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Tax Alert- CBDT relaxes indirect transfer provisions for multi-tier structures of investment funds to avoid double taxation

13 November 2017

Background

Section 9 (1)(i) of the Income-tax Act, 1961 (the IT Act) deems income arising from transfer of share or interest in a foreign company/entity to be taxable in India, if such share or interest derives its value substantially from assets located in India (indirect transfer provisions).

In cases liable for indirect transfer provisions (other than category I or category II foreign portfolio investors and 5% threshold for small shareholders), issue arose that non-resident investment funds which are set up as multi-tier investment structures suffer multiple taxation of the same income (explained below):

  • Firstly, at the level of fund in India on its short- term capital gain/ business income and
  • Then at every upper level of investment in the fund chain on subsequent redemption or buyback.

* Venture Capital Company, Venture Capital Funds etc.

Concerns had been expressed by investment funds, including private equity funds and venture capital funds, investing in India in relation to such multiple taxation of income.

Clarification by CBDT

The CBDT has clarified that indirect transfer provisions shall not apply in respect of redemption or buy back of share or interest of non-resident held indirectly (i.e. through upstream entities registered or incorporated outside India) in specified funds subject to following conditions:

  • Income on redemption or buyback accrues or arises from or in consequence of transfer of shares or securities held in India by the specified funds; and
  • Capital gain income of specified funds is chargeable to tax in India.

The above benefit is available only in cases where the proceeds of redemption or buyback arising to the non-resident do not exceed the pro-rata share of the non-resident in the total consideration realised by the specified funds from the transfer of shares or securities in India.

However, non-resident investing directly in the specified funds shall continue to be taxed as per the provisions of the IT Act.

BDO Comments

This clarification will avoid double taxation of income in certain cases, therefore can be seen as a booster to investors investing in India through multi-layered structure.

The circular only addresses multiple taxation issue where there is a back to back / corresponding transfer by the specified fund (which is chargeable to tax in India) and consequent upstream to non-residents on pro rata basis. Further clarity is required on application of this circular in situations where:

  • The proceeds are paid back pursuant to redemption of a single non-resident investors amongst all other investors continuing to hold their share.
  • Sale of interest or share by non-resident to another non-resident will continue to attract indirect transfer provisions. In such cases, multiple level taxation will continue to apply.
  • Investment fund has invested in India directly and money is remitted to non-resident investors