With silent trade wars, rising protectionism and more recently, the Covid-19 pandemic making a heady cocktail of challenges for businesses across the globe, multinational companies are looking to consolidate their businesses to rationalize costs, investors are looking to take advantage of attractive valuations and global players are eyeing targets with a presence in multiple jurisdictions.
Typically, global deals comprise either of share acquisition outside India or a hybrid model of share acquisition coupled with asset/business acquisitions for certain jurisdictions.
When such cross-border deals involve any India assets, either in the form of direct or indirect transfer, a thorough assessment of any possible implications from Indian tax laws is crucial.
In this article, we look at the key areas that may have a bearing in any cross-border transaction involving an India leg.
Does the Offshore Transfer of Shares Attract any Tax in India?
Famously known as the Vodafone tax, a seller who is not a resident in India is taxed on transfer of shares or interest in a foreign entity that derives substantial value from India (the indirect transfer test). To ascertain if the indirect transfer test is met, one must determine if the target foreign entity has any Indian asset, the value of which as on the specified date,
- exceeds 100 million rupees ($1.3 million); and
- represents at least 50% of the total value of the entity.
This determination is equally important from the buyer’s perspective as the buyer is required to withhold applicable income tax from the purchase consideration and deposit it with the Indian government; failure to do so can attract adverse consequences.
Tax exemption is inter alia available for nonresidents holding not more than 5% stake and meeting certain conditions, for nonresidents governed by a beneficial tax treaty, where India assets are held by a foreign portfolio investor, for indirect nonresident investors in Category I and II alternative investment funds (subject to certain conditions).
Direct Transfer of India Assets
Another global arrangement that could have Indian tax implications is the transfer of assets (tangible or intangible), liabilities, contracts, or employees in India as part of a global deal.
The tax implications would depend primarily on the transaction structure, including the nature of assets and liabilities being transferred. The transaction could either be a plain vanilla asset transfer or transfer of India business on a slump sale basis or a de-merger, or selective assignment of contracts or employees.
Asset Transfer v. Business Transfer
An itemized sale of assets is treated as an asset transfer and tax implications for each of such assets has to be determined separately. If the transfer is of a business undertaking (including all its assets and liabilities) on a going concern basis for a lump sum consideration, it is treated as a slump sale.
Questions often arise if a transaction where the business undertaking is transferred excluding certain assets or liabilities, or employees should be treated as slump sale or an asset sale. While this determination is largely driven by the facts, principally if the assets and liabilities transferred together constitute a business undertaking and the buyer on acquisition is able to carry on such business on an “as is” basis, it should be a slump sale.
Assignment/Transfer of Employees
Interestingly, global transactions which, at India level, involve only certain employees to be transferred, also need to be evaluated from an Indian tax perspective. Some of the factors relevant are (a) impact on the global deal value if the employees of the Indian entity are not transferred; (b) number of employees being transferred; (c) value addition made by the employees to the business being acquired globally; (d) discretion of the employees; (e) certainty on continuity of employment if the employee does not accept buyer’s offer; and (f) treatment of employee related liabilities.
Arm’s-length Test as per Transfer Pricing Provisions
The arm’s-length test is applicable to transactions between associated enterprises wherein one of them is a nonresident or between unrelated parties where the terms are in substance determined by an offshore affiliate. In case of transfer of Indian assets between unrelated parties, the applicability of the arm’s-length test would depend on whether the terms of transaction are determined independently between the Indian seller and the buyer or by an offshore affiliate.
Attribution of Fair Value to India Leg
A valuation for transfer of assets at India level is imperative to ensure that (a) consideration allocated to the India leg as a part of global deal is at arm’s length and (b) the said fair value consideration is considered for tax computation of the seller and withholding tax obligation of the payer, if any. From the buyer’s perspective, it also important that the fair value consideration is actually paid to the seller for the buyer to be eligible to claim such fair value as its cost of acquisition for tax purpose. From the transaction standpoint, obtaining an independent robust valuation report supporting the transaction price should be helpful.
Specified Tax Valuations
For certain specified assets such as shares, immovable property, Indian tax laws provide for valuation norms both from seller and buyer’s perspective.
Withholding Tax Obligation
In an arrangement, where the seller is a nonresident, the payer (whether Indian resident or not) is required to comply with its withholding tax obligation. As a practical measure, the payer can ask the nonresident seller to furnish its tax computation, on the basis that the payer can withhold the applicable tax coupled with suitable contractual protections including exploring insurance.
In case of acquisition of assets directly from an Indian resident, the withholding tax obligation is limited to specified payments, namely payment for acquisition of land or building, non-compete fee, etc. and would depend on the specifics of the transaction.
No Objection Certificate
Under Indian tax law, sale of assets such as plant and machinery, shares, securities, land, buildings, while there are Indian income tax demands or proceedings pending against the seller could be treated as void unless:
- a no objection certificate is obtained by the seller from the Indian tax authorities; or
- the sale is undertaken at fair value and buyer has no knowledge of any such demand and proceedings pending against the seller.
Considering the status of income tax demand and proceedings outstanding against the seller, etc. the buyer may undertake a commercial evaluation to obtain a factual representation that the transaction would not be treated as void, along with a certificate from a chartered accountant and an indemnity from the seller vis-à-vis a no objection certificate.
Deferred Consideration, Holdback, Earn-outs
Given the uncertainty that the parties may have over the closing of the transaction and other commercial considerations, transactions often provide for deferral or holdback for some part of the consideration, or consideration in the form of earn-out (linked to business performance of the target). The sticky point that arises is the timing of the taxability of such deferred consideration, i.e. whether the deferred/holdback component should be taxed upfront or taxable only on receipt basis and characterization thereof (i.e. capital gains or ordinary income). This is also relevant for the buyers and needs to be weighed in while complying with withholding tax obligation.
As noted above, though India may play a smaller part in global deals, there are quite a few tax nuances (fair valuation of India assets being the most important) to be considered. Emphasis should therefore be made to factor in India tax aspects right from conceptualizing the transaction to negotiations and execution of documents to avoid any unnecessary complications that could reduce the commercial gains on the deal.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Vinita Krishnan is Director and Rahul Jain is Principal Associate at Khaitan & Co, India
The views of the author(s) in this article are personal and do not constitute legal/professional advice of Khaitan & Co.