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Retrospective taxation likely to spare most foreign M&A deals
June, 04th 2012

The controversial provision to retrospectively tax indirect transfer of Indian assets through deals executed overseas is likely to spare a large number of transactions by excluding those where the Indian assets account for less than half the total deal size.

The retrospective amendment to the Income-Tax Act, part of this year's budget and which most tax experts say is targeted at Vodafone Plc, says overseas acquisitions and mergers that involve 'substantial' Indian assets will be taxed here.

It does not define 'substantial'. "It (substantial) could be defined as more than 50%," a finance ministry official told ET.

The finance ministry has begun internal discussions on administrative guidelines to be issued in the form of a circular to provide clarity on how such transactions will be dealt with by the tax authorities.

The clarification is intended to reassure edgy foreign investors, including foreign institutional investors and private equity investors, and also help improve the overall investment climate.

Such a definition of 'substantial' stake change would be in line with the one provided in the Direct Taxes Code that is likely to be implemented from the next fiscal.

Experts say the clarification will give much-needed relief to foreign investors as it will help exclude transfer of Indian assets in a global scheme of merger and acquisition, where these assets account for only a small proportion of the deal.

"If the 'substantial value' test is rightly defined at more than 50% Indian value attribution to the global transaction, it would give great comfort to global investors that the tax laws in India are not unreasonable," says Pranay Bhatia, associate partner, Economic Law Practice.

Says Rahul Garg, National Direct Tax Leader, PwC: "This would bring clarity and also exclude cases where substantial assets are not in India. But it would still need to be clarified that internal restructuring does not get hit even if value of asset derived from India is more than 50%."

Once internal discussions are over, a detailed circular will be issued by the Central Board of Direct Taxes, the apex body in charge of direct taxes.

Government officials say the circular will provide certainty to foreign investors on the kind of transactions that could become taxable.

The rule will apply to deals in which income tax assessment is not complete. The law does not apply to cases where assessment has been concluded.

A dozen such deals could fetch the government as much as 40,000 crore - more than half of it from Vodafone alone, finance ministry officials say.

Vodafone, which is being pursued by Indian authorities for not withholding tax on a 2007 deal in which it bought the local telecom business of Hutchison, is likely to challenge the validity of the tax demand before an international arbitration tribunal.

Foreign investors have been wary of investing here after the budget introduced the General Anti-Avoidance Rules, or GAAR, and changed the income-tax law retrospectively. Responding to the widespread concern, the government deferred GAAR by a year after FIIs pulled out nearly $1 billion from India in April.

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