Background

The taxation of indirect transfer of shares was a direct fallout of the Supreme Court decision in the Vodafone case in 2012.   The Income-tax Act, 1961 (‘the Act’) was amended vide the Finance Act, 2012 by insertion of Explanation 5 to section 9, seeking to tax sale of shares by overseas companies in India, if such shares derived their value from assets substantially situated in India.  The amendments created a furore not just because of their retroactive application right from 1961 but also from the ambiguous nature of the wordings.  Thereafter, the Government appointed the Shome Committee and further amendments were made vide Finance Act, 2015 by way of Explanations 6 and 7 to clarify the manner of determining the substantial value of assets. 

Indirect transfers taxation provisions at a glance

After the amendments made via Finance Act, 2015, the law regarding indirect transfers taxation, as it currently stands, is summarised as under:

i) Income is deemed to accrue or arise in India if it accrues or arises through transfer of a capital asset situate in India.

ii)The expression “through” means and includes “by means of”, “in consequence of” or “by reason of”.

iii) An asset or a capital asset being any share or interest in an overseas company/entity is deemed to be situate in India if such overseas company/entity derives its value substantially from assets held in India, directly or indirectly.

iv) Value is said to be derived substantially from assets held in India when such value:

a) Exceeds Rs. 10 crores; and

b) Represents 50% of the value of all assets owned by the overseas company/entity.

v) Such valuation is made as per prescribed Rules and on specified dates.

vi) Exception to the above substantial asset test is where the overseas company/entity does not hold the right of management or control nor holds more than 5% of the voting power or share capital or interest in the Indian asset held by it, either directly or indirectly. Exceptions also apply to certain corporate re-organisations.

vii) Where all assets owned, whether directly or indirectly, by such overseas company/entity are not located in India, then income will be taxable in India only to the extent as is reasonable attributable to assets located in India, determined in a prescribed manner.

Reporting requirements for indirect transfers

The Finance Act, 2015 also introduced section 285A in the Act, whereunder certain reporting obligations are thrust upon the Indian entity.  Failure to fulfil reporting obligations invites penalty under section 271GA as follows:

a) 2% of the value of the transaction, if such transaction had the effect of directly or indirectly transferring the right of management or control of the Indian asset; and

b) 5 lakhs in any other case.

The Rules relating to indirect transfers were also notified on 28^th June 2016, prescribing, inter alia, the reporting requirements by the Indian concerns by way of Rule 114DB.  Under the said Rules, the following are the documentation / reporting requirements:

i) Information relating to indirect transfers should be electronically submitted to the jurisdictional tax officer in Form 49D.

ii) Such information should be submitted within 90 days from the end of the financial year. In cases where the transfer results in transfer of management rights or control in the Indian concern, the information should be submitted within 90 days of the transaction.

iii) The Indian concern should maintain various shareholding details, financial statements, contracts /agreement evidencing the transfer of the immediate holding company, intermediate holding company and the ultimate holding company.

iv) The Indian concern is also required to maintain information relating to the decision or implementation process of the overall arrangement of the transfer, the asset valuation reports, details of tax paid outside India and business operation information in respect of the foreign company and its subsidiaries.

v) Where there are more than one Indian concerns that are constituent entities of a group, the information may be furnished by any one of the Indian concerns designated by the group, such designation being communicated to the Assessing Officer.

vi) The documentation is required to be maintained for 8 years from the end of the relevant assessment year.

Requirements in Form 49D

Form 49D has been split into three parts as follows:

i) Part A – General information to be filled in relating to the Indian concern and the immediate, intermediate and ultimate holding company;

ii) Part B – Reporting of the transaction resulting in transfer of right of management or control, including the percentage transferred, valuation report basis, breakup of assets, financial statements, etc.

iii) Part C – Reporting of information in respect of transfer of share / interest during the previous year including percentage transferred, basis of determination, etc.

Issues with the prescribed reporting requirements

It can be discerned from the above-mentioned requirements that they are quite onerous and detailed and that stringent penalties have been specified for non-compliance.  Hence, there is substantial burden placed on the Indian entity, whereas the transaction takes place between its shareholders!

The reporting requirements envisage maintenance of a great deal of information of the shareholders i.e. the immediate, intermediate and ultimate holding companies.  It could be a practical challenge for the Indian entity to obtain that information in many cases.  Further, share transfers can take place between shareholders without the knowledge or role by the Indian entity and agreements etc., relating to such transaction/s could be confidential, thus increase the practical difficulties of the Indian entity to obtain and submit such information within 90 days. The overseas share transfers may not be in knowledge to its Indian group concerns at the time of transaction.  In some cases, it could be difficult to ascertain the exact date of transfer of management or control in the Indian entity. The requirement to maintain such documents for a period of 8 years adds further to the burden.

Whether the reporting requirements apply in all cases of indirect transfers?

