If related party transactions or transactions that may raise conflict of interest cannot be avoided, a policy should be outlined where events and mechanisms to identify and resolve events which could lead to potential conflicts, should be recorded. Suitable measures that demonstrate governance and that the interest of the investors would be unimpaired, should be adopted.
The rulings discussed confirm that a fund’s board has duties cast on it and the ‘business judgment rule’ may not shield from liability in all cases.
There are certain non-delegable functions for the directors to discharge on an on-going basis and none more paramount than reviewing of the fund’s performance, portfolio composition and ensuring that an effective compliance program is in place. These functions require action ‘between’ board meetings and not ‘during’ board meetings only.
I. Taxation of Indirect Transfers
In India, residents are taxable on their worldwide income whereas non-residents are taxable on Indian source income i.e. income that accrues or arises, or is deemed to accrue or arise, or is received or is deemed to be received in India.As stated above, for a non-resident to be subject to tax in India, the Tax Act requires that the income should be received, accrued, arise or deemed to be received, accrued or arisen to him in India.56 In this regard, section 9(1) (i) of the Tax Act provides the circumstances under which income of a non-resident may be deemed to accrue or arise in India:
Section 9(1): “The following income shall be deemed to accrue or arise in India: (i) 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.”
This source rule pertaining to a “capital asset situate in India” was examined by the Supreme Court of India in Vodafone International Holdings 57, which dealt with transfer of shares of a foreign company between two non-residents. It was held that a share is legally situated at the place of incorporation of the company. Therefore while the shares of an Indian company would be considered situated in India, the shares of a company incorporated outside India would ordinarily be viewed as situated outside India. This position has undergone a change pursuant to the Finance Act, 2012 which amended section 9 of the Tax Act through the insertion of Explanation 5 cited below:
“For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.”
Therefore, under the current law, shares of a foreign incorporated company can be considered to be a “situate in India” if the company derives “its value substantially from assets located in India”. The Tax Act is silent on how to compute / allocate the derivation of substantial value.
Therefore, in the absence of any binding statutory or judicial analysis, there is no clarity on the circumstances when shares of an offshore company substantially derive their value from assets located in India. Thus, there is an uncertainty on the applicability of the source rule in case of transfer of shares of an offshore company with assets in India and there is a possibility that Indian tax authorities may seek to tax the transfer or redemption of shares in an India-focused offshore fund by its investors notwithstanding that there is no transfer taking place in India, on the basis that the shares of the Fund derive substantial value from India. Where the shares of an offshore company are deemed to be capital assets situated in India under Section.9(1)(i), the entire gains arising of such transfer would be subject to the charging provisions of the Act, regardless of the extent to which such shares may also derive their value from assets and revenue abroad.
Based on the recommendations made by the Shome Committee appointed by the then Prime Minister, the Finance Act, 2015 has made various amendments to these provisions which are summarized below:
9. International Tax Considerations
56. SEBI Circular CIR/IMD/DF/10/2013 57. Section .5(2) of the Tax Act.
Provided upon request only
A. Threshold test on sub substantiality
and valuation
The Finance Act, 2015, provides that the share or interest of a foreign company or entity shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India, if on the specified date, the value of Indian assets (i) exceeds the amount of INR 10 Crore (INR 100 million); and (ii) represents at least 50% of the value of all the assets owned by the company or entity. The value of the assets shall be the Fair Market Value (FMV) of such asset, without reduction of liabilities, if any, in respect of the asset. The manner of determination of the FMV of the assets has not been prescribed in the Finance Act, 2015, and is to be provided for, in the rules.