Overseas acquisition deals between foreign companies involving Indian assets Vodafones purchase of Hutchison Essar, for example would be taxed in the country, according to the new direct tax code.

Section 5(1)( d) of the Direct Taxes Code says, Income shall be deemed to accrue in India, if it accrues, whether directly or indirectly, through or from transfer, directly or indirectly, a capital asset situated in India.

The provision supports the Indian tax authorities stand on the taxation of profit that is generated in the country.

The move is an attempt by the government to tackle controversies such as the $2billion dispute between Vodafone and the income tax department, said analysts.

This is a significant provision which gives wide-ranging powers to the I-T department to cover overseas transactions, which deal with assets linked to Indian operations, Vikas Vasal, director KPMG, told The Telegraph.

Current income tax rules do not specify the liability of global firms entering into deals involving Indian holdings.

Vasal said the provision would have a considerable impact on the way foreign firms structure merger and acquisition deals involving Indian assets.

Analysts, however, said the provision should not be used to tax purely foreign transaction involving predominantly offshore assets, unless there was a clear connection with India.

In February 2007, British telecom giant Vodafone acquired a 67 per cent stake in Hutchison Essar from Hutchison Telecom International for about $11 billion.

The government approved the deal in May of the same year. Hutchison, the seller, controlled its Indian subsidiary through a web of companies that finally led to a Cayman Islands-registered firm receiving the payment from Vodafone.

The I-T department felt the Cayman Islands transaction was essentially the transfer of an Indian asset and said that Vodafone should have deducted tax at source when it paid Hutchison.

The tax department, subsequently, raised revenue questions on the deal before the courts and asked the telecom firm to pay a capital gains tax of $2 billion.

Vodafone had argued that the deal was outside the jurisdiction of the Indian tax authorities since the transaction was done overseas.

However, the Supreme Court on January 23, 2009, dismissed Vodafones appeal against the tax department. No final decision has been arrived at in the case.