The indirect transfer provisions in section 9(1)(i) lay down certain thresholds, exceptions and conditions under which sale of shares/interest in overseas companies/entities are taxable in India i.e. it is not that each of sale of share/ interest is compulsorily taxable in India. 

Hence, apart from the above-mentioned difficulties, by far the largest issue is the scope of applicability of section 285A.  It has been a matter of considerable debate whether the reporting requirements under the said section trigger in all cases of indirect transfers or trigger only when such transfers are taxable under Explanation 5 to Section 9(1)(i) i.e. where the value is held to be derived from assets substantially situated in India?

Section 285A begins with the words “Where any share of, or interest in, a company or an entity registered or incorporated outside India derives, directly or indirectly, its value substantially from the assets located in India, as referred to in Explanation 5 to clause (i) of sub-section (1) of section 9……..”.  A plain reading of Section 285A suggests that the section refers to only situations arising under Explanation 5 to section 9(1)(i) i.e. only those cases where the value is derived substantially from assets situated in India.

However, there is a prevailing view that the reporting under section 285A covers all cases of indirect transfers, irrespective of whether conditions mentioned in Explanation 5 have been fulfilled as it is only when all transactions are reported, that the tax authorities can review whether the substantial asset test under Explanation 5 has been correctly applied by the taxpayer. In other words, if reporting is not done for situations excluded by Explanation 5, then the tax authorities will not be able to ascertain whether in such cases, the values were computed correctly as per the Rules and that the exclusion was correctly applicable and therefore such interpretation seeks to limit the jurisdiction of the tax authorities to review the transaction.  Proponents of this view try to seek further support from the wordings in Form 49D.

Clause 9 in part A of the Form 49D reads as:

(a) Whether share of, or interest in, any company or entity derives its value substantially from assets located in India, which are held in, or through, the Indian concern;

(b) If yes, give details of the company(ies) or entity(ies)

It can be seen from the above that it needs to be specifically stated in this clause, by way of Yes/No, whether the share/interest derives its value substantially from assets located in India.  This could imply that even where the transfer did not fulfil the requirement of Explanation 5, it may still need to be reported here else there was no need to answer this as a Yes/No.

A similar argument is made for reporting under Clause 11 of Part C, which reads as under:

11(a) Whether share of, or interest in, the company or entity referred to in 9 has been transferred during the previous year, the income from which is deemed to accrue or arise in India under the previous section 9(1)

(b) If yes, give details-

It appears from the above that all cases of transfer of management and control are required to be reported under the relevant clauses i.e. even where income is not deemed to accrue or arise in India should be reported because of the specific Yes/No clause.        

Consequently, this would mean that whenever there is a transfer of shares of overseas companies, even of one share, the reporting is envisaged under this section as the intention of the legislation is manifest in the manner in which the information is asked from by the Indian concern.  

Notwithstanding these arguments, it certainly appears that section 285A is very clear and specific in its opening words itself. It is a well-settled position that the Rules are sub-ordinate to the Act and therefore cannot override the Act in any manner. 

The Hon’ble Supreme Court in the case of CIT v Taj Mahal Hotel [TS-5059-SC-1971-O] held that the Rules are meant only for the purpose of carrying out the provisions of the Act and they could not take away what was conferred by the Act or whittle down its effect.  Hence, any Rule which purports to do so may be ultra vires / void. 

The Madras High Court, in the case of M.C.T. Muthiah Chettiar Family Trust Vs Income Tax Officer [TS-5331-HC-1971(MADRAS)-O] affirmed in [TS-5145-HC-1975(MADRAS)-O] has held that: 

“All rules or forms which are creatures of such rules, prescribed for the purpose of effectuating the policy of the statute, must be read in the light of the statutory provisions in the main enactment under which they are made and, therefore, such rules or forms cannot contradict or create an irreconcilable position resulting in an anomalous situation.” 

Hence, any provision in the Rules or in the Forms prescribed by the Rules cannot impose any additional requirements than that is required under the Act.  Accordingly, it is reasonable to take a view that the reporting requirements should get triggered only when Explanation 5 of Section 9(1)(i) is applicable and not otherwise, in view of the wordings of Section 285A.

Conclusion

Under section 285A, the entire burden of reporting to the tax authorities is put on the Indian company who may not even play any role in the transfer between shareholders.  Non-compliance can result in heavy penalties, linked with the transaction value.  It means that penalty may be leviable even if such indirect transfer resulted in a loss for the transferor shareholder. 

Further, the obligation to designate one of the constituent entity to comply with the reporting appears to have been borrowed from the Country-by-Country reporting guidelines for transfer pricing purposes, which typically apply to only very large enterprises.  It appears that the Government considered the Indian company as a convenient means of obtaining all the information regarding the transaction.  This appears to be against the Ease of Doing Business mantra of the Government. 

Hence it is hoped that the Government will consider lessening the rigour of the reporting requirement as well as providing clarity in the scope as it would go a long way in uneasing the burden for Indian companies having foreign shareholding.