Delhi Tribunal rules on indirect transfer of shares on transaction undertaken in 2006

Transcription

1 15 March 2017 EY Tax Alert Delhi Tribunal rules on indirect transfer of shares on transaction undertaken in 2006 Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Delhi Income Tax Appellate Tribunal (Tribunal) in the case of Cairn UK Holding Ltd. (Taxpayer/UK Co) [1] which deals with tax implication of a transaction undertaken pursuant to an internal re-organization (sometime in 2006) by the Taxpayer s group with an intent to simplify the existing group structure, to improve its effective management and also gain access to the Indian capital market. Briefly, the transactions involved are: Cairn Energy Plc, the parent entity of the Taxpayer in the UK, transferred shares of its nine Indian wholly owned subsidiaries (WOS) to the Taxpayer against issuance of shares. No capital gains tax was paid on this transaction. These shares were again transferred by the Taxpayer to a subsidiary incorporated in Jersey (Jersey Co) [2] against issuance of shares. Post this, Jersey Co held investments in Indian WOS and derived its value substantially from the assets located in India. Subsequently, shares of Jersey Co were transferred to a newly incorporated Indian company (I Co) for consideration partly payable in cash and partly by issuance of shares. The Tribunal ruled that the transfer of shares of Jersey Co by the Taxpayer was liable to tax in India based on the indirect transfer provisions under the India Tax Laws (ITL) (which were introduced in the year 2012 with retrospective effect from 1 April 1962) as the Indian WOS, which controls the oil and gas sector in India, will be regarded as the property in which the shareholders have the right to manage and control the [1] [TS-89-TRIBUNAL-2017 (Del)] [2] Tax implication of this transaction are not the subject matter of dispute.

2 business in India. The Tribunal disregarded the Taxpayer s claim of no real income being accrued in the hands of the Taxpayer and relied on the financial statements provided by the Taxpayer, wherein exceptional gain on transfer of shares of Jersey Co was accounted by the Taxpayer without any tax implications. Further, the Tribunal also noted that cash consideration paid by I Co to the Taxpayer for acquisition of Jersey Co shares was partly from out of the funds raised from initial public offering (IPO) in India. Thus, the reorganization created wealth for the Taxpayer which would be liable to capital gain tax in India. Cairn Energy Plc (Cairn Energy), a Scotland-based company, had been acquiring oil and gas assets in India through its subsidiaries since During the year 2006, the Cairn group with an intent to simplify its existing group structure and to improve on effective management and gain access to the Indian capital market, undertook a series of transactions in the form of internal reorganization. The existing structure of the group is pictorially depicted below: On validity of retrospective amendment, the Tribunal stated that it was not the right forum to challenge the validity of the provisions of the ITL. Further, the Tribunal also disregarded the Taxpayer s argument that for the purpose of computing capital gain, the ITL as was existent on the date on which India UK Double Taxation Avoidance Agreement (DTAA) was notified is to be considered. On levy of interest, the Tribunal basis judicial precedents agreed that the Taxpayer could not have visualized its liability for payment of advance tax in the year of transaction, hence interest on tax liability arising out of retrospective amendment cannot be levied. Cairn Energy Subsidiaries in India Jersey Co UK Co I Co UK Jersey India Background and facts While the transfer of shares in an Indian company is taxable in India under the ITL, an indirect transfer was held not taxable by the Supreme Court (SC) in the case of Vodafone International Holdings BV (341 ITR 1). However, the ITL was amended in 2012, with retrospective effect from 1 April 1962, to clarify that transfer of shares of a foreign company would be taxable in India if the shares of the foreign company derived its value, directly or indirectly, substantially from assets located in India.

3 As part of internal reorganization in 2006, the group undertook certain transactions, wherein the Taxpayer, a UK Co, was a party to the arrangement. A pictorial representation of the transactions undertaken is given below: Cairn Energy UK Co Step 1* UK Jersey Co Jersey Subsidiaries in India Step 2** Step 3***: Transfer by UK Co of Jersey Co shares to I Co in exchange for ~49% shares in I Co and cash consideration I Co India *Step 1: Transfer of subsidiaries in India held by Cairn Energy to UK Co ** Step 2: Transfer of subsidiaries (acquired from Cairn Energy) by UK Co to Jersey Co *** Step 3: This step was the subject matter of consideration before the tribunal These transactions briefly included the following: The Taxpayer (UK Co), a UK Company, entered into a share exchange agreement with its parent entity (Cairn Energy) in June 2006 for the transfer of the entire share capital of nine Indian WOS in exchange of shares of the Taxpayer. Later, in August 2006, the Taxpayer, set up a subsidiary in Jersey, Cairn India Holdings Ltd. (Jersey Co) and entered into another share exchange agreement with Jersey Co for exchange of shares of the nine Indian WOS for shares of Jersey Co. Jersey Co derived substantial value from assets located in India. Subsequently, the Taxpayer formed another subsidiary in India in August 2016 i.e. Cairn India Ltd. (I Co) and transferred all the shares of Jersey Co to I Co in October 2016 for consideration partly payable in cash and partly by issuance of shares of I Co. Before executing the transfer of Jersey Co shares, in September 2016, UK Co infused funds into I Co by subscribing shares of I Co to the extent of ~20%. Further, additional funds were also raised by offering shares of I Co to general public in the form of Initial Public Offering (IPO). Post the issue of IPO, the shareholding of UK Co stood at ~69% (being ~20% received upon subscription and additionally ~49% received in relation to consideration receivable from I Co on acquisition of Jersey Co shares), balance ~31% was issued and subscribed by general public. In the books of ICo, the acquisition of shares of Jersey Co from the Taxpayer made in excess of the book value of the acquired assets was represented by Goodwill in the consolidated financial statements.

