Taking Sting Out of Retro Tax

Mar 01 2015 : The Economic Times (Mumbai)

IN FOCUS - Taking Sting Out of Retro Tax

Hema Ramakrishnan





SILVER LINING: While Vodafone case continues, foreign investors can draw comfort as tax will be charged only on certain offshore deals where the underlying asset and value derived are in India

British mobile giant Vodafone hasn't been bailed out, with Finance Minister Arun Jaitley maintaining status quo on taxing past offshore deals. However, foreign investors can draw comfort as tax will be charged in India only on certain offshore deals where the underlying asset and the value derived thereon are in India.The Budget offers clarity on the conditions under which tax will be charged when Indian assets change hands between offshore entities. Here, Jaitley has done well to accept the recommendations of the Parthasarathi Shome panel, set up by the previous UPA government.

A US company, for example, holds global assets in various countries including India. The sale of the US company will attract tax in India only when the value of the Indian assets in its total assets is 50% or more. However, if the value is less than Rs 10 crore, then the sale will be tax free. The law says the Indian entity will have to provide information on offshore deals if they directly or indirectly change the ownership structure of the Indian company. Failure to do so will attract penalties.

"The clarification on indirect transfers is fair and reasonable as it will only impact any change in strategic interest, and not minority stakes. Moreover, the law is clear that indirect transfers through participatory notes and other indirect investments through off-shore funds will not be charged to tax", says Sudhir Kapadia, partner and national tax leader, E&Y.

Capital gains will be exempt when the transfer of shares of a foreign company deriving its value substantially from the shares of an Indian company is under a scheme of amalgamation or demerger.

However, the festering dispute with Vodafone or similar cases will not end with the Budget clarification. Vodafone had bought 67% of Hutchison Essar in February 2007 from the target company's Hong Kongbased parent. The actual payment was received by a Cayman Islands-based Hutchison group company; hence the parties to the deal held no tax was liable to be paid in India. This interpretation was contested by the I-T department. The Supreme Court ruled in Vodafone's favour, but Pranab Mukherjee's 2012 Budget changed the language of law. A retrospective clarification on the intent of tax law was meant to remove any un certainty or ambiguity. But that stays.

"While the threshold for `substantial' investment is accepted at 50%, the ex emption for small investors is only avail able for holding less than 5%. Moreover, while foreign mergers and demergers have been granted exemption from indirect transfers, there is a reporting requirement and penal consequences on failure to do so on the Indian company. In portfolio investment structures, the Indian firms may not be privy to the information on change in shareholding at the investor level. Therefore, the penal provisions are draconian," says Shefali Goradia, partner BMR Associates.