INDIA: Taxability of overseas share sale – India influences African Tax Administrations
Since the 2012 Union Budget specified that shares of a foreign company would be deemed to be situated in India if it derives its value “substantially” from assets located in India, there has been uncertainty over what this really means. A recent case clarifies the matter.
Delhi High Court clarifies taxability of overseas share sale
Nikhil Rohera is an executive director and Ravindra Agrawal is an associate director at PricewaterhouseCoopers Pvt. Ltd, Mumbai, India
Corporates undertaking group reorganisations or share sale at overseas holding company levels have been facing uncertainty with regard to tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure... in India, owing to a specific provision which triggers Indian capital gains taxCapital Gains Tax (CGT) is a tax imposed on the profit an individual or entity earns from the sale or disposal of a capital asset. This tax is not levied on the total sale price of the asset but rather on the capital gain, which is the difference between the asset’s acquisition cost (or “base cost”) and its sale price.... in certain situations. The Indian revenue authorities have been asserting capital gains taxCapital Gains Tax (CGT) is a tax imposed on the profit an individual or entity earns from the sale or disposal of a capital asset. This tax is not levied on the total sale price of the asset but rather on the capital gain, which is the difference between the asset’s acquisition cost (or “base cost”) and its sale price.... where the ostensible objective was to transfer business in India.
Indian income taxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable...tax lawTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... provides that any share or interest of a foreign company will be deemed to be situated in India if it derives directly or indirectly its value ‘substantially’ from assets located in India. In other words, once this deeming fiction is triggered, a foreign share is treated as an Indian share thereby triggering capital gains taxCapital Gains Tax (CGT) is a tax imposed on the profit an individual or entity earns from the sale or disposal of a capital asset. This tax is not levied on the total sale price of the asset but rather on the capital gain, which is the difference between the asset’s acquisition cost (or “base cost”) and its sale price.... in India. However owing to the ambiguous nature of these provisions, uncertainties have arisen as to which transactions could get covered, what is threshold of assets in India, applicability of Tax TreatyA Double Taxation Agreement (DTA), also known as a Double Taxation Treaty (or a Tax Treaty), is an international tax treaty between two or more countries that aims to prevent individuals or businesses from being taxed twice on the same income. With globalisation and the increase in cross-border economic activities, DTAs have become essential tools for promoting trade, investment, and... provisions, etc.
Recently the Delhi High Court held, in a landmark judgment, the issue in favour of the taxpayer by prescribing a high benchmarkBenchmarking, within the context of transfer pricing, refers to the process of analysing and comparing financial and economic data from independent companies to establish a fair and arm’s length price for controlled transactions. It is typically conducted using databases that provide details about comparable companies and transactions. The objective is to determine whether the terms and conditions of intercompany transactions... of 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} for triggering the capital gains taxCapital Gains Tax (CGT) is a tax imposed on the profit an individual or entity earns from the sale or disposal of a capital asset. This tax is not levied on the total sale price of the asset but rather on the capital gain, which is the difference between the asset’s acquisition cost (or “base cost”) and its sale price.... in India.
In this case, Copal Group had undertaken a certain sale of shares of its group companies to Moody’s Group companies via a series of transactions. Earlier, the Authority for Advance RulingA tax ruling is a formal decision provided by a tax authority, clarifying how specific tax laws and regulations apply to an individual taxpayer or a corporate entity in particular circumstances. Often sought before a significant financial transaction or investment, tax rulings offer legal certainty by outlining the tax implications and obligations in advance. Such rulings are pivotal for multinational... (AAR) had decided this issue in favor of the taxpayer by pronouncing that no capital gain arises to Copal Group companies (Mauritius) from the transfer of their underlying shares / business in India to Moody’s Group companies outside India. The revenue appealed before the Delhi High Court against the AAR ruling. Their main plea was that the transaction of sale of shares by the Mauritius group companies was structured prima facie for avoidance of tax in India. They also argued that the real intention of the parties was to undertake a sale of shares at the ultimate parent level in Jersey which, if done prior to the other sale transactions, would have attracted capital gains taxCapital Gains Tax (CGT) is a tax imposed on the profit an individual or entity earns from the sale or disposal of a capital asset. This tax is not levied on the total sale price of the asset but rather on the capital gain, which is the difference between the asset’s acquisition cost (or “base cost”) and its sale price.... in India.
The High Court has now upheld the AAR’s decision by observing that the sale of shares by Mauritius companies was a bona fide transaction, having strong commercial justification. It therefore came to a conclusion that the transaction was not designed for avoidance of any tax in India.
