By TII News Service

NEW DELHI, DEC 21, 2016: UNDER the indirect transfer provisions contained in section 9(1)(i) of the Income Tax Act, 1961, 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. Explanation 5 thereof 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. Explanation 6 provides that the said Explanation 5 will be applicable, if on the specified date the value of such assets exceeds the amount of Rs 10 crore and represents at least 50% of the value of all the assets owned by the company/entity. Explanation 7, however, provides a carve out from the applicability of Explanation 5 to small investors holding no right of management or control of such company/entity and holding less than 5% of the total voting power/share capital/interest of the company/entity that directly or indirectly owns the assets situated in India. Section 285A of the Act casts a reporting obligation on the Indian concern whose shares are substantially held directly or indirectly by a company or entity registered or incorporated outside India.

In this background, the Board received several queries from the India Inc and to study the same the Board set up a Working Group on June 15 and has finally issued detailed clarifications:

Question No. 1: A Fund is set-up in a popular jurisdiction and registered as FPI for undertaking portfolio investment in Indian securities. It pools monies from retail/institutional investors and invests in shares of Indian listed companies. The value of assets in India i.e. shares of Indian companies held by the Fund constitute more than 50% of its total assets and exceed Rs.10 crores. The Fund buys and sells shares on the Indian stock market and pay taxes as per section 115 AD of the Act or applicable tax treaty rates. On the ongoing basis, the Fund, on request of its unit holders/shareholders, redeems their units/shares. Does Explanation 5 to section 9(1)(i) of the Act apply to above redemption made by the Fund?

Answer: Explanation 5 to section 9(1)(i) of the Act will be applicable in respect of investors in the Fund also, as their case falls within the ambit of clause (a) of Explanation 6 of the said section. However, the investors covered under Explanation 7(a)(i) of the Act are excluded.

Question No. 5: An offshore listed fund is registered as an FPI for undertaking portfolio investment in Indian securities. The value of Indian assets i.e. shares of Indian companies held by the offshore listed fund constitute more than 50% of its total assets and exceed Rs.10 crores. The investors or unit holders of the offshore listed fund keep on changing on daily basis and settlement of funds for buying and selling is done through stock exchange prescribed settlement mechanism. Will indirect transfer provisions apply on transfer of shares or units of an offshore listed entity?

Answer: Explanation 5 to section 9(1)(i) of the Act will be applicable in respect of investors in the Fund also, as their case falls within the ambit of clause (a) of Explanation 6 of the said section. However, the investors covered under Explanation 7(a)(i) of the Act are excluded.

Question No. 7: Fund X and Fund Y are 'non-corporate' entities formed in country A. Company Z is a SPV formed in a tax efficient jurisdiction exclusively for Indian investments. Fund X holds 100% of shareholding of Company Z. On account of a scheme of amalgamation, Fund X is merged into Fund Y in Country A. The merger is tax neutral in Country A. Consequent to the merger, investors of Fund X became investors in Fund Y. Will indirect transfer provisions apply in case of offshore amalgamation or demerger of foreign 'non-corporate' entities?

Answer: The provisions of section 47 of the Act apply only in respect of amalgamation of corporate entities. Consequently, the amalgamation of non-corporate entities well attract the provisions of section 9(1)(i) of the Act.

Question No. 19: Given the uniqueness in FPI operational structure and the challenges to comply with indirect transfer tax provisions, it is suggested that FPIs should be relieved from the withholding tax requirement. Alternatively, the threshold for enforcing such requirement on the FPIs may be increased. Further, it should be clarified that no interest or penalty for failure to deduct taxes at source will be levied and the FPI will not be treated as an 'assessee in default' or the 'representative assessee', on account of retrospective application of indirect transfer provisions.

Answer: The provisions of withholding tax, interest and penalty shall apply as per law.

(See Circular No 41)