Under the deal, Walmart will acquire a 77 percent stake in the Singapore-based holding company of Flipkart. Sale of the Singapore-based entity’s shares by non-resident shareholders will trigger indirect transfer provisions under the Income Tax Act.
Under the tax law, all income – accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situated in India – shall be deemed to accrue or arise in India.
In essence, as per indirect transfer rules, if a substantial portion (more than 50 percent) of underlying assets in respect of shares which are being sold are in India, then India will tax capital gains arising from the said transaction, Maulik Doshi, a transaction advisory services partner at consultancy firm SKP, pointed out.
The substantial value of this deal is being derived from India. And so, India value and non-India value needs to be bifurcated, an M&A tax partner at one of the big four consulting firms pointed out requesting anonymity as commenting on a specific deal is not its policy. The consultant explained:
- If the bifurcation is 95:5, 95 percent of the deal value will be subject to tax in India.
- This will be further bifurcated based on long- and short term capital gains—if the shares have been held for more than two years, 10 percent long-terms capital tax will be applicable; if less than two years, then a 40 percent rate will be applicable.
Since more than 50 percent value of Flipkart Singapore is derived from Flipkart India, even the sale of shares of Singapore company would attract tax in India, Doshi of SKP added. To be clear, the deal structure is not yet public.
If the Singapore-based parent is selling shares of Flipkart India to Walmart—a direct sale—the holding firm could take benefit of non-taxability of capital gains in India under the India-Singapore tax treaty.
This is, however, subject to meeting limitation of benefits clause requirements under the treaty and passing the General Anti Avoidance Rules test, especially for any investments made by Singapore parent post April 1, 2017.Nitesh Mehta, Partner-Transaction Tax, BDO India
Starting April 2017, a complete capital gains tax exemption has been done away with under the India-Singapore tax treaty. For investors who have come in after that, and assuming the deal closes by year-end, there will be no capital gains tax exemption plus a 40 percent short-terms capital gains tax will be applicable. A good example is Japan’s SoftBank Vision Fund that had pumped about $2.5 billion into Flipkart in August last year.
In a structure where the Singapore entity is selling shares of Flipkart India, the immediate shareholding of the Indian company would change and the Indian company may not be able to utilise the huge brought-forward losses, Doshi pointed out. Section 79 of the Income Tax Act says losses can’t be carried forward or set off when more than 51 percent of shareholding changes hands.
The tax obligation of non-resident investors will have to be fulfilled by Walmart in the form of withholding tax. In such deals, when some investors want to claim treaty benefits, the buyers—in this case Walmart—will seek indemnities for any future tax demands that may be made, the consultant quoted above said. The indemnity will be useful if the tax department decides to deny the treaty benefit by, for instance, applying GAAR rules.
Either of the non-resident shareholders or Walmart can go to the Authority for Advance Rulings to get certainty and know its liability on this transaction, Doshi said.
For Indian investors selling their shares as part of this transaction, there will capital gains tax implications. If the shares have been held for more than two years, long-term capital gains tax at 20 percent will be applicable and they will get the benefit of indexation, the consultant quoted above said. If any of the resident investors have been holding the shares for less than two years, short-term capital gains tax of 30 percent plus a surcharge will be applicable. Also, this will have to be paid as advance tax, this consultant added.