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Retrospective taxability of Indirect Transfer of Assets
March, 17th 2012

India continues to be a preferred destination for global investment in view of its demographic advantage and burgeoning middle class.  Even as the developed world continues to struggle with its swelling debt, aging population and lower demand, the India story looks strong and upbeat and hence, overseas investors continue to show a keen interest in India.

Historically, overseas investors have adopted multi-tier holding structures typically based out of tax friendly jurisdictions while investing in India.  Such a structure provided an opportunity to overseas investors to exit from India by means of a cross border transaction involving non-residents, resulting in minimal or nil tax implications.
The posture adopted by the Revenue authorities in the case of the Hutch-Vodafone transaction has lead to overseas investors reviewing their shareholding structure.  The Hutch-Vodafone transaction entailed sale of shares of Hutch's British Virgin Island entity (which ultimately held shares in the Indian company) to Vodafone's Dutch entity.  The Revenue authorities sought to tax this transaction on the ground that it involved the transfer of underlying capital assets situated in India and hence was taxable in India.  Since Vodafone had not withheld tax on the payment made to Hutch, Vodafone would have to make good the tax loss caused to the Indian treasury. On the other hand, Vodafone contended that since the transaction was between two non-residents and involved sale of shares of a non-resident company, India did not have the jurisdiction to tax the same.

After a long and bruising battle for Vodafone, the Indian Supreme Court accepted Vodafone's contention on the grounds that there were no enabling provisions within India's laws to levy tax on such a transaction.
Given the stakes involved, the global interest generated by the case and the fact that enabling provisions had already been mooted in the proposed Direct Tax Code, it was expected that the Government would bring in legislation to plug any loop holes in India's laws to ensure that such transactions would be brought within the tax net.  However, today's budget has gone a step further and has not only brought in amendments to tax indirect transfer of assets but has done so with retrospective effect and has hence negated the ruling of the Supreme Court.
Introducing the above legislation with retrospective effect would have far reaching implications on foreign investments in India, since such an amendment would create a perception amongst global investors that even a ruling of India's highest judicial authority is not sacrosanct.  It would be indeed interesting to see as to how the Vodafone ruling will be implemented in light of the proposed amendment.  Although the growth story of India looks promising, with the new retrospective amendments India is likely to lose some of its sheen for foreign investors.

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