Indirect Transfers Taxation

What makes a transfer “indirect”?

• A direct transfer sells an Indian asset, such as shares of an Indian company.
• An indirect transfer sells shares of a foreign company instead.
• The deal happens abroad, between two foreign parties.
• The tax question arises because the foreign company’s value comes substantially from assets located in India.

How do you remember it?

• Ask where the value sits, not where the paper is signed.
• Foreign shares plus Indian value equals an indirect transfer.

What does the law say?

• Section 9(1)(i) deals with income that is deemed to accrue or arise in India.
• Explanation 5 to this clause was inserted by the Finance Act, 2012.
• It says shares of a company registered abroad are deemed to be situated in India.
• This applies if the shares derive their value substantially from assets located in India.
• The shares are deemed to be in India, so the gain on selling them is taxable in India.

Is this the same as transfer pricing?

• No. Transfer pricing is about the price charged between related firms.
• Indirect transfer taxation is about where a share sale is deemed to take place.

What was the deal?

• In 2007 a Netherlands company, Vodafone International Holdings, bought a stake in Hutchison Essar.
• Hutchison Essar was an Indian telecom company.
• The seller was a Hong Kong based entity that held the stake through a chain of subsidiaries.
• The deal was done offshore, between foreign parties.

What did India do?

• The Indian tax department demanded tax from Vodafone under the Income-tax Act, 1961.
• Vodafone did not pay. The matter went to court.

What did the Supreme Court decide?

• In 2012 the Supreme Court ruled in Vodafone’s favour.
• It held that gains from an indirect transfer of Indian assets were not taxable under the law as it then stood.

What did the Finance Act, 2012 do?

• It inserted Explanation 5 into Section 9(1)(i).
• It gave the change retrospective effect from 1 April 1962.
• It also validated tax demands in cases of indirect transfers.
• The Bill’s own statement says the court’s verdict was inconsistent with legislative intent.

Why did people object?

• Critics said retrospective changes break the principle of tax certainty.
• They said it damaged India’s image as an attractive place to invest.
• The Government itself later called the demand “a sore point” for investors.
• Demands were raised in 17 cases.

What happened to Vodafone?

• Vodafone began arbitration in 2014 under the India-Netherlands investment treaty.
• On 25 September 2020 the Permanent Court of Arbitration passed its award.
• The tribunal found India’s retrospective demand breached the fair and equitable treatment standard.

What happened to Cairn?

• Cairn Energy, a British firm, used the India-UK investment treaty.
• In December 2020 its tribunal also ruled against India.
• It awarded about $1.2 billion, plus interest and costs.
• India’s authorities had seized dividends and shares and withheld tax refunds to recover the dues.

How many cases reached arbitration?

• Of the 17 cases, arbitration under the UK and Netherlands treaties was invoked in four.
• In two of them the tribunal ruled for the taxpayer.

What did Parliament pass?

• The Taxation Laws (Amendment) Bill, 2021 was introduced on 5 August 2021.
• Lok Sabha passed it on 6 August and Rajya Sabha on 9 August.
• The President gave assent on 13 August 2021.

What does the Act say?

• No tax demand is raised on the 2012 amendment for an indirect transfer made before 28 May 2012.
• Earlier demands are treated as never made, but only if the taxpayer meets set conditions.
• Any amount paid is refunded without interest.

What conditions must the taxpayer meet?

• Withdraw pending appeals and writ petitions.
• Withdraw arbitration, conciliation or mediation claims.
• Give an undertaking waiving any further claim on the same income.

What stays and what goes?

• The 28 May 2012 date is the day the Finance Bill, 2012 got the President’s assent.
• Transfers before that date are no longer taxed on the basis of the 2012 amendment.
• The deemed-situs idea in Explanation 5 is still the rule for later transfers.

Which wrong ideas should you clear?

• Myth: the 2021 Act scrapped indirect transfer tax. Fact: it only withdrew the retrospective reach.
• Myth: every taxpayer got relief automatically. Fact: relief needed the conditions, such as withdrawing litigation.
• Myth: the Supreme Court upheld the retrospective law. Fact: the 2012 ruling went for Vodafone, and Parliament then amended the law.

The options were:

• (a) “An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment”
• (b) “A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment”
• (c) “An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India”
• (d) “A foreign company transfers shares and such shares derive their substantial value from assets located in India”

The answer is (d).

How do you check it?

• Options (a) and (b) are about taxes on profits from investment. That is not a share transfer.
• Option (c) sells tangible assets abroad. No foreign company shares are sold.
• Only option (d) has foreign shares whose value comes from Indian assets.