HC's 50% assets threshold for indirect transfers - Setting controversy at rest?

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The recent Delhi High Court judgment, setting a 50% Indian assets threshold for invoking taxability on offshore sale, is significant on many counts, not least for bring a semblance of clarity in an otherwise grey zone. Sec 9(1)(i) of the Act read with Explanation 5, introduced by Finance Act, 2012, sought to overrule the Apex Court judgment in Vodafone, by bringing indirect transers into the tax net if 'substantial' assets are located in India. But while doing so, the Legislature left the term "substantially", undefined.
Has the Delhi HC put an end to the controversy over indirect transfers taxation, especially the definition of the term 'substantially'? Will it end the confusion on how to define the term 'substantially, or are there still some unanswered questions'? Is the HC right in taking the aid of Shome Committee report, OECD & UN Model conventions to set a 50% assets threshold? Is it high time for CBDT to come up with a clarification or should the Revenue let the matter rest by accepting the High Court interpretation? 


Gautam Doshi
Group MD, Reliance ADAG

At the outset, it must be realized that the interpretation of the Explanation to Sec 9(1) (i) in the case of Copal Research may be held to be by way of “obiter” and hence not binding. In Para 22, the Hon’ble Court has held that the sale of shares by companies based in Mauritius was for “commercial reasons” and was not made “only to avoid tax”. Hence, the selling companies were entitled to exemption under the DTAA between India and Mauritius. It was therefore, unnecessary for the Hon’ble Court to consider on merits whether; if the sale of shares was the sale of shares of a Jersey Company, it would have been taxable in India.

However, the Hon’ble Court has used the opportunity to explain the provisions of Explanation 5 to Sec 9 (1)(i). It needs to be respectfully, noted that the Hon’ble Court has been able to harmonize Explanation 5 as a “clarification” and not an “extension of the charge to tax”. This is a very significant move which the Revenue will welcome. The Hon’ble Court has thus interpreted the Explanation as an Explanation and therefore, referred to the substance of what the Explanation seeks to achieve – charge of tax on the transfer of an asset where “in substance the assets in India are transacted by transacting in shares of overseas holding companies”. The Hon’ble Court has expressed its view that a transfer of shares of foreign companies would not in substance be held to be a transfer of underlying Indian assets unless at least 50% of the value of such shares is derived from assets held in India.

The observations of the Hon’ble Court are welcome. But, they cannot be and are not a substitute for statutory clarity. The Act needs to define “substantially”. It is also necessary that ancillary issues – such as the mode of determining the contribution to value, business value vs asset value, fair market value vs book value, the date on which the value is to be examined are all clarified. It is the obligation of the legislature to give a clear provision - a provision which can be implemented with certainty. In closing, it may be noted that the 50% threshold is in the opinion of the Hon’ble Court, a minimum threshold. The possibility of some other Tribunal or Court or this very Court, in the context of a different case, applying a higher threshold, say, 90% cannot be ruled out. Hence, it would also help the Revenue to lay down both – a clear threshold and clear guidelines for applying the threshold.