, amendments are not merely clarificatory in nature (and are possibly substantive) and thus should be applied prospectively and not retrospectively.
Alternative recommendations if the government chooses to apply the law retrospectively: The buyer i.e. the payer of the purchase consideration for shares, should not be liable for failure to withhold tax from such consideration as this would amount to imposing a burden that is impossible to perform. Accordingly, no interest or penalties should be levied on such buyers. Importantly, the buyer should also not be liable for the substantive capital gains tax liability of the seller involved in an indirect transfer. Impliedly, only the seller who earned capital gains on such indirect transfers should be subject to tax. Even on the sellers, no interest and penalties should be charged such as under sections 234A, 234B and 234C and penalty under section 271(1)(c) for purported concealment of income by the seller. CBDT may issue a circular in this regard.
Define what is meant by ?derive value substantially from India?: Shares of a company incorporated outside India are held to be situated in India if such shares substantially derive their value from assets located in India. However, what is ?substantial? is not defined. It has been recommended that the criterion under the Draft Direct Taxes Code Bill 2010 should be adopted. Accordingly, such shares will be capital assets situated in India if the value of assets located in India is more than 50% of the value of global assets of such a foreign company. Capital gains taxable in India should be gains attributable to assets located in India based on proportionality between Indian assets and global assets.
Relief for transfer of shares of a listed foreign company: Indirect transfer provisions should not apply to transfer of shares of a foreign company listed on a ?recognised stock exchange? and which are ?frequently traded?. The concepts of a ?recognised stock exchange? and ?frequently traded? may be adopted from Sebi and RBI laws and regulations.
Exemption for overseas intra-group restructuring: Transfer of shares or interest in a foreign company in course of intra-group restructuring should be exempted. However, exemption should be based on the condition that such transfer should not be taxable in the jurisdiction where the foreign company is a tax resident. Amalgamation and demerger as well as any other form of restructuring subject to continuity of 100% ownership within the group will be covered under the scope of ?intra-group restructuring?.
Foreign institutional investors (FIIs) will be liable to pay tax on their investments. However, non-resident investor interacting with the FII will not be taxed in India. In other words, FIIs will be taxable and any non-residents investors represented in the trades conducted by FIIs (such as through P-notes) will not be taxed in India. Thus, there is a helpful reiteration that P-notes will not suffer an additional tax burden due to indirect transfer provisions.
Private equity investors would also generally benefit from the recommendation made by the Shome committee in respect of indirect transfer provisions.
Relief in case a tax treaty benefit is available to the non-resident transferor: A non-resident seller involved in an indirect transfer should not be taxed in India if a relief is available under the tax treaty applicable to such a non-resident. However, such a non-resident could be taxed in India if the applicable tax treaty provides the right of taxation of capital gains to India based on its domestic law or the right to tax capital gains is specifically assigned to India under the treaty.
The Shome Panel has suggested that its recommendations may be implemented through an amendment of the tax laws or by a circular as appropriate in law. However, most of the key recommendations can be suitably implemented by way of amendments at the time of next finance bill (general budget). Alternatively, the President of India can promulgate an ordinance, if according to him, circumstances necessitating an immediate action exist and the Parliament is not in session. Such an ordinance will cease to operate at the expiration of 6 weeks from the first reassembly of Parliament, unless approved. It will be useful if the Finance Bill 2013 also undoes the damage done by treating payments for the use of software and satellite services as ?royalties? with retrospective effect.
The author is Partner, J Sagar Associates. Views are personal
