The government put on hold a controversial circular on the taxation of indirect transfers of Indian assets and may amend the income tax law to provide stability and clarity to foreign portfolio investors (FPIs) as it looks to rekindle interest in the country as an investment destination.

FPIs became concerned about being landed with tax bills from transactions in previous years following a clarification issued by the Central Board of Direct Taxes (CBDT) in December. Its statement on Tuesday sought to set those fears at rest, at least for now.

"Representations have been received from various FPIs, FIIs (foreign institutional investors), VCFs (venture capital funds) and other stakeholders," CBDT said. "The stakeholders have presented their concerns stating that the circular does not address the issue of possible multiple taxation of the same income. The representations made by the stakeholders are currently under consideration and examination."
FPIs
Pending a decision in the matter, the operation of the December circular has been kept in abeyance, it said.

The December statement said FPIs were subject to provisions relating to the indirect transfer of Indian assets. That circular, in the form of frequently asked questions (FAQs), said that if the value of shares of Indian companies held by a fund constituted more than 50% of its total assets and the value of the holding exceeded Rs 10 crore, the transaction would be taxed in India under the indirect transfer rules.

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The government is looking to take the sting out of the provisions with regard to FPIs.

"It is being examined... It needs to be seen how it can be addressed," said a government official.

The government may look at providing 'carve-outs' or substantially dilute the applicability of the provisions on FPIs. An amendment to this effect may be introduced in the February 1 budget, the official said.

This needs to be codified in the income tax law itself to remove any doubts and provide stability to foreign investors.

The circular was issued following representations from the industry that had sought to know whether the provisions applied to FPIs. It unnerved foreign funds who fear that transactions prior to 2015 could be taxed with retrospective effect. Public market funds and private equity funds that manage India-focused funds via the special purpose vehicle investment structure are particularly concerned over extra-territorial applicability of the Indian income tax law.

Experts agree that the FAQ was only a reading of the law and the intent behind the legislation was not to tax FPIs in the first place.

"Best way to do it would be to provide a carve-out for foreign portfolio investors like it was done in the case of minimum alternate tax (MAT)," said Ashutosh Dikshit of BMR & Associates. In the FY16 budget, the government had said MAT will not apply to foreign institutional investors. A similar clarification will suffice in the case of indirect transfers as well, Dikshit said.

RETROSPECTIVE ORIGIN

The issue has its origin in the controversial retrospective amendment to the Income Tax Act 1961 in 2012 to negate a Supreme Court ruling in favour of Vodafone over a significant tax claim on its 2007 deal with Hutchison Whampoa to buy a majority stake in its Indian telecom subsidiary.

The retrospective law enacted by the previous United Progressive Alliance government sought to tax the indirect transfer of an Indian asset by providing that a share or interest in a company or entity registered or incorporated outside India shall be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from assets located in India.

The government decided not to repeal the amendment but assured investors that there would be no retrospective application of the law. The government introduced substantive clarifications to the provision from 2015.

Interestingly, the circular ignored the recommendations of the Parthasarathi Shome committee set up by the previous government on indirect transfer issue that suggested keeping FPIs out of the indirect transfer rule.