Background
The Finance Act 2012 had retrospectively amended Indian domestic tax law, to enable India to tax capital gains arising to non-residents on transfer of shares or interest in a foreign company (Foreign Target) which derives 'substantial value' from the underlying Indian assets (Underlying Indian Assets).
Thereafter, to clarify the applicability of this retrospective amendment, the Finance Act, 2015 made certain critical amendments, including laying down criteria for 'substantial value', providing for taxability of only the income attributable to Indian assets and introducing a reporting requirement for underlying Indian entities. In furtherance of these amendments, the Central Board of Direct Taxes (CBDT) had released draft rules (Draft Rules), in May 2016 setting out the valuation methods and related filings (as applicable) in relation to indirect transfer of Underlying Indian Assets. The CBDT had then invited comments and suggestions of stakeholders and general public, on the Draft Rules.
We had analysed the Draft Rules and also provided our comments to the CBDT. Our Newsflash analysing the Draft Rules can be accessed here.
Final Rules
The CBDT has now notified the final set of rules relating to methods for determining the fair market value (FMV) of Underlying Indian Assets and all assets of the Foreign Target vide Notification No 55 /2016 [F No 142/26/2015-TPL] / SO 2226(E) dated 28 June 2016 (Final Rules).
Summarised below are the key changes brought about by the Final Rules:
Definition of 'right of management or control'
The Draft Rules provided that the FMV of share of an Indian listed company is to be the observable price of the share on the recognized stock exchange. However, where the share confers, directly or indirectly, any right of management or control to the foreign transferee, even the book value of liabilities of the underlying company was to be included in determination of the FMV. Further, reporting timelines for the Indian concern are also linked to transfer of the right of management or control. However, the phrase 'right of management or control' was not defined, the Final Rules have now defined the phrase 'right of management or control' to include the right to appoint majority of the directors or to control the management or policy decision exercisable by a person, or persons acting individually or in concert, directly or indirectly, including by virtue of shareholding or management rights or shareholder agreements or voting agreements or in any other manner.
Determination of the FMV of an interest in partnership firm or an association of persons (AoP)
The Draft Rules had provided that the FMV of an interest in a partnership firm or an AoP shall be the proportional enterprise value as determined by a merchant banker or an accountant in accordance with any internationally accepted valuation method, as increased by the liability considered in such determination. To clear doubts around the manner of proportioning the value, the Final Rules have clearly laid down the manner of allocating the value amongst the partners or members, which is now based on the capital contribution and the profit sharing ratio.
Transfer of shares between persons who are not 'associated persons'
The Draft Rules provided that (a) where the transfer of share or interest was between persons who are not 'associated persons'; and (b) the consideration for transfer of share or interest was determined on the basis of the valuation report prepared by an accountant or merchant banker of international repute, the FMV of all the assets of the Foreign Target shall be the value determined in such report as increased by the aggregate amount of liabilities.
The Final Rules have made some modifications in the valuation method as under:
- Firstly, the phrase 'associated persons', which was not defined under the Draft Rules, has been changed to 'connected persons' as defined under the General Anti Avoidance Rules in domestic Indian tax law
- Secondly, the manner of determining the FMV of all the assets of the Foreign Target, has been changed. Under the Final Rules, the FMV of all the assets of the Foreign Target shall be the market capitalisation of the foreign company based on the commercially negotiated consideration as increased by the book value of liabilities as certified by a merchant banker or an accountant;
- Thirdly, the Final Rules have done away with the requirement of the merchant banker or an accountant to be of an international repute. Instead, the term 'accountant' has been defined under the Final Rules to include any valuer recognised for undertaking similar valuation by the government of the country where the Foreign Target is registered or incorporated or any of its agencies provided they meet tests in respect of professional experience, gross receipts, and geographical presence laid down for this purpose
Transfer of shares of Foreign Target not listed on stock exchange on the specified date
Under the Draft Rules, the FMV of an unlisted Foreign Target was determined on a consolidated basis and included the FMV of its subsidiaries. The requirement for including the FMV of subsidiaries has now been done away with under the Final Rules.
Determination of book value of liabilities
The Draft Rules had defined the term 'book value of the liabilities' to mean value of liabilities as shown in the books of the company or entity excluding the paid up capital in respect of equity shares or member's interest. The Final Rules have provided that apart from the paid up capital, even the general reserves, surplus and security premium related to paid up capital are to be excluded from the meaning of the 'book value of liabilities'.
Finalization of the FMV if based on interim balance sheet
The Final Rules require that if the FMV has been determined on the basis of an interim balance sheet, then the FMV shall be modified after finalization of the relevant financial statement.
Determination of FMV of any asset located in India
The Final Rules provide that for determining the FMV of an asset which is located in India being a share of an Indian Company or interest in a firm or AOP, all the assets and business operations of such entity shall be taken into account, irrespective of the location of such assets or business operations.
Determination of income attributable to assets in India
While the Draft Rues had provided that if the information necessary for application of formula for determining income attributable to assets in India is not available, then the whole of the income from transfer of such share or interest would be deemed to be the income attributable to assets located in India. To rationalize this provision, the Final Rules provide that in such a case, instead of deeming the whole of income as income attributable to assets located in India, the attribution shall be determined in the manner the tax authorities deem fit in the facts of each case.
Reporting Obligation on the Indian concern
The Draft Rules required the underlying Indian entity to furnish the prescribed information within 30 days of the date of the transaction, where the transaction had the effect of directly or indirectly transferring the rights of management or control in relation the Indian concern. The Final Rules have extended this period and provide that information in such case shall be furnished within 90 days of the transaction.
Further, in case of group entities, the Final Rules have enabled the furnishing of information by a designated Indian concern when there is more than one Indian concern, provided that:
- The group has designated the concern to do the same; and
- The information has been conveyed in writing on behalf of the group to the Assessing Officer.
Comment
Some welcome changes have been made to the Draft Rules such as definitions of 'accountant' and 'book value of liabilities' have been included. The Draft Rules were not clear on these aspects. The Final Rules also seek to ease the compliance burden where there is more than one underlying Indian entity in the structure. Under the Draft Rules all the Indian entities were to undertake the specific compliances. The CBDT must be applauded for manifesting a consultative approach and considering the stakeholders' suggestions before formulating the Final Rules. Some of the other key aspects which the CBDT was expected to but have not addressed include relaxing the exhaustive nature of information which the Indian entity is required to maintain and furnish to the tax authorities; and easing prescribed compliances in a scenario where the applicable tax treaty exempts the transaction from taxation in India.
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