Which one of the following situations best reflects “Indirect Transfers” often talked about in media recently with reference to India?
- An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment
- A foreign company investing in India and paying taxes to the country based on the profits arising out of its investment
- An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India
- A foreign company transfers shares and such shares derive their substantial value from assets located in India
Explanation
Option (d) is the correct answer
- “Indirect Transfers” refers to situations where shares of a foreign company are transferred, but those shares derive substantial value from assets located in India. Even though the transaction occurs outside India (between foreign entities), India claims taxation rights because the underlying value is linked to Indian assets. This concept became prominent after the Vodafone International Holdings v. Union of India case and subsequent amendments to the Income Tax Act.
- Vodafone case:
- Background: Hutchison Telecommunications International Limited (HTIL), a company based in Hong Kong, held a majority stake in Hutchison Essar Limited (HEL), which operated in India. Vodafone, a UK-based company, wanted to enter the Indian telecom market and decided to acquire HTIL’s stake in HEL.
- The Transaction: Vodafone structured the deal in a way that it purchased shares of a Cayman Islands-based company that held the stake in HEL. The transaction took place outside India, between two foreign entities (Vodafone and HTIL), involving shares of a foreign company.
- The Issue: Although the transaction happened abroad, the Indian tax authorities argued that the substantial value of the transferred shares was derived from assets located in India (HEL’s telecom business). The Indian government claimed that Vodafone should have withheld capital gains tax and paid it to the government, since the transaction’s value was tied to Indian assets.
- In the provided question:
- “A foreign company transfers shares and such shares derive their substantial value from assets located in India” directly reflects the Vodafone scenario. The shares being transferred are foreign, but their value is largely derived from HEL’s Indian assets (its telecom business). This situation exemplifies “indirect transfers” because the Indian tax authorities sought to tax the transaction based on the underlying assets located in India, even though the actual transfer of shares happened outside India.
