Taxability of Indirect Transfer of Indian Assets

1. Background

When a foreign Company holds shares of foreign companies which having substantial interest in Indian entities and derive their value from Indian assets. In this article we are addressing  if a company transfers its stake of Foreign entity outside India whether capital gains will be applicable on the said transaction.

This Article  addresses “the tax implications on Company with regards to Sale of shares of Foreign Company having direct / indirect stake in  an Indian  entity.

Let’s understand the legal provisions with a case study:

Dubai based company  hereinafter referred to as “ABC Inc” holds shares of a company in United States of America  hereinafter referred to as “XYZ Inc” which further has a subsidiary in India  hereinafter referred to as “ I Ltd” and therefore derives its value from Indian assets.  ABC Inc in Dubai is now transferring shares of such USA based entity XYZ Inc to  a company in Singapore hereinafter referred to as “Holding Co ”

2. Legal provisions and Analysis

Capital gain arising through or from the transfer of a capital assets situated in India would be deemed to accrue or arise in India in all cases irrespective of the fact whether

• The capital asset is movable or immovable, tangible or intangible;
• The place of registration of the document of transfer etc., is in India or outside India; and
• The place of payment of the consideration for the transfer is within India or Outside India.

Accordingly, the expression “Through” Shall mean and include and shall be deemed to have always meant and included “by means of”, in consequence of or “By reason of”. [Explanation 4 to section 9(1)(i)].

Legal provision related to taxability:

• As per Section 2(14), “capital asset” means property of any kind held by an assessee, whether or not connected with his business or profession.
• As per Section 2(47), “transfer”, in relation to a capital asset, includes

1. The sale, exchange or relinquishment of the asset; or

2. The extinguishment of any rights therein;

Explanation .—For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India;

According to this explanation transfer includes indirect transfer of right in Indian Company I Ltd.  through shares of XYZ Inc.

Income deemed to accrue or arise in India.

As per section 9: All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India shall be deemed to accrue or arise in India.

Explanation 5.— For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India;

In Our Case XYZ Inc shall be deemed to be situated in India as the share of XYZ Inc derive its value substantially from business of Indian company (I Ltd) located in India.

Explanation 6 :– The shares shall be deemed to derived its value from assets located in India, if on the specified date the value of assets is:

• More than the amount of 10 Crores &
• Represent at least 50% of the value of all the assets owned by company.

In our case study it is assumed that USA Company XYZ Inc fullfills the conditions of explanation 6 and does not have exemptions available to a small shareholder)

However, an asset or capital asset, which is held by a non-resident by way of investment, directly or indirectly, in category -I or category-II foreign portfolio investment under the SEBI (FPI) Regulation,2014, made under the SEBI Act 1992, shall not deemed to be or deemed to have been situated in India. [Proviso to Explanation 5 to section 9(1)(i)].

Special provision for full value of consideration for transfer of share other than quoted share.

As per section 50CA: Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being share of a company other than a quoted share, is less than the fair market value of such share determined in such manner as may be prescribed, the value so determined shall, for the purposes of section 48, be deemed to be the full value of consideration received or accruing as a result of such transfer.

Calculation of capital gains in case of Non-resident

As per section 48:  The income chargeable under the head “Capital gains” shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely: —

(i)  expenditure incurred wholly and exclusively in connection with such transfer;

(ii)  the cost of acquisition of the asset and the cost of any improvement thereto:

As per First Proviso of section 48 in the case of an assessee, who is a non-resident, capital gains arising from the transfer of a capital asset being shares in, or debentures of, an Indian company shall be computed by converting the cost of acquisition, expenditure incurred wholly and exclusively in connection with such transfer and the full value of the consideration received or accruing as a result of the transfer of the capital asset into the same foreign currency as was initially utilised in the purchase of the shares or debentures, and the capital gains so computed in such foreign currency shall be reconverted into Indian currency, so, however, that the aforesaid manner of computation of capital gains shall be applicable in respect of capital gains accruing or arising from every reinvestment thereafter in, and sale of, shares in, or debentures of, an Indian company, And the conversion of foreign currency shall be done in accordance with Rule 115A as follows:

Note: TTBR: Telegraphic transfer buying rate of State Bank of India, TTSR: Telegraphic transfer selling rate of State Bank of India.

If there is a capital loss, then there is no requirement of payment of tax. If there is a capital gain, then gains shall be calculated as sale consideration less cost of acquisition and expenses.

3. Withholding Tax

As per Section 195 related to any sum paid to a non-resident:

“(1) Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest referred to in section 194LB or section 194LC) or section 194LD or any other sum chargeable under the provisions of this Act (not being income chargeable under the head “Salaries”) shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force :

Explanation 2.—For the removal of doubts, it is hereby clarified that the obligation to comply with sub-section (1) and to make deduction thereunder applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident, whether or not the non-resident person has—

• a residence or place of business or business connection in India; or
• any other presence in any manner whatsoever in India.

In the current case, the Transferee Company  Holding Co will have to withhold tax on capital gains of the Transferor Company (Dubai based company) from the consideration payable to them. Please note that in the present case, if  Holding Co does not withhold proper taxes from consideration payable to Dubai company, then it might be considered as an Assessee in default as per Indian tax laws.

Further practically, the requirement for  Holding Co., is to not just deduct such taxes but also ensure that it has deducted proper taxes which will be dependent on calculations undertaken based on data of cost price and sales consideration/ Fair market value of shares provided by the transferor company. We should ensure that tax calculations are properly verified & vetted as section 195 (which requires tax to be deducted in case of payment to Non-resident), mentions that tax should be deducted at applicable rates. Therefore, we should also ensure that capital gains tax (though liability of transferor company) is properly calculated and then deducted from the purchase consideration.

Conclusion: XYZ Inc shall be deemed to be situated in India as the share of XYZ Inc derive its value substantially from business of Indian subsidiary (I Ltd) located in India. Transfer of Shares of XYZ Inc shall be taxed in India and Holding Co shall be required to deduct withholding taxes from payments being made to company in Dubai for acquiring shares of USA entity.