4 The resultant structure of the group post reorganization is as follows: Cairn Energy 100 % UK Co UK 69 % ICo 100 % 31 % Public Shareholders India Jersey Co Jersey 100 % India Subsidiaries in India The Tax Authority assessed capital gains tax in the hands of Taxpayer on transfer of shares of Jersey Co to I Co, treating it as an indirect transfer of Indian assets under the ITL. Being aggrieved, the Taxpayer preferred an appeal before the Tribunal [3] on the issue whether transfer of shares of Jersey Co was liable to tax in India. [3] The Taxpayer pleaded adjournment of the case on the ground that the Taxpayer along with Cairn Energy was engaged in the Arbitration under Article 9 of India UK DTAA and the issue was already sub-judice before the International Court of Justice. However, The Tribunal opined that keeping the issue unnecessarily pending for a very long time where there is no timeline available about the disposal of the application of the taxpayer for arbitration proceedings is not proper and considering the huge quantum involved, the Tribunal decided to proceed with the matter.

5 Taxpayer s contention: Tribunal s ruling The taxability of the transaction under the indirect transfer provisions should be denied, as the said retroactive amendment is bad in law and ultra vires. The transactions undertaken by the Taxpayer was for internal reorganization with a view to consolidate Indian business operations. There was no change in controlling interest as a result of such internal reorganization. Hence, such transaction was non-taxable. The Taxpayer relied on the Calcutta High Court (HC) ruling in the case of Kusum Products Ltd. [4] to suggest that post internal organization no real income accrued to the Taxpayer as all Indian assets were available in different form. Mere accounting entry cannot be regarded as income, unless real income has actually been earned. For the purpose of computing capital gain, the Cost Of Acquisition (COA) should be stepped up to the fair value of the shares of Jersey Co on the date of acquisition. Further, there was no timing difference between the acquisition and disposal of shares by the Taxpayer, and accordingly, the full value of consideration and the COA remain the same. Reliance was placed on the Delhi HC ruling in the case of New Skies Satellite and contended that the provisions of the ITL as were in existence on the date on which India UK DTAA was notified is to be considered, retroactive amendment in relation to indirect transfer provisions should be ignored. The Tribunal, based on the below arguments, held that the transfer of Jersey Co s shares to I Co by the Taxpayer was taxable under the provisions of the ITL: On transfer of shares of Jersey Co to I Co On validity of retrospective amendment On the contention of non-applicability of indirect transfer provisions, due to the same being retrospective in nature and ultra vires, the Tribunal relying upon the SC decision in the case of L Chandra Kumar [5] concluded that the Tribunal is not the right forum to challenge the validity of the provisions of the ITL. On there being no change in controlling interest due to internal reorganization The Tribunal ruled that the steps undertaken were not a mere business reorganization and noted the fact that the series of transactions culminated into the IPO of I Co from which the funds were used to pay part consideration to the Taxpayer for acquisition of shares of Jersey Co. On property being situated in India In the present case, as the Indian WOS, which controls the oil and gas sector in India, will be regarded as the property in which the shareholders have the right to manage and control the business in India. Therefore any income arising through or from any property in India shall be chargeable to tax as income deemed to accrue or arise in India in terms of the indirect transfer provisions of ITL. [4] [49 taxmann.com 403] [5] [2002-TIOL-159-SC-SB]

