The 'indirect transfer provisions' monster

The most important task of the Finance Minister in the 2017-18 budget is to tame the Indirect Transfer Provisions monster born out of amendments to Section 9 of the Income Tax Act, 1961.

By Vaijayantimala S Belsare  
Wednesday, January 25, 2017

The most important task of the Finance Minister in the 2017-18 budget is to tame the "Indirect Transfer Provisions" monster born out of amendments to Section 9 of the Income Tax Act, 1961. In response to the Supreme Court's judgement in the famous Vodafone case, the Finance Act, 2012 amended Section 9 of the Income Tax Actto cover gains earned by overseas investors from sale or transfer of business interests/shares in companies/capital assets/property situated/held in India.  Accordingly, such gains were made subject to capital gains tax under Section 9(1)(i) of the Income Tax Act, 1961 with the conditions that the Indian assets should exceed INR 10 crore and should represent at least 50 per cent of the value of total assets held by the overseas investor.  Small investors holding less than 5 per cent of the share capital/voting power/interest and/or holding no right to management/control of the company are exempted from the above provisions.The Foreign Portfolio Investors ('FPI'), PE and VC investors are the most affected from these amendments as significant challenges stare in their faces, which are made worse as the provisions are applicable with retrospective effect.Stakeholders have multiple questions on the applicability of Section 9(1)(i), without much clarity from the Central Board of Direct Taxes (CBDT).  Hence, the present uncertainty could resultin "not so positive" outlook for India as an attractive global investment destination going forward.

Section 9(1)(i) levies a long-term capital gains tax @20 per cent on sale or redemption of the investments.  The tax rate could go up to 40 per cent in case the investments are held for less than 3 years.  The FPI's are already subject to short term capital gains tax and securities transaction tax (STT) on the gains earned on the transfer of Indian securities listed on the stock exchanges.  This clearly suggests "double taxation" on the same income.  Further, to the extent investors are subject to tax in their home jurisdictions, there is a risk of triple taxation.  The whole thing could result into multiple layers of taxation on the same income with the possibility of total tax bill exceeding the amount of income earned.  This certainly is a cause of significant concern to the investors.

One of the most important contributors to the development of the Indian stock marketshas been the increasing participation of Foreign Institutional Investors (now FPI) over the past two decades.  Be it pumping in huge amount of external capital, transformation of the stock exchange infrastructure or improving the visibility of listed stocks and a consequent boost to the domestic investor confidence, FPI's have been responsible for providing impetus to the overall economy and increased valuations of the Indian stocks.  

Financial year 2015-16 witnessed the highest volume of net FPI investments aggregating INR 18,106 crore ($2.68 billion) at 31 March 2016 (Statistics: India Brand Equity Foundation).  However, since the last quarter ended December 2016, the FPI's have been net sellers of investments, primarily due to the collective impact of demonetisation, results of US elections and increase in the interest rates by US Federal Reserve.  

Despite the impact of demonetisation on the economy where growth in some sectors hasbeen significantly impacted, India'smodified GDP forecast still stands at 7.10 per cent, which FPI's will be looking forward to.  India is the most preferred investment destination within Asia and other emerging markets due to its growth potential. So far, the FII participation has been very consistent over the years and the trend should continue.  

India needs external capital to boost key sectors such as "infrastructure", "IT" and to support the overall "start-up" eco system. Excessive tax burden can significantly impact FPI's portfolio asset valuations and a consequently affect the investor demand. Accordingly, one of the critical factors to ensure successful FPI investments is establishing reasonable and efficient tax regime, which will ensure optimum returns for the investors. This is non-negotiable if we want to continue the India growth story!

The way forward should be to modify "Indirect Transfer Provisions" under Section 9 of ITA to eliminate double and triple taxation on same income, to make it applicable prospectively and reduce the administrative burden of related tax filings on the investors.  Hope the budget 17-18 brings about the changes to ensure the sustained growth of the economy!(The writer is an alumnus of PGPMAX, Indian School of Business(ISB) and Partner, ASA & Associates LLP)

 

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