As part of its argument, the Revenue had also alleged that since the two Mauritius group companies were effectively managed by an individual resident of UK, the Mauritius Tax TreatyA Double Taxation Agreement (DTA), also known as a Double Taxation Treaty (or a Tax Treaty), is an international tax treaty between two or more countries that aims to prevent individuals or businesses from being taxed twice on the same income. With globalisation and the increase in cross-border economic activities, DTAs have become essential tools for promoting trade, investment, and... benefit should not be granted to them as their place of effective management was not situated in Mauritius. They further pleaded that the two Mauritius group companies should be treated as non-operative or shell companies as their only income was from rendering services to other group companies. The High Court disagreed with the Revenue and confirmed the AAR’s conclusion that in the absence of any material available to the contrary, the management of the two companies rested with their Board of Directors in Mauritius. The High Court also observed that the corporate veil of the Mauritius entities cannot be lifted simply because they were rendering services to group companies.
For the sake of completeness, the High Court also dealt with the other contention of the revenue regarding alleged taxability under the indirect transfer tax provisions although the transactions were anyway held as non-taxable under the Tax TreatyA Double Taxation Agreement (DTA), also known as a Double Taxation Treaty (or a Tax Treaty), is an international tax treaty between two or more countries that aims to prevent individuals or businesses from being taxed twice on the same income. With globalisation and the increase in cross-border economic activities, DTAs have become essential tools for promoting trade, investment, and....
It will be recalled that after the Indian Supreme Court’s landmark decision in the Vodafone case in 2012, the then Indian Government had brought about a ‘clarificatory’ amendment to tax certain overseas share transfers. The retrospective amendment provided that any share or interest of a foreign company is deemed to be situated in India if it derives directly or indirectly its value ‘substantially’ from assets located in India. The retrospective amendment not only virtually overruled the Supreme Court ruling but was also widely and ambiguously drafted leaving many questions unanswered including on the precise threshold for applicability of the provisions.
The Delhi High Court has now thrown light on the term ‘substantially’ for the purpose of triggering indirect transfer provisions in India. It held that this issue can be addressed by reference to the express language of the provision as well as by applying the principle that income which is sought to be taxed in India must have territorial nexus with India.
The High Court observed that the intention of the amendment was not to extend the scope of deeming provisionsDeeming provisions are statutory mechanisms that treat a situation or entity as something other than what it is in reality for legal or tax purposes. These provisions are crucial in various areas of tax law, serving as tools for tax authorities to ensure that tax outcomes reflect economic substance rather than mere form. Essentially, a deeming provision can impose a... to income which had no territorial nexus with India. It was not justifiable to tax overseas income which arises from transfer of assets outside India and which do not derive the’bulk’ of the value from assets in India. The High Court therefore held that that the term “substantially” would necessarily have to be read as synonymous to “principally”, “mainly” or at least “majority”.
Reference was also made to an earlier Report of a Parliamentary Committee which recommended that the term ‘substantially’ should be defined at a threshold of 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the total value being derived from assets located in India. The High Court also referred to the OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... and UN Model Conventions, holding that these Conventions propose a regime which is generally accepted in respect of indirect transfers. Although not binding on Indian revenue authorities, the same would certainly have a persuasive value in interpreting the expression ‘substantially’ in a reasonable manner and in its contextual perspective. The High Court observed that the Capital GainsCapital gains refer to the profit earned when an asset, such as real estate, stocks, bonds, or even a collectible, is sold or exchanged for a price that exceeds its original purchase cost. These gains are a critical component of personal and corporate finance, as they influence investment strategies and tax obligations. Capital gains are realised when an asset is... Articles in these Model Conventions provide a threshold of 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} to determine if the share derives its value ‘principally’ from immovable property situated in India. In other words, the taxation rights in case of sale of shares are given to the country where the underlying assets are situated only if more than 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the value of such shares is derived from such property.
In the case before the Delhi High Court, the value of Indian assets appeared to be much less than 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the total assets of the foreign company. The High Court thus held that gains arising from sale of shares of a foreign company which derives less than 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of its value from assets situated in India would be outside the purview of the Indian income taxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable...tax lawsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public....
It is worthwhile to note that the present Indian income taxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable...tax lawTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... is proposed to be replaced by a new piece of legislation called the Direct Tax Code, which is currently at draft stage. In arriving at its conclusion, the High Court sought to draw analogy from the proposed Direct Tax Code draft of 2010 (which provided a similar threshold of 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}); interestingly however it did not refer to the 2013 draft which now provides a lower threshold of 20{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}.
To sum up, the decision of the High Court certainly is a welcome development, being the first Indian judgment which has provided much needed clarity with regard to the threshold for triggering indirect transfer provisions. The taxpaying community now hopes that the Indian Government will provide further clarity on other open issues concerning these farFunctional analysis is the cornerstone of transfer pricing and international tax compliance, ensuring that intercompany transactions adhere to the arm’s length principle. It evaluates the roles, contributions, and risk profiles of entities within a multinational enterprise (MNE) to determine how profits and costs should be allocated. This process ensures that related-party transactions reflect the pricing that independent enterprises would establish... reaching provisions, so that disputes with the revenue authorities can be avoided.
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