Valuing indirect transfers: New rules introduced

A US$11 billion deal between Vodafone and Hutchison Group brought the taxability of indirect transfers of Indian assets into the limelight. The Supreme Court of India in 2012 held that Hutchinson’s sale of shares of a Cayman Island company to Vodafone did not give rise to capital gains chargeable to tax in India. The Indian government then retrospectively amended the Income-tax Act, 1961 (ITA), to enable taxation of the transfer of a share/interest of a company or entity registered/incorporated outside India, if such share/interest derives substantial value from assets located in India.

Controversies arose as to the validity of the retrospective amendment to tax concluded transactions and interpretation of the term “substantial”, embodied in explanation 5 to section 9(1)(i) of the ITA.

Delhi High Court in 2014 analysed the term “substantial” and held that gains arising from sale of a share of a company incorporated overseas, which derives less than 50% of its value from assets situated in India, would not be taxable under the ITA. However, to resolve the uncertainty and ambiguity as regards interpretation of the term “substantial”, in 2015, provisions were incorporated in the ITA, to prescribe the threshold as being 50% in order to be “substantial”. Other amendments pertained to the proportionate basis of income attribution to the extent of value of Indian assets of the non-resident transferor, and certain reporting obligations relating to indirect transfers.

Ranjeet Mahtani is a partner and Hardik Choksi is a senior associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.