INDIRECT TRANSFER PROVISIONS
Proposed Amendment
Vide clause 4 of The Finance Bill, 2017 (for short “Bill”) Explanation 5A has been proposed to be inserted after Explanation 5 in clause (i) of section 9(1) (for short ‘Explanation 5’) with retrospective effect from 1st day of April, 2012. Proposed Explanation 5A reads as under:
“Explanation 5A — For the removal of doubts, it is hereby clarified that nothing contained in Explanation 5 shall apply to an asset or capital asset mentioned therein, which is held by a non-resident by way of investment, directly or indirectly, in a foreign institutional investor as referred to in clause (a) of the Explanation to section 115AD and registered as Category-I or Category-II foreign portfolio investor under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 made under the Securities and Exchange Board of India Act, 1992.”
Introduction
Section 115AD specifies different rates of tax in respect of income of Foreign Institutional Investors (FIIs) from securities or capital gains arising from their transfer. Clause (a) of Explanation to Section 115AD defines expression “Foreign Institutional Investor” being such investor as the Central Government may, by notification in the Official Gazette specify in this behalf.
Accordingly, with retrospective effect from 1st day of April, 2012 the Foreign Institutional Investor, as referred to in clause (a) of the Explanation to section 115AD and who is also registered as Category-I or Category-II foreign portfolio investor under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 made under the Securities and Exchange Board of India Act, 1992, has been proposed to be exempted from the applicability of Explanation 5 in clause (i) of section 9(1).
This amendment has been made retrospectively w.e.f. 1-4-2012 and applicable to A.Y. 2012-13 and subsequent years.
Legislative History of the Provision
To understand the importance and impact of such proposed amendment, it would be necessary to refer to the legislative history of the Explanation 5. This Explanation was added to clause (i) of section 9(1) along with Explanation 4 by the Finance Act, 2012 w.r.e.f. 1st day of April, 1962. Section 9 in Chapter II of The Income Tax Act 1961 (Act) specifies the incidences of income deemed to accrue or arise in India. Explanation 4 was added to this section to clarify the expression ‘through’ which shall mean and include and shall be deemed to have always meant and included ‘by means of’, ‘in consequence of’ or by ‘reason of’. At the same time Explanation 5 clarifies 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.
After insertion of Explanations 4 and 5 to section 9(1)(i) w.r.e.f 1-4-1962, number of representations were received by the CBDT expressing the apprehensions about the applicability of the Explanation to the transactions not resulting in any transfer, directly or indirectly of assets situated in India. It has been pointed out that such an extended application of the provisions of the Explanation may result in taxation of dividend income declared by a foreign company outside India. This may cause unintended double taxation and would be contrary to the generally accepted principles of source rule as well as the object and purpose of the amendment made by the Finance Act, 2012. To remove such doubts the CBDT has issued Circular No. 4/2015 dated 26-3-2015 and clarified that “Declaration of dividend by such a foreign company outside India does not have the effect of transfer of any underlying assets located in India. It is therefore, clarified that the dividends declared and paid by a foreign company outside India in respect of shares which derive their value substantially from assets situated in India would not be deemed to be income accruing or arising in India by virtue of the provisions of Explanation 5 to section 9(I)(i) of the Act.”
Thereafter, Explanations 6 and 7 are inserted in section 9(1)(i) by the Finance Act, 2015, w.e.f. 1-4-2016. The scope of these Explanations on ‘Notes on clauses’ in the Finance Bill, 2015 as under:
Clause 5 of the Bill seeks to amend section 9 of the Income-tax Act relating to income deemed to accrue or arise in India.
Clause (i) of sub-section (1) of the aforesaid section provides a set of circumstances in which income accruing or arising, directly or indirectly, is taxable in India. Explanation 5 to the said clause provides that an asset or 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.
It is proposed to amend the said clause (i) by insertion of Explanation 6 to provide that the share or interest shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India, if, on the specified date, the value of such assets is more than ten crore rupees and represents at least fifty per cent of the value of all the assets owned by the company or entity, as the case may be. The definition of value of assets and the specified date is also proposed to be provided in the said Explanation.
It is further proposed to insert Explanation 7 in the said clause (i) so as to provide that the income shall not accrue or arise to a non-resident in case of transfer of any share or interest referred to in Explanation 5, unless——
(a) He along with its associate enterprises,——
(i) Neither holds the right of management or control;
(ii) Nor holds voting power or share capital or interest exceeding five per cent of the total voting power or total share capital, in the foreign company or entity directly holding the Indian assets (direct holding company);
(b) He along with its associate enterprises, in case of the transfer of shares or interest in a foreign entity which does not hold the Indian assets directly ——
(i) Neither holds the right of management or control in relation to such company, as the case may be, or the entity.
Discussion
Section 9(1)(i) describes that any income accruing or arising whether directly or indirectly; a) through or from any business connection in India, or b) through or from any property in India, or c) through or from any asset or source of income in India, or d) through the transfer of a capital asset situated in India, is deemed to accrue or arise in India. Several Explanations are added to explain this clause of section 9. Explanations 4 and 5, as mentioned earlier, were added by the Finance Act, 2102.
