Lakshmisha S, Director – M&A Tax, PwC India

Lakshmisha S

We distinctly remember the controversy on taxation of indirect transfer of assets located in India, with the Supreme Court’s (SC) ruling in the case of Vodafone International Holdings BV. The Government of India amended section 9 of the Income-tax Act, 1961 (Act) in 2012 with retrospective effect, to bring the indirect transfer of shares deriving substantial value from an asset situated in India, within the purview of Indian tax.

There have been occasional amendments to this section by the insertion of various explanations and proviso’s. However, there has been ambiguity of applicability on distribution/ repatriation by a foreign company, by payment of dividend, buy-back, upstreaming of income by funds, capital reduction, redemption of shares, etc.

Dividend declaration

Under the Act, the distribution of dividends by a foreign company deriving substantial value from Indian assets per se would be liable to tax in India. This peculiar tax issue sent ripples across foreign companies with subsidiaries in India, as this could result in double taxation, i.e., tax on Indian companies declaring dividends and again in the hands of foreign companies distributing such dividend. After receiving various representations, the Central Board of Direct Taxes (CBDT) issued Circular No 4/2015 dated 26th March 2015, clarifying that dividend declared and paid by a foreign company outside India, which derives substantial value from assets situated in India, would not fall within the purview of indirect transfer provisions. This circular provided much-needed relief to foreign companies.

However, this circular only covers cases in which the dividend is paid in cash and the ambiguity for dividend in kind (other than cash) continues.


Buy-back of shares would qualify as “transfer” under the Act and buy-back by foreign companies or funds deriving substantial value from assets in India would trigger indirect transfer provisions under the Act.

Similar to dividends, foreign private equity funds and venture capital funds were liable to multi-level taxation of income; first, while transferring underlying investments in India, and thereafter, during the distribution of income to its investors by buy-back of units.

To provide an investor-friendly environment and promote foreign investments, the Government amended the Act in 2017, whereby, Specified Funds (i.e. Investment funds, Venture Capital Company and Venture Capital Funds) were exempted from the applicability of indirect transfer provisions, retrospectively from 01 April, 2015. However, this circular does not provide clarity in the event of buy-back by the aforesaid Specified Funds.

The CBDT issued Circular No 28/2017 dated 7th November 2017 clarifying that indirect transfer provision would not apply to income arising to a non-resident on account of buyback of its shares held indirectly in Specified Funds, if the income arising to such Specified Funds on transfer of shares or securities held in India has been subject to tax in India.

Although non-resident investors holding direct or indirect interest in Specified Funds are not liable to tax under the Act upon buy-back of units, buy-back by foreign companies not having interest in Specified Funds would be liable to tax in terms of indirect transfer provisions, resulting in taxability for each level of distribution (such as multi-layer holding structures).

Redemption of shares

Implications on redemption of shares are similar to buy-back of shares as discussed above.

Capital reduction

Typically, in capital reduction, an existing shareholder agrees for reduction/ cancellation of share capital in consideration for cash. If a foreign company deriving substantial value from assets situated in India undertakes capital reduction, a question arises whether this would trigger indirect transfer provisions.

As capital reduction results in “extinguishment of right,” it would be regarded as “transfer” in terms of the Act. Further, if the foreign company has accumulated profits, the amount of capital reduced to the extent of accumulated profits would be deemed as dividend. Hence, dividend arising on the “transfer” (i.e. on capital reduction) of shares of a foreign company can be held as income accruing, directly or indirectly, from assets situated in India in terms of the Act.

However, one can argue that the legislative intent, as explained in the Memorandum to Finance Act, 2012, provides that the right to tax would be with the country where the actual nexus of income is situated. If the shareholder/ shareholding of the foreign company remain the same post capital reduction, no nexus of income with any asset situated in India exists. Further, it could also be argued that deemed dividend under the Act, arising on capital reduction, should be regarded as “dividend,” which is exempt in terms of Circular No 4/2015 dated 26th March 2015, as discussed above.

Any capital gain arising on account of capital reduction could trigger indirect transfer implications.

The views expressed in this article are personal to the author. This article includes inputs from Vishal Mohan Krishnam – Associate Director – M&A Tax, PwC India and Ankit Toshniwal – Assistant Manager – M&A Tax, PwC India.

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November 2020