Amendments relating to Foreign Companies

Taxation on indirect transfer

• In view of the decision of Supreme Court in the Vodafone case, Finance Act, 2012 brought retrospective amendments whereby transfer of share or interest in a company or entity registered or incorporated outside India was deemed to be taxable in India if such share or interest derived its value (directly or indirectly) substantially from assets located in India. Since this amendment was implemented retrospectively, it raised apprehensions in the minds of the foreign investors regarding stability and predictability of the tax regime in India. Also no clarity was provided regarding what would be considered to be deriving value “substantially” from Indian assets. This kind of arbitrary approach of the Government in the matter has resulted in withdrawal of investment plans in India by foreign investors, who are already dealing with huge tax litigations.
• In order to fulfill the objective of fiscal discipline, protecting the revenue of the country and at the same time promoting a non-adversarial tax regimen, the Finance Minister has proposed to clarify the meaning of the term “substantially”.
• It has been proposed that the share or interest shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India, if, on the specified date, the value of such assets,
  • exceeds Rs 10 crore; and
  • should comprise of at least 50% of the value of total assets of the company as on the specified date (without reduction of any liabilities)
• “Specified Date” has been defined as
  • date on which the accounting period of the company ends preceding the date of transfer of a share or an interest, or,
  • date of transfer, if the book value of the assets of the company on the date of transfer exceeds the book value of the assets as on the date referred above, by 15%.
• Exemption from applicability of tax on indirect transfers has been proposed to be provided in the following cases:
  • Where assets of Indian company are owned directly by the foreign company or entity whose shares are being transferred:

The transferor (individually or along with its associated enterprises) neither holds the right of management or control of such company or entity nor holds share capital or voting power exceeding 5% of the total share capital or voting power of the foreign company or entity owning assets of Indian company

• Where the assets of Indian company are indirectly owned by the foreign company or entity whose shares are being transferred:
  • The transferor (individually or along with its associated enterprises) neither holds the right of management or control of such foreign company or entity nor holds any right in such company or entity which would entitle him to the right of management or control in the company or entity that directly owns the assets situated in India.
  • Also the transferor does not holds such percentage of voting power or share capital or interest in such foreign company or entity which results in holding of (either individually or along with associated enterprises) a voting power or share capital or interest exceeding 5%. of the total voting power or total share capital or total interest, of the company or entity that directly owns the assets situated in India.
• any transfer of a capital asset, in a scheme of amalgamation, being a share of a foreign company which derives, directly or indirectly, its value substantially from the share or shares of an Indian company, held by the amalgamating foreign company to the amalgamated foreign company, if—
  • at least 25% of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company; and
  • such transfer does not attract tax on capital gains in the country in which the amalgamating company is incorporated;”
• any transfer in a demerger, of a capital asset, being a share of a foreign company, which derives, directly or indirectly, its value substantially from the share or shares of an Indian company, held by the demerged foreign company to the resulting foreign company, if,—
  • the shareholders, holding 3/4th or more in value of the shares of the demerged foreign company, continue to remain shareholders of the resulting foreign company; and
  • such transfer does not attract tax on capital gains in the country in which the demerged foreign company is incorporated
• It is also proposed only that portion of income arising on transfer of share or interest of a foreign company as is reasonably attributable to assets located in India would be taxable in India.
• It is also proposed that where the foreign company or entity derives its value substantially from the assets located in India through, or in, an Indian concern, then, such Indian concern shall furnish information in respect of Offshore transactions resulting into modification of its control or ownership structure. Any non-compliance in this regard by the Indian concern would attract penalty of Rs.5 lakhs or 2% of transaction value, as the case may be.
• These amendments have been proposed to be added by way of insertion of Explanations to Section 9(1)(i), insertions of sub-sections in Section 47 and addition of Sections 285A and 271GA.
• These amendments have been proposed to be made effective from 1st April, 2016.

Interest received by the non-resident in certain cases

• The foreign banks doing business through their branches in India were claiming deductions on interest payments to their foreign parent/ head office interpreting provisions of the Indian Income tax Act along with corresponding Double Taxation Avoidance Agreement (DTAA). They considered the permanent establishment/branch as a separate and independent entity from its head office as specified in the applicable DTAA. On the other hand, they did not extend this principle while determining taxability of the same interest income in the hands of the head office. Hence, due to the absence of an enabling provision in the Income Tax Act, they were not offering this interest income to tax in India.
• Now through the finance bill, 2015 it is proposed that now, the Indian branch shall be deemed to be a separate and independent person from the head office. Hence, the interest payable by the Indian branch to its head office shall be deemed to accrue in India and shall be chargeable to tax in India. Also, the Indian branch has to withhold tax on such interest and failure will attract penalty.
• This proposed amendment is by way of insertion of explanation in Section 9(1)(v).
• This amendment is proposed to be made effective from 1st April, 2016.