6 On no real income accruing in the hands of the Taxpayer The Tribunal ruled that real income accrued to the Taxpayer as the audited financial statement of the Taxpayer itself discussed about disposal of part of the company s investment and resultant exceptional gains earned upon disposal of shares. This rendered the Taxpayer s argument of no real income unjustified. While computing capital gains, cost of acquisition should be stepped up to fair value of Jersey Co The Taxpayer argued that while computing capital gain, the COA should be stepped up to the fair value of the shares of Jersey Co on the date of acquisition. The Taxpayer contended that the 1 st transaction of transfer of shares by Cairn Energy to the Taxpayer may have been liable to capital gain tax and the same being an exchange transaction, the Fair Market Value (FMV) on the date of such transfer should be regarded as the full value of consideration. Taxpayer (i.e. shares of foreign company (Jersey Co)) and its mode of acquisition did not fall under any of the clauses of the ITL which requires for substitution of COA as was in the hands of the previous owner. The Tribunal also denied the Taxpayer s contention on transaction being in the nature of swap and leading to resultant cost step up by stating that in the present case, the price of the shares in each of the agreement is identified and the amount of acquisition recorded in the books of accounts represents cost of acquisition of share which cannot be substituted by fair value. On whether the ITL provisions at the time when India-UK DTAA was signed is to be considered The Taxpayer argued that for the purpose of computing capital gain, the ITL as was existent on the date on which the India UK DTAA was notified is to be considered. In this regard, the Tribunal disregarded the argument of the Taxpayer and held that: The 2 nd transfer between Taxpayer and Jersey Co would have nil capital gains as there is insignificant timing difference between the two transfers and COA should be the FMV as determined on 1st transfer, being cost to the previous owner. Similarly the 3 rd transfer which was as sale transaction between the Taxpayer and I Co would also have nil capital gains as the FMV and the COA will be taken as same value in absence of any timing difference. Additionally, the Taxpayer contended that when any asset is transferred in lieu of another asset and no consideration is agreed between the parties, it is a case of transfer by exchange. As, in none of the agreements, no specific amount for consideration is mentioned, FMV of the assets transferred should be regarded as the COA. As per the India-UK DTAA, capital gains are taxable as per the domestic law of respective countries and, hence, the provisions in the DTAA cannot make the domestic law static when both states have left it to domestic law for taxation of an particular income. In cases where exemption is provided with retroactive effect under the domestic law, non-resident cannot be denied exemption by citing that such law was not in existence at the time DTAA was entered into. DTAA is a mechanism of avoiding multiplicity of taxation globally. Accordingly, it stated that if in the country of residence (i.e. UK) taxes are chargeable then the taxpayer must not suffer the tax burden in the country of source of income. In the present case, the facts of the Taxpayer suggested that capital gains were not taxable in its resident state, accordingly there was no multiplicity of tax being levied. Distinguished the Taxpayer s reliance on Delhi HC ruling in the case of New Skies Satellite [6] which held that amendments The Tribunal, without reference to the above contentions of the Taxpayer, referred the provisions under the ITL and ruled that the property held by the [6] In the case of New Skies Satellite [TS-64-HC- 2016(DEL)], the HC held that definition of process royalty as amended under the ITL cannot be read into treaty provisions while interpreting the meaning of Process without amending the treaty itself.

7 made under domestic law cannot be applied to relevant DTAAs. Where the provisions of DTAA simply provides that particular income would be chargeable to tax in accordance with the provisions of domestic laws, such article in DTAA also cannot limit the boundaries of domestic tax laws. On levy of interest The Tribunal relied upon various judicial precedents [7] and agreed with the Taxpayer s claim that it could not have visualized its liability for payment of advance tax in the year of transaction, hence consequently interest on tax liability arising out of retrospective amendment cannot be levied [8]. The Taxpayer was also subject to withholding tax, however, based on the SC ruling in the case of Ian Peter Morris vs. ACIT [9] and Delhi HC ruling the case of DIT v. GE Packaged Power Incorporation [10] which held that a non-resident cannot be burdened with the interest for default of withholding compliance and the fact that liability arises out of a retrospective amendment which could not be foreseen, the Tribunal ruled in favor of the Taxpayer. Comments Taxation of cross-border acquisitions involving indirect transfer of shares of an Indian company has been subject to controversy over the last several years. While the SC has rendered a favorable ruling in case of Vodafone [11], the law was amended retroactively to tax such gains overruling the SC decision [12]. The present decision of the Tribunal is one of the cases where indirect transfer provisions have been applied retroactively to transactions undertaken prior to retroactive amendment in the year Though, the decision does not provide any guidance on whether the retroactive amendment of indirect transfer provisions overturning the SC decision is valid in law, this decision is likely to be considered by the tax authorities as a precedent to apply indirect transfer provisions in relation to transactions undertaken before 2012 [13]. [11] Refer EY alert titled The Vodafone case: SC rules transfer of shares of a foreign company that indirectly held underlying Indian assets not taxable dated 20 January [7] Madras HC in CIT v. Rewati Equipment Ltd. [(2008) 298 ITR 67], MRF Ltd. v. DCIT TC [(Appeal No. 234/2016)] [12] Refer EY Tax Alert titled Budget PLUS Key amendments proposed by the Finance Bill, 2012 to international tax provisions of the Indian tax law dated 16 March [8] In a recent development, we understand that the Tax Authority has filed an appeal against the Tribunal s order in respect of waiver of levy of interest with the High Court. [13] Refer EY alert titled CBDT sets up a Committee to deal with retroactive indirect transfer taxation dated 1 September [9] [389 ITR 501 (2016)] [10] [373 ITR 65]

8 While noting that the issue of validity of retroactive amendment is pending before the International Court of Justice under the arbitration proceedings but the issue was taken up and decided on the basis that the matter has been long pending without any specific timelines for completion at the international level. Taxpayers will have to evaluate critically the impact of transactions wherein indirectly India interest is transferred. It may be noted that in the present case transferor had no treaty protection but many of Indian treaties do not provide for source taxation in respect of indirect transfers.

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