16 May 2021

Income arising on Indirect Transfer of Shares

BACKGROUND

In India, non-residents are taxed on income which accrues, arises or received or is deemed to accrue, arise or received in India. However, many developing countries including India have concerns with non-residents avoiding capital gains on assets located in source country, by transferring those assets indirectly, i.e. by transferring interests in entities that own such assets, rather than the assets themselves. This is possible where global businesses are held through multi-tiered structures with intermediate holding company outside India deriving substantial value from assets/business carried on in India.

In order to tax such offshore indirect transfer deriving value from Indian business/assets/entities, India has deemed such indirect transfer to accrue in India so as to tax them in certain circumstances.

The Coverage of the article is as under:

What is Indirect Transfer?

When shares of foreign company or interest in any entity incorporated or registered outside India is transferred and if such shares or interest derives its substantial value from assets located in India directly or indirectly, then such transfer is commonly referred to as ‘Indirect Transfer’.

In case of such indirect transfer, the income shall be deemed to accrue or arise in India and would be taxable for all including not ordinarily residents as well as non-residents.

When Share/Interest is said to derive its substantial value from assets located in India?

The share or interest would be regarded as deriving substantial value from assets located in India if on specified date, fair market value of such assets –

• Exceeds INR 100 million, AND
• Represents at least 50% of the fair market value of total assets owned by the foreign company/entity.

For the above purpose, specified date shall be -

• End date of the last accounting period preceding the date of transfer of share/interest of foreign company/entity; or
• Date of transfer, if book value of total assets of foreign company/entity on date of transfer exceeds book value of total assets on end date of last accounting period as above by 15%.

Note – Accounting period means 12 months period ending 31st March. If a foreign company/entity follows any other 12 months period for complying with tax provisions or reporting to shareholders/ interest holders, then such period shall be considered as the accounting period.

Note – The above deeming provision of indirect transfer does not cover declaration of dividend by such foreign company/entity.

Exceptional situations where Indirect Transfer provisions are not applicable to Non-residents

• The indirect transfer provisions are not applicable to Category I and II Foreign Portfolio Investors under SEBI (FPI) Regulations, 2014 prior to 23rd September 2019. Now the exemption from indirect transfer is available only to Category I FPI under SEBI (FPI) Regulations, 2019 effective 23rd September, 2019.
• Indirect transfer provisions shall not apply, if the non-resident transferor, directly or indirectly, at any time in the 12 months preceding date of transfer individually or along with its Associated Enterprise –
  • does not hold management or control rights
  • does not have voting power or interest or share in capital exceeding 5% of total voting power or interest or share capital, as the case may be.
• Transfer of shares of a Foreign Company (which directly or indirectly derives its value substantially from shares of Indian Company) under scheme of amalgamation or demerger subject to fulfillment of certain conditions. However, there is no express exemption available to shareholders of such Foreign Company.
• For a non-resident transferor, only that part of income shall be deemed to accrue or arise in India, which is reasonably attributable to assets located in India i.e. gains arising from transfer of share or interest in a foreign company/entity shall be taxable to the extent as such share or interest derives its value from Indian assets.

As per Rule 11C of Income Tax Rules, the above attribution shall be based on the following formula:-

Note – If above formula is not applied, then assessing officer shall determine such income attributable to Indian assets as he/she may deem fit.

• CBDT has also clarified1 that provisions of indirect transfer shall not apply to multi-tiered investment structures on redemption or buyback of share or interest held indirectly through upstream entities registered/incorporate outside India in Investment Fund/Venture Capital Fund/Venture Capital Company (specified funds) if such income accrues or arises from or in consequence of transfer of shares or securities held in India by specified funds and is chargeable to tax in India. The benefit shall be applicable only in those cases where the proceeds of redemption/buy back to non-resident do not exceed the pro rata share of non-resident in the total consideration realized by the specified funds from the said transfer in India. However, non-resident investing directly in the specified funds shall continue to be taxed as per the extant provisions.

Reporting requirements for Transferor

• The transferor of such share or interest needs to obtain an eligible accountant’s certificate in Form No. 3CT providing the basis of the apportionment in accordance with above formula prescribed as per Rule 11UC and certifying that income attributable to assets located in India is correctly computed.
• Form 3CT shall be furnished along with return of income u/s 139(1).
• Information required in Form 3CT.
• Details of consideration received
• Cost of Acquisition
• Date of Transfer
• Income derived from transfer of share or interest
• Income attributable to Indian Assets
• Value of Indian Assets
• Value of Global Assets
• Methods used for above valuations
• Other Supporting Documents

Reporting Requirements for Indian Concern

The Indian concern in/through which the foreign company /entity derives its substantial value shall have following reporting requirements as per Section 285A of income Tax Act, 1961 and rules laid down under Rule 114DB –

• Indian Concern shall electronically furnish information in Form 49D within 90 days from the end of financial year in which any indirect transfer has taken place. However, when above transfer has resulted in transferring the right of management or control in relation to Indian concern, then Form 49D shall be furnished within 90 days from the date of transfer.
• Various information has to be provided by Indian Concern, few details that are required are –
  • Details about complete Holding Structure of Indian concern along with other group entities in India
  • Contract/Agreement for transfer of asset
  • Financial statements of Foreign Company/Entity for 2 years prior to date of transfer
  • Information on business operations, personnel finance, properties, etc
  • Audit Reports, Valuation Reports, etc. of foreign entity
  • Details of payment of tax outside India.
  • Valuation Report in relation to Indian Asset and Total Assets

Computation of value of Assets

The valuation of assets is necessary to determine the income attributable to assets located in India. The value of assets shall be Fair Market value without reduction of liabilities and shall computed as per provisions of Rule 11UB of Income Tax Rules. The summary of such rules is given as follows:-

Rules for FMV Calculation of Indian Assets

Rules for FMV Calculation of Total Assets of Foreign Company/Entity

Disclaimer :

The information contained in this write up is to provide a general guidance to the intended user. The information is based on our interpretation of various prevailing laws, rules, regulations, pronouncements as on date mentioned below. The information should not be used as a substitute for specific consultations. The information has been provided in simplified manner for general reference of the public which can lead to interpretation not intended under law. Hence, we recommend that professional advice is sought before taking any action on specific issues before entering into any investment or financial obligation based on this Content.

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