Indirect transfer – not just an Indian phenomenon
To some extent, the AP High Court has settled the debate in favour of the taxpayer in the case of Sanofi
A debatable topic in international tax relating to cross-border transaction that has held the attention of tax/transaction advisors and tax payers, has been, ‘indirect transfer’ of assets. The debate surrounds taxability of an offshore transaction (of a resident state), which has underlying assets in a foreign jurisdiction, and if that jurisdiction in its capacity as a source country, has the right to tax such transactions. In India alone, the subject has been debated post-apex court verdict, which has led law makers to resort to retrospective law to overrule the judiciary’s verdict.
In the recently concluded International Fiscal Association Congress 2014 in Mumbai, the debate occupied centre stage from an international tax and treaty policy perspective. This piece is devoted to capture the debate.
While one may agree that the roots of ‘indirect transfer’ can be traced back to tax treaty provisions providing for taxability of capital gains derived by a resident (of the resident state) on indirect transfer of immovable property situated in the source state, the ‘Chongqing’ case(1) and ‘Vodafone’s case(2) did prove to be controversy’s springboard. A technical debate on ‘indirect transfer’ law usually starts with fundamental principles for enacting laws to administer cross border transaction, i.e.extra-territoriality and jurisdictional aspects.
From an Indian standpoint, Article 245 of the Constitution does provides sufficient basis to law makers for levying tax on ‘indirect transfer’of Indian assets by non-residents. However, the debate on ‘extra-territoriality and jurisdictional aspects’ is still relevant to evaluate whether such an approach is appropriate when viewed from bilateral and multilateral treaty standpoints, and from the point of view of sharing tax revenues between the source and the resident states. Countries typically resort to two approaches – Ex ante and Ex post approaches – for levying tax on ‘indirect transfer’. Whilst Ex-ante approach involves enacting specific provisions (as implemented by countries like India, Israel), under Ex post approach, countries (like China) invoke General Anti-Avoidance Rules regime to tackle such situations.
Israel has had fairly detailed provisions in its domestic law since 2009, before the controversy gathered momentum in India and China, asserting its source right to levy tax. Holistically speaking, whilst domestic tax law provisions are the backbone for enforcing tax regime for ‘indirect transfer’, the domestic tax law provisions need to be calibrated with treaty provisions. Whilst fundamentally, tax treaty wording needs to be respected for interpretation purpose, the literature available in model tax conventions(3) and commentaries serve as a useful guidance.
Reviewing the ‘indirect transfer’ in the backdrop of Model Conventions(and commentary), it appears that insofar as a source state’s right to tax transfer of assets is concerned, the limited situation envisaged deals with taxability of capital gains on indirect transfer of immovable property, situated in the source state.
Whilst, it appears that Model Conventions do not envisage allocating taxing rights to source states for ‘indirect transfer’ of other assets (such as shares of an offshore company) situated in source state, in the wake of high profile cases in India and China, tax administrators globally, are making an attempt to read the treaties in a manner as would suit them to bring to tax such transactions. To some extent, the Andhra Pradesh HC has settled the debate in favour of the tax payer in the case of Sanofi wherein it has held that even after retrospective amendment to law, the terms of tax treaty with France have to be respected, which shifts the burden of taxation to France. Computational challenges such as determining situs of intangibles (contracts, patents) for testing the degree of nexus with the source state, double taxation, tax credit mechanism, valuation methodologies and a host of open issues were identified by experts. Indian policymakers seem to have ‘boxed’ themselves by enacting a law without figuring out ways to compute the tax.
In conclusion, the’indirect transfer’ controversy to the world at large is at a nascent stage, with more tangles being discovered and straightened out, as countries move forward in the Base Erosion & Profit Shifting era, advocating no ‘stateless tax’. Countries need to rev up the activity on multilateral instruments’, facilitate exchange of information, secure compliance in source & resident countries failing which it may prove to be ‘a law difficult to administer’. Whilst a few countries have made efforts to articulate in their domestic law, a lot is yet to be done for uniformity in intent and syncing of actions, amongst tax administrators across the globe. It would otherwise lead to uncertainty, besides domestic court and treaty disputes.