Tax Hotline August 03, 2012

Taxation of Offshore Share Transfers

Concerns of FIIs and QFIs Referred to GAAR Committee

The Indian Prime Minister has recently referred the amendment to the Income Tax Act, 1961 (“ITA”), providing for taxation of offshore share transfers, to the Expert Committee on General Anti-Avoidance Rules (“GAAR”). In particular, the Government seeks to examine whether any relief should be provided in respect of transfer of offshore assets, which derive value from underlying Indian listed securities or portfolio investments made pursuant to the guidelines framed by the Securities and Exchange Board of India (“SEBI”). The reference to the Expert Committee seeks to address the concerns of Foreign Institutional Investors (“FIIs”), and the newly introduced category of Qualified Foreign Investors (“QFIs”), which are permitted to make portfolio investments through a recognized stock exchange in India under applicable SEBI guidelines.

The issue referred to the Expert Committee emanates from the recent amendment of the Income Tax Act, 1961 (“ITA”)1, which provides for (i) retroactive taxation of gains arising from transfer of any share or interest, in a company or entity registered or incorporated outside India, where such shares or interest derives, directly or indirectly, its value substantially from assets located in India2; and (ii) the introduction of the GAAR with effect from April 1, 2013. There are concerns that both of these amendments could potentially capture the transfer or redemption of shares, or an interest, in FIIs or QFIs with underlying Indian investments; including the transfer or redemption of an economic interest like a offshore derivative instruments (“ODIs”) or participatory notes issued by FIIs to their non-resident clients.

Due to widespread representations from stakeholders in relation to the much criticized draft guidelines on GAAR3, the Prime Minister had constituted an Expert Committee on GAAR on July 13, 2012 to carefully study the relevant issues and formulate a road map for implementation of GAAR in India. The Expert Committee will now consider the additional issue relating to taxation of portfolio investments, by virtue of the new amendment for taxation of offshore transfer of assets where underlying assets are in India. This would include cases of redemption or transfer of ODIs which trace their value to Indian listed stocks. The Government has indicated that any clarification from the Expert Committee needs to be harmonized with the GAAR guidelines and will have to address any residual concerns outside of GAAR, thus, leaving scope for the stakeholders to bring any additional concerns to the notice of the Expert Committee.

Before the enactment of the 2012 amendments, the erstwhile Finance Minister of India had given an oral assurance that the retrospective amendments to the ITA for taxation of indirect transfer of Indian assets would not be applicable to participatory notes or ODIs issued by FIIs. However, a plain reading of the provisions of the ITA may indicate that they are wide enough to apply to cases of redemption or transfers of shares or interests in non-resident investors, like FIIs and QFIs. It is hoped that the Expert Committee will consider the special difficulties faced by FIIs, QFIs and their investors in light of the recent amendments and ensure that the assurances regarding exclusion of ODIs are translated into law.

Another important issue that requires consideration by the Expert Committee is the issue regarding taxation of trades in foreign listed securities. In order to reassure foreign investors and remove unintended hardships, it is necessary to clarify that purchase and sale of a foreign company listed on a foreign stock exchange would not be taxed in India.

The reference of the tax issues to the Expert Committee certainly adds a degree of fairness to the process of finalization of tax policy and it is hoped that industry concerns and difficulties faced by investors are duly considered. Since the reference enables the Expert Committee to address additional concerns outside GAAR, it is a good opportunity for stakeholders to provide their consolidated feedback on some of the new onerous provisions of the ITA that are of special concern to FIIs, QFIs and other foreign investors. It is necessary for the country to take all steps to improve investor sentiments and boost investments into the country.

Vivaik Sharma & Mahesh Kumar
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1 Finance Act, 2012.

2 With effect from April 1, 1962.

3 Refer to our hotline ‘Draft GAAR guidelines: More threatening than Welcoming to Foreign Investors’, dated July 3, 2012.

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