Previous Year Question
Which one of the following situations best reflects ‘Indirect Transfers’ often talked about in media recently with reference to India?
An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment.
A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment.
An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India.
A foreign company transfers shares and such shares derive their substantial value from assets located in India.
Correct Answer: D
Detailed Solution
An Indirect Transfer occurs when shares or an interest in a foreign company are legally transferred outside India, but the economic value of those shares is derived substantially from assets situated in India.
It can be understood through an example:
Foreign Company-A holds shares in Foreign Company-B.
The principal assets or the subsidiary business of Company-B is situated in India.
Company-A sells the shares of Company-B to another foreign entity outside India.
Legally, the transferred asset is a share in a foreign company, not the underlying Indian asset.
However, a substantial part of the share’s economic value is derived from assets situated in India.
Therefore, ownership of the Indian assets does not change directly, but the transfer of shares in the foreign company indirectly changes economic control over the Indian assets. This is known as an Indirect Transfer of Indian Assets.
Under Section 9(1)(i) of the Income-tax Act, 1961, a share or interest in a foreign company may be deemed to be situated in India if it derives substantial value, directly or indirectly, from assets located in India. Consequently, the corresponding capital gains may be taxable in India even when the transfer takes place outside India between two non-residents.
Substantial-value test
Shares of a foreign entity are considered to derive substantial value from assets situated in India if, on the specified date:
the value of Indian assets exceeds ₹10 crore; and
such value represents at least 50% of the value of all assets owned by the foreign company.
Both value conditions must be satisfied. The law also provides specified relief or exceptions for small shareholders and certain reorganisation transactions.
Examination of the options
Option (a) involves direct investment by an Indian company in a foreign enterprise. It constitutes outward foreign investment, not an indirect transfer of Indian assets.
Option (b) describes investment in India by a foreign company and payment of tax in its home country. It does not establish the share-asset relationship necessary for an indirect transfer.
Option (c) involves the direct purchase and sale of foreign tangible assets by an Indian company. It represents a direct transfer of foreign assets.
Option (d) involves a transfer of shares in a foreign company where those shares derive substantial value from assets situated in India. This precisely represents the statutory concept of an indirect transfer.