Location of Fund Managers in India not to constitute business connection of Offshore Funds

• According to the current provisions of the Income Tax Act, 1961, an Indian fund manager may result in a business connection for an Offshore Investment fund, resulting in tax liability on investment income earned by the firm from jurisdictions outside India which are managed by the Indian fund manager. This may also lead to Offshore funds being held as resident in India on the basis of its control and management being in India, resulting in taxation of the entire income of the Offshore fund in India. Hence the Offshore funds do not retain fund managers in India. They generally have fund managers based outside India and have only advisory relationship in India.
• In order to facilitate the location of fund managers of Offshore funds in India, it has been proposed in the Finance Bill, 2015 that having an eligible fund manager in India should not create a tax presence (business connection) for an eligible investment fund in India.
• Various conditions have been prescribed for a fund to be an eligible investment fund, some of the major conditions being:
  • It should not be a person resident in India
  • It should be from a country with which India has entered into DTAA.
  • Participation, directly or indirectly by persons resident in India in the fund<= 5% of the corpus of the fund
  • no. of members= 25. They should not be directly or indirectly connected persons
  • participation interest by a single member, directly or indirectly, along with connected persons <= 10% of the fund
  • Participation interest, directly or indirectly of 10 or less members along with their connected persons in the fund < 50% of the fund
  • Investment in a single entity by the fund <= 20% of the corpus of the fund
  • the fund shall not make any investment in its associate entity
  • the monthly average of the corpus of the fund >= Rs 100 crore
  • the fund shall not carry on or control and manage, directly or indirectly, any business in India or from India
  • the fund is neither engaged in any activity which constitutes a business connection in India nor has any person acting on its behalf whose activities constitute a business connection in India other than the activities undertaken by the eligible fund manager on its behalf
  • the remuneration paid by the fund to an eligible fund manager in respect of fund management activity undertaken by him on its behalf is not less than the arm’s length price of the said activity
• Various conditions have been prescribed for a fund manager to be an eligible fund manager, which are as follows:
  • The person is not an employee of the eligible investment fund or a connected person of the fund
  • The person is registered as a fund manager or an investment advisor in accordance with The specified regulations
  • The person is acting in the ordinary course of his business as a fund manager
  • The person along with his connected persons shall not be entitled, directly or indirectly, to more than 20% of the profits accruing or arising to the eligible investment fund from the transactions carried out by the fund through the fund manager.
• However this amendment shall not result in excluding any income from the total income of the Eligible Investment Fund, which would have been included irrespective of whether the activity of the eligible fund manager constituted business connection in India or not.
• It is further proposed that every eligible investment fund shall furnish within 90 days from the end of the financial year, a statement in the prescribed form, to the prescribed income-tax authority containing information relating to the fulfillment of the conditions specified in this section and also provide such other relevant information or documents as may be prescribed. In case of non-furnishing of the prescribed information or document or statement, a penalty of Rs. 5 lakh shall be leviable on the Fund.
• This proposed amendment is by way of insertion of Section 9A.
• This amendment is proposed to be made effective from 1st April, 2016.

Amendments relating to Global Depository Receipts (GDRs)

• A new Depository Receipts Scheme has been notified on 21st October, 2014 which replaced the “Issue of Foreign Currency Convertible Bonds and Ordinary Shares (through depository receipt mechanism) Scheme, 1993”.
• The current taxation scheme of income arising in respect of depository receipts under Section 115ACA of the Act is aligned with the earlier scheme which was limited to issue of Depository Receipts (DR’s) based on the underlying shares of the company issued for this purpose (i.e sponsored GDR) or FCCB of the issuing company and where the company was either a listed company or was to list simultaneously. Besides, the holder of such DR’s was a non-resident only.
• As per the new scheme, DRs can be issued against the securities of listed, unlisted or private or public companies against underlying securities which can be debt instruments, shares or units etc. Further, both the sponsored issues and unsponsored deposits and acquisitions are permitted. DR’s can be freely held and transferred by both residents and non-residents.
• Since the tax benefits under the Act were intended to be provided in respect of sponsored GDR’s and listed companies only, it is proposed to amend the Act in order to continue the tax benefits only in respect of GDRs against the issue of
  • Ordinary shares of issuing company, being a company listed in a recognized stock exchange in India, or
  • Foreign Currency Convertible Bonds of issuing company.
• This proposed amendment is by way of substitutions in Section 115ACA.
• This amendment is proposed to be made effective from 1st April, 2016.

No MAT on long term capital gains derived by FII

• Due to amendment by the Finance Act, 2014, securities held by FIIs have been classified as capital assets. However the FII’s also have to pay mat on capital gains on sale of such securities, since the same is not excluded for the purpose to computing MAT.
• To correct this current situation, it is proposed that income from transactions in securities (other than short term capital gains arising on transactions on which securities transaction tax is not chargeable) arising to a FII, shall be excluded from the chargeability of MAT and the profit corresponding to such income shall be reduced from the book profit.
• Also, the expenditures, if any, debited to the profit loss account, corresponding to such income are also to be added back to the book profit for the purpose of computation of MAT.
• This proposed amendment is by way of additions in Section 115JB.
• This amendment is proposed to be made effective from 1st April, 2016.

Decrease in rate of taxation for royalty or fees for technical services

The rate of taxation for non-residents receiving income by way of royalty or fees for technical services has been reduced from 25% to 10%.

Extension of time-limit for lower TDS on interest to FIIs and QFIs on certain investments

• The existing provisions provide for lower withholding tax at the rate of 5% on interest payable to FIIs and QFIs on their investments in Government securities and rupee denominated corporate bonds, at any time on or after the 1st June, 2013 but before 1st June, 2015.
• The time-limit for lower withholding tax is proposed to be extended from 1st June 2015 to 1st July, 2017.
• This proposed amendment is by way of substitution in Section 194LD.