CBDT puts on hold circular on taxation of indirect transfer of shares

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In a move that will provide a respite to foreign portfolio investors (FPIs), venture capital and private equity investors, the central board of direct taxes (CBDT) has decided to put on hold its recent circular on taxation of indirect transfers.

On 21 December, the tax department issued a clarification on the scope of indirect transfer provisions that sought to even apply these provisions to FPIs. This would have taxed any profits made by funds with underlying assets (including equities) in India.

These clarifications, in the form of answers to 19 questions, would have subjected FPIs, especially those with India-focused funds, to greater scrutiny by the income-tax (I-T) department and led to double taxation in many cases.

A Bloomberg Gadfly analysis estimated that “181 publicly traded funds whose India exposure is more than half of total assets” could be affected. These funds managed $39 billion of assets.

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The circular forced many foreign investors to make representations to the finance ministry asking the latter to reconsider the circular. They had pointed out that applying these provisions on offshore investors investing in these foreign funds or FPIs would lead to double taxation as they already pay securities transaction tax and tax on capital gains from selling of shares.

“After the issue of the aforementioned circular, representations have been received from various FPIs, FIIs (foreign institutional investors), VCFs (venture capital funds) and other stakeholders. The stakeholders have presented their concerns stating that the circular does not address the issue of possible multiple taxation of the same income,” said a statement by the tax department. “The representations made by the stakeholders are currently under consideration and examination. Pending a decision in the matter the operation of the above mentioned circular is kept in abeyance for the time being.”

Indirect transfer provisions were introduced in the I-T act in 2012 with retrospective effect, as the government sought to bring Vodafone Group Plc.’s $11 billion acquisition of Hutchison Essar Ltd in 2007 (by acquiring a Cayman subsidiary owned by Hutchison International) and other such transactions under the tax net in India.

Indirect transfer provisions deal with taxation of transactions wherein even though the transfer of shares took place overseas, the underlying assets were in India.

To remove the sting from the retrospective amendment to the tax laws by the previous government, the government had subsequently clarified that only those indirect transfer transactions wherein more than 50% of the underlying assets are in India will be subject to a levy of capital gains tax in India. But the clarifications also extended the tax to funds, including those outside India.

“We had sought that the circular be withdrawn. It would have impacted private equity investors,” said Mahendra Swarup, former president of the Indian Private Equity and Venture Capital Association.

“When private equity investments change hands, it happens overseas. The concern with the indirect transfer provision was that the Vodafone principle would have applied to them as well.”

Rajesh Gandhi, partner at Deloitte Haskins and Sells Llp, said the suspension of the circular will provide relief to FPIs. “We will now have to wait and see how the government amends the indirect transfer provisions to give relaxations to FPIs and other portfolio investors,” he said.