In 2012, the Supreme Court of India in the Vodafone case1 held that any transfer by a non-resident of shares of a non-resident company which derives its value from the shares or interest situated in India would not attract Indian capital gains tax. The legislative fallout of this ruling was retrospective2 insertion of Explanation 4 to section 9 of the Income Tax Act, 1961 (“I-T Act”) to tax such indirect transfers, provided that the shares of the non-resident company derives its value substantially3 from assets located in India.

The Central Board of Direct Taxes4 on 28th June 2016, notified5 rules to prescribe the manner in which the Fair Market Value (“FMV”) of assets (tangible and intangible), held directly or indirectly, by a foreign company shall be computed. These rules provided that income shall be taxable in the proportion in which the FMV of the Indian assets bears to the total assets of the non-resident entity on a specified date6.

The legislative intent was to tax the indirect transfer of only those shares which contain right of management or control of assets situated in India7. However, an unintended consequence of the above-said amendments was taxation of transfer of shares of regulated and broad-based FPIs8 by its Non-resident investors. This issue got aggravated when the CBDT confirmed the taxation of indirect transfer of shares of FPIs by way of another clarification in December, 20169.

The FPIs got a sigh of relief in January, 201710 when the December, 2016 circular was withdrawn. Now the Government has proposed an amendment to section 9 of the Act via 2017 Budget Proposals to carve-out an exception for FII/FPIs by way of retrospective11 insertion of an Explanation 5A to section 9 of the Act. Accordingly, the Category-III FPIs which includes the investors which are not broad-based (i.e owned and controlled by certain individuals) are not exempted.

It may however be noted that Explanation 5A to section 9 of the Act is given retrospective effect from 1st April, 2012 whereas the 2012 amendment was given effect from 1st April, 1962. Therefore, it leaves room for ambiguity about the taxation of non-resident investors who would have sold their units in FIIs prior to 2012 amendment. A clarification in this regard from the Government would be congenial.


1 Vodafone International Holdings B.V. v. Union of India [2012] 341 ITR 1 (SC)

2 The amendment was given retroactive effect from 1961, the year in which I-T Act was introduced.

3 Fair Market Value (“FMV”) of assets located in India comprise at least 50% of the FMV of total assets of the company and exceeds Rs. 10 crores.

4  CBDT- Policy making body of the Indian Income Tax Department

5 Notification No 55/2016 dated 28th June 2016

6 “specified date” shall have the meaning as assigned to it in clause (d) of Explanation 6 to clause (i) of subsection(1) of section 9

7 Shares holding less than 5% of the voting powers are exempted.

8 Category-I or Category-II Investors under SEBI(Foreign Portfolio Investors) Regulations, 2014 which includes Government related investors and professionally managed broad based- funds

9 Circular No. 41 of 2016 dated 21st December, 2016.

10 Circular No. 4 of 2017 dated 20th January, 2017.

11 With effect from 1st April, 2012.

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