Transfer of Indian assets to Cairn taxable

The income-tax department slapping tax demands of ₹20,495 crore on Vedanta Group- controlled Cairn India and ₹10,247 crore on its former parent, UK-based Cairn Energy Plc, raises many questions on the basis of these tax notices. Rakesh Nangia, Managing Partner, Nangia & Co, answers some question relating to this dispute. Edited excerpts:

Would transfer of assets to Cairn India qualify as indirect transfer since one of the parties to the transaction was an Indian entity?

Indirect transfer is a transaction wherein the foreign company’s shares being sold derives, directly or indirectly, its value substantially from assets located in India. In this case, Cairn Energy transferred its foreign subsidiary to Cairn India and the foreign subsidiary derived its value from assets located in India. As per the provisions of section 9(1)(i) (as amended by Finance Act 2012), a capital asset being any share in a company incorporated outside India shall be deemed to have been situated in India, if the share derives, directly or indirectly, its value substantially from the assets located in India. So the transfer of foreign subsidiaries qualified as indirect transfer is liable to tax in India as per the amended provisions of section 9(1)(i) of the Act.

Since the transfer was between 100 per cent subsidiaries, will capital gains tax be charged to this deal?

Before the Cairn India IPO, the India operations of Cairn Energy were owned by a company called Cairn India Holdings based in Cayman Island and its subsidiaries. Cairn India Holdings was a 100 per cent subsidiary of Cairn UK Holdings, which was a 100 per cent subsidiary of Cairn Energy. At the time of the IPO, the ownership of the India assets was transferred from Cairn UK Holdings to a new company – Cairn India. In 2006, Cairn India acquired 100 per cent share capital of Cairn India Holdings from Cairn UK Holdings in exchange of 69 per cent shares in Cairn India issued to Cairn UK Holdings. Hence, Cairn Energy, through Cairn UK Holdings, held a 69 per cent stake in Cairn India. As per the provisions of section 47(iv) of the Act, a transfer of capital assets by a company to its wholly owned Indian subsidiary is not liable to capital gain tax in India.

However, since in the present case, Cairn India is not a wholly owned Indian subsidiary of Cairn Energy, benefit of section 47(iv) of the Act could not have been claimed.

Why was capital gains tax at the rate of 42 per cent levied on Cairn Energy Plc by the I-T department?

In case of a foreign company, income accruing or arising in India under section 9(1)(i) is liable to tax at 40 per cent plus a surcharge of 5 per centof such tax, i.e. 42 per cent.

It appears that the capital gain in the instant case is short-term and, hence, the beneficial rate of 20 per cent was not applicable.

Why is the interest on tax charged only on Cairn India by the I-T authorities and not on Cairn Plc?

According to the provisions of section 144C of the Act, in case of a foreign company, the assessing officer is required to first issue a draft assessment order proposing the assessed income and tax thereon, against which the assessee can file its objection before the Dispute Resolution Panel (DRP) and the Assessing Officer on receipt of directions of the DRP, passes the final assessment order.

Computation of assessed income, tax and interest thereon is issued by the assessing officer only with the final assessment order. 

Hence, in the case of Cairn Energy Plc’s subsidiary Cairn UK Holdings, being a foreign company, the assessing officer has issued the draft assessment order proposing the assessed income and tax thereon, interest due shall be levied only at the time of passing the final assessment order. Whereas in the case of Cairn India, being an order u/s 201, interest has been levied.