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The current tax law provides for deeming provisions by virtue of which it creates a legal fiction and enables to tax income whether or not arising in India. One of such situation covered under the current tax law is income arising or accruing directly or indirectly through transfer of capital asset situate in India.

This was inter-alia the central point of dispute in Vodafone case which ultimately involved Honorable Supreme Court to resolve the controversy. It was argued by Vodafone that overseas transfer of shares of a foreign company does not fall within the ambit of aforesaid deeming fiction and consequently not be subject to tax in India. Honorable Supreme Court held that (based on the facts) the aforesaid deeming section cannot be extended to cover indirect transfer of capital assets or property situated in India, giving a huge relief to Vodafone and other international investors and a huge blow to revenue authorities.

However, the bliss conferred to international investors by the Supreme Court was short-lived as the Finance Bill, 2012 (‘the Bill’) seeks to re-open the controversy surrounding taxation in India of overseas transfers.  The Bill proposes to amend the deeming fiction to provide for taxation of overseas transfer of shares or interest of an overseas entity deriving substantial value from Indian assets (directly or indirectly). So much so the aforesaid changes are retrospective and have been brought by way of an explanation which essentially means that such overseas transfers were always subject to tax in India.

Incidentally, the proposed Direct Taxes Code, 2010 (‘DTC’) also proposes to tax transfers outside India of shares in a foreign company in proportion to fair market value of assets located in India, where fair market value of assets in India exceeds 50 per cent of the value of all assets owned by such foreign company.

Further, Bill proposes to specify certain transactions which would be subject to withholding tax obligations irrespective of the fact whether or not such transactions are taxable in India.

The proposed amendments are outrageous and if enacted, would impact numerous cross border transactions as all transactions involving overseas transfers where there the value is substantially derived from Indian assets would get impacted. Offshore private equity funds, which either wholly or substantially focus on India investments, would most certainly be impacted as any overseas exit by the Fund or the investors of the Fund would become taxable in India subject to tax treaty benefits. Given the retrospective amendment, it may re-open the settled cases too and cases which were hoping to rely on Honorable Supreme Court decision in Vodafone case.

The aforesaid amendment is bound to adversely impact investor sentiments. One would have to wait and watch whether the intention of the Finance Ministry sees the light of day.

(Punit Shah is Partner, KPMG and Heads Tax & Regulatory Services for Private Equity/Venture Capital Funds)

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