Hon’ble Delhi High Court in the case of DIT v. Copal Research Ltd. 371 ITR 114 (Del.) has considered the scope of Explantion 4 and 5 to section 9(1)(i) of the Act. The reference can be made to the following observations:
“It is trite law that a legal fiction must be restricted to the purpose for which it was enacted. The object of Explanation 5 was not to extend the scope of section 9(1)(i) of the Act to income, which had no territorial nexus with India, but to tax income that had a nexus with India, irrespective of whether the same was reflected in a sale of an asset situated outside India. Viewed from this standpoint there would be no justification to read Explanation 5 to provide recourse to section 9(1)(i) for taxing income which arises from transfer of assets overseas and which do not derive bulk of their value from assets in India. In this view, the expression “substantially” occurring in Explanation 5 would necessarily have to be read as synonymous to “principally”, “mainly” or at least “majority”. Explanation 5 having been stated to be clarificatory must be read restrictively and at best to cover situations where in substance the assets in India are transacted by transacting in shares of overseas holding companies and not to transactions where assets situated overseas are transacted which also derive some value on account of assets situated in India. In our view, there can be no recourse to Explanation 5 to enlarge the scope of Section 9(1) of the Act so as to cast the net of tax on gains or income that may arise from transfer of an
asset situated outside India, which derives bulk of its value from assets outside India.”
Their lordships also observed that “by virtue of Section 9(1)(i) of the Act all income arising from transfer of a capital assets situated in India would be deemed to accrue or arise in India and would thus be exigible to tax under the Act. A share of a company incorporated outside India is not an asset which is situated in India and, but for Explanation 5 to Section 9(1)(i) of the Act, the gains arising out of any transaction of sale and purchase of a share of an overseas company between non-residents would not be taxable in India. This would be true even if the entire value of the shares of an overseas company was derived from the value of assets situated in India. This issue arose in the case of
Vodafone International Holdings BV v. Union of India [2012] 341 ITR 1/204 Taxman 408/17 taxmann.com 202 (SC) and the Supreme Court held that the transaction of sale and purchase of a share of an overseas company between two non-residents would fall outside the ambit of Section 9(1)(i) of the Act.”
The above decision has been challenged by the Department in SLP filed before Apex Court which has been admitted. The legal battle on this issue will be going on until set at rest by the Apex Court.
Conclusion
Not going into much detail and restricting the discussion to the subject, it may be mentioned that by proposed insertion of Explanation 5A after Explanation 5 to Section 9(1)(i), an attempt has been made to bring certainty to some extent to the incidence of tax in the hands of Foreign Institutional Investors (of the categories specified in proposed Explanation 5A) with retrospective effect from A.Y. 2012-13 onwards which is a welcome move and augment foreign investment in India.
DOMESTIC TRANSACTIONS
Inroduction
Section 92BA was introduced by section 36 of the Finance Act, 2012, w.e.f. 1-4-2013 in order to give an exhaustive meaning of the expression “specified domestic transaction” as appearing in sections 92, 92C, 92D and 92E of the Act. It inter alia provides that any expenditure in respect of which payment has been made by the assessee to certain “Specified Persons” u/s. 42A(2)(b) is covered within the ambit of specified domestic transactions.
With the efflux of time it was noticed that the related parties to whom such payments are made by the entities, which were under obligation to comply with the transfer pricing provisions, were also bearing maximum marginal rate of tax. Section 92BA was brought to the statute with an objective to introduce anti-domestic tax avoidance regulations extending the scope of India transfer pricing regime and such step was in accordance with the decision of the Hon’ble Supreme Court in the case of
Glaxo Smithkline Asia (P.) Ltd. [2010] 236 CTR 113 (SC).
These provisions were introduced with a minimum compliance of threshold limit of ₹ 5 crore. It was noticed by the authorities that assessee’s have faced a lot of administrative and compliance burden and therefore, the said limit of ₹ 5 crore was enhanced to ₹ 20 crore by the Finance Act, 2016 w.e.f. 1-4-2016 and the proposed amendment by the Finance Bill, 2017 is in furtherance of reducing the over burdened compliance obligations of the entities falling under these provisions.
Thus, in order to relieve the entities falling within this category from over-burdened compliance, an amendment has been proposed by introduction clauses 15 and 41 in the Finance Bill, 2017 which provides that expenditure in respect of which payment has been made by the assessee to a person referred to in u/s. 40A(2)(b) are to be excluded from the scope of section 92BA of the Act. Accordingly, it is proposed in the Finance Bill, 2017 to omit clause (i) in section 92BA which reads as under:-
(i) Any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A;
Consequential amendment has also been proposed to be made in the proviso to clause (a) in sub-section (2) of section 40A of the Act. These amendments will take effect from 1-4-2017 and would be applicable in relation to Assessment Year 20017-18.
Conclusion
It is a welcome amendment as it has relieved the domestic assessees from the great burden of compliance and reporting of the transactions which, from the past experience, have largely been found to be tax neutral. However, the other clauses of section 92BA of the Act remain ineffective particularly in relation to the entities where any of them is claiming deductions/exemption. So, without losing any revenue, the amendment has been made to reduce the burden of compliance.
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