TAX TREATMENT IN CASE OF TRANSFER OF ECONOMIC INTEREST BY UK HOLDING COMPANIES OF SHARES HELD IN INDIAN COMPANY
I would try to address the tax position by the way of an example.
XYZ Ltd is an Indian Company which is registered in India having two major foreign shareholders D Ltd and Y Ltd holding 30% and 45% shares respectively and both these companies are under the same foreign group company.
The Foreign companies doesn’t have a Permanent Account Number in India nor they have filed return in India.
XYZ Ltd is a profit making company and declares dividend every year. Now recently D & Y Ltd by way of an agreement transferred the dividend receipt rights to Z Ltd. (a subsidiary of common group company) although there was no transfer of shares from D & Y Ltd to Z Ltd i.e. at present both (D&Y) are shareholders in the books of XYZ Ltd.
The issue involved is whether the economic transfer of dividend receipt rights of XYZ Ltd ( an Indian Company ) by foreign shareholders would result in Capital Gains taxable in India in the hands of foreign shareholders.
“Economic Interest” means a person’s right to share in the income, gains, losses, deductions, credits or similar items of the company, but excluding any other rights of a member including the right to vote or otherwise participate in the affairs or in the management of the company or any right to information concerning the business and affairs of the Company.
In this case as understood there is a transfer of purely economic interest in shares of XYZ Limited (through dividend payment rights). Normally these are effected through contracts and agreements between the economic interest holder and the legal registered owner of the shares.
The term “Economic Interest” is nowhere defined under the Income Tax Act 1961 or the Companies Act 2013 prevalent in India.
As per Sec 2(14) of Income Tax Act Capital Asset means –
(a) Property of any kind held by any assessee whether or not connected with his business or profession
The word property is very wide and takes in its ambit rights associated with the property.
The above stated Foreign Companies are not assessed to Income under Income Tax Act nor was deemed to be an assessee under any provision of this act as of date.
If by virtue of the transfer of economic interest outside India the Foreign Companies are liable to tax in India then only they would be assessee under Income Tax Act 1961.
Sec 2(47) of the act gives an inclusive definition of transfer.
As per Sec 2(47)(ii) transfer includes the extinguishment of any rights therein that is in the asset.
Now the Foreign Companies did extinguish their rights to receive dividends as and when declared by the Indian company.
Therefore it falls under the definition of transfer.
Now it is to be seen whether the transfer of economic interest by the above stated Foreign companies to the economic interest holder outside India and consideration to be received outside India results in income liable to tax in India
Sec 5 gives the scope of total income, it states in sub section 2 : –
Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year.
Explanation 1.—Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India.
Explanation 2.—For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India
As a fact the consideration for transfer of economic interest was paid by the economic interest holder to the above stated Foreign companies and that consideration was paid outside India therefore non-resident Foreign companies didn’t receive any income arising out of such transfer of economic interest in India.
On this count there is no income taxable in India in the hands of the two foreign companies.
Now it is to be seen whether income deemed to accrue or arise in India as per Sec 9 of the act.
As per provisions of Sec 9 transfer of economic interest by the above stated Foreign companies to an economic interest holder outside India do not result in income deemed to accrue or arise in India.
In view of the above the transfer of economic interest by the above stated Foreign Companies did not result in income liable to tax in India.
But now after the recent amendment Dividend payment by Indian Company to their foreign shareholders would be subjected to TDS at applicable rates or DTAA rates.