The CBDT has issued Circular No.28/2017 dated 7th of November 2017 in which it has provided important clarification on Indirect Transfer provisions in case of redemption of share or interest outside India under the Income-tax Act, 1961
Government of India
Ministry of Finance
Department of Revenue
Central Board of Direct Taxes
Dated, the 7th of November 2017
Sub: Clarification on Indirect Transfer provisions in case of redemption of share or interest outside India under the Income-tax Act, 1961
Under the provisions contained in section 9(1 )(i) of the Income-tax Act, 1961 (‘Act’), all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situate in India, shall be deemed to accrue or arise in India. Explanations 5, 6 and 7 of section 9(1 )(i) further define the scope of said provision.
2. Concerns have been expressed by investment funds, including private equity funds and venture capital funds that on account of the extant indirect transfer provisions in the Act, non-resident investment funds investing in India, which are set up as multi-tier investment structures, suffer multiple taxation of the same income at the time of subsequent redemption or buyback. Such taxability arises firstly at the level of the fund in India on its short term capital gain/ business income and then at every upper level of investment in the fund chain on subsequent redemption or buyback. The Board has received representations to exclude investors above the level of the direct investor. who is already chargeable to tax in India on such income. from the ambit of indirect transfer provisions of the Act.
3. Addressing such concerns in his Budget speech on 1st February, 2017. the Finance
Minister had stated that Category I and Category II Foreign Portfolio Investors (FPI) will be exempted from indirect transfer provisions. It was also stated that a clarification will be issued that indirect transfer provisions shall not apply in case of redemption of shares or interests outside India as a result of or arising out of redemption or sale of investment in India which is chargeable to tax in India.
4. Vide Finance Act, 2017, Category I and Category II FPls have already been exempted from indirect transfer provisions of the Act through insertion of proviso to Explanation 5 to section 9(1)(i) of the Act, with effect from 01 .04.2015.
5. There could be situations in multi-tiered investment structures, where interest or share held indirectly by a non-resident in an Investment Fund or a Venture Capital Company or a Venture Capital Fund (hereinafter referred to as ‘specified funds’), is redeemed in an upstream entity outside India in consequence of transfer of shares or securities held in India by the specified funds, the income of which have been subject to tax in India. In such cases, application of indirect transfer provisions on redemption of share or interest in the upstream entity may lead to multiple taxation of the same income. In respect of Category I and Category II FPls though, such multiple taxation will not take place on account of the insertion of proviso to Explanation 5 to section 9(1)(i) of the Act, vide Finance Act, 2017 .
6. The matter has been examined by the Board and it has been decided that the provisions of section 9(1)(i) of the Act read with Explanation 5 thereof shall not apply in respect of income accruing or arising to a non-resident on account of redemption or buyback of its share or interest held indirectly (i.e. through upstream entities registered or incorporated outside India) in the specified funds if such income accrues or arises from or in consequence of transfer of shares or securities held in India by the specified funds and such income is chargeable to tax in India. However, the above benefit shall be applicable only in those cases where the proceeds of redemption or buyback arising to the nonresident do not exceed the pro-rata share of the non-resident in the total consideration realized by the specified funds from the said transfer of shares or securities in India. It is further clarified that a non-resident investing directly in the specified funds shall continue to be taxed as per the extant provisions of the Act.
For the purposes of this Circular, (i) “Investment fund” shall have the meaning assigned to it in clause (a) of Explanation 1 to section 115UB of the Act.
(ii) “Venture capital company” and “venture capital fund” shall have the meanings respectively assigned to them in Explanation to clause (23FB) of section 10 of the Act.
Under Secretary [FT&TR-IV(1)]
The Circular is purported, and obviously intended, to be a benevolent circular, of a clarificatory nature. That has come to be issued as a result of a protracted dialogue, and at the end of prolonged consideration. In doing so, the Revenue has presumably realized the validity, rather conceded , in principle, the legitimacy of the point of issue raised.
However, what is not readily reconcilable is the portion of the clarification, which reads, that the tax exemption shall apply, – “…….ONLY IN THOSE CASES WHERE THE PROCEEDS OF REDEMPTION OR BUYBACK ARISING TO THE NONRESIDENT DO NOT EXCEED THE PRO-RATA SHARE OF THE NON-RESIDENT IN THE TOTAL CONSIDERATION REALIZED BY….”.
As quickly viewed, to state briefly, in so carving out, and limiting the scope for the agreed exemption, the circular issued suffers from the malady of a self-contradiction, an apparent inconsistency; and as such, the disputed point of issue does not seem to have been fully and finally resolved, amicably.
And,as such, one and all concerned, directly or indirectly, – including the vested interests and their advising professionals, may have to wait for possible further developments.