Indian government proposes to impose capital gains tax on acquisitions made overseas if the acquired company holds over 50 per cent assets in an Indian company

In a move aimed at preventing disputes between overseas firms and the Indian Income Tax Department, the Indian government proposed to have capital gains tax imposed on acquisitions made overseas if the acquired firm holds 50% assets in an Indian firm. The measure comes as a reaction targeted at sealing loopholes that brought about Vodafone’s conflict with the Indian Income Tax Department over taxes.

The bill has already been tabled in the Indian parliament and according to Finance Ministry officials, the bill provides that if a transaction is undertaken for which a company owns underlying assets that are in excess of 50% Indian assets, then it follows that in such a case, and based on a proportional basis, capital gains will be chargeable. The Finance Ministry was explaining the details of the proposed law, after it had been presented to parliament Monday.

Named the Direct Taxes Code Bill, it is expected to avoid further friction between overseas firms with 50% assets in Indian firms and the tax department in the event that they are undertaking further overseas investments, said the officials. As such, the Direct Taxes Code Bill will eventually replace the Income Tax Act effective April 1st, 2012 thus effectively sealing loopholes that could cause friction as in the case of Vodafone in the future.

The conflict in question between Vodafone and the tax department arises from Vodafone’s US$11.1 billion deal with Hutchison, done three years ago. Vodafone is disputing tax claims from the Income Tax Department with regard to that transaction. On its part, the Indian Income Tax Department claims that it reserves the full jurisdiction to tax the UK based, global telecoms giant, Vodafone. Vodafone acquired 67% stake in Hutchison Essar from Hong Kong based Hutchison Telecommunications International Ltd and the deal was then successfully approved by the Indian government in May of 2007.

However, after receiving the necessary regulatory approvals, the Income Tax Department issued a show cause notice to the effect that Vodafone had not deducted tax, pegged at about US$2 billion from the deal. Opposed to the show cause notice, Vodafone challenged it in the Bombay High Court but unfortunately, its petition was dismissed.

Undeterred, Vodafone moved on to petition its challenge to the show cause notice in the Supreme Court, seeking clarity as to whether the tax department had the authority to tax a transaction that took place outside the country between tow global firms.

1 Sep 2010