International Tax Panorama

I. Background:

The biggest e-commerce deal in the history of the world — the Flipkart-Walmart deal was announced on May 9. According to the announcement, Walmart will pay approximately $16 Bn for an initial stake of about 77% in Flipkart. The remainder of the business will be held by some of Flipkart’s existing shareholders, including cofounder Binny Bansal and investors Tencent Holdings Ltd, Tiger Global Management LLC, and Microsoft Corp.

Among the stakeholders selling their stakes to Walmart are Tiger Global (16.99%), SoftBank (22.3%), Naspers (13.76%), Ebay (6.55%), Accel Partners (2.88%), Sachin Bansal (5.96%), Binny Bansal (1.63%), and others (6.93%).

However, the deal is still subject to regulatory approvals. On the other hand the complexity associated with the deal can trigger different forms of tax implications, which are elaborated under the following sections.

II. How the deal will be structured?

While Flipkart is owned by its parent entity that is incorporated in Singapore, Walmart is a US-based company. Flipkart’s assets and businesses lie in India. Flipkart’s existing investors have made an investment in Flipkart Singapore, which in turn invested in Flipkart India.

The final tax liability will depend on the way the transaction is structured. According to the terms of the deal, the transaction is expected to be a two-step process. The first step will be the Singapore entity selling its stake in the Indian entity to Walmart. This will be done through a direct transfer.

In the second step, Flipkart Singapore will provide an exit to the identified shareholders. This could lead to a buyback or a capital reduction process by using the money received by it from the sale of shares of Flipkart India.

The whole transaction can trigger domestic tax obligations as well as tax treaty issues as discussed below:

III. Domestic Tax Law implications: 

• Taxation on Capital Gains :

There is a potential capital gains tax for both non-resident & resident investors under following circumstances:

• Non-Resident Investors : 

The majority of the shares sold to Walmart belong to non-resident shareholders, apart from the resident investors. They are selling their shares in a Singapore-based company — Flipkart Pvt Ltd, which owns an Indian company — to a non-resident (US) company, Walmart.

Singapore-registered Flipkart Pvt Ltd holds the majority stake in Flipkart India. As per the proposed deal, Walmart is expected to acquire shares of the Singapore entity. This will effectively result in transfer of ultimate ownership in Flipkart India.As per indirect transfer provisions of IT laws, value of shares of a foreign company is deemed to be substantially derived from India if the value of the Indian assets is greater than 50 per cent of its worldwide assets. As more than 50% of the value of Flipkart Singapore is derived from Flipkart India, Section 9(1)(i) of the Income Tax Act will be applicable to non-resident player selling their stakes in a capital asset based in India to another non-resident player.

According to Section 9(1)(i) of the I-T Act, any income accruing or arising, whether directly or indirectly, inter-alia, through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India. 

Thus such sale of shares would trigger capital gains tax under the indirect transfer provision of Income Tax Act, considering that substantial value of such shares is being derived from India, subject to tax treaty benefits.

• Resident Investors: 

The Flipkart Founders intending to sell their shareholding, being Indian residents, would be liable to pay income tax in India on capital gains arising from such transaction. The income tax law provides that taxes have to be withheld by the buyer if the share purchase agreement is being entered into with a non-resident entity. With regard to share purchase agreement entered into with India resident entity, Sachin Bansal and Binny Bansal in this case, capital gain would be charged in their hands and they have to pay 20 per cent income tax.

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. Since the founders have held their shares for more than two years, a long-term capital gain tax of 20% will be applicable in the transfer of their shares to Walmart.

• Carry forward of the losses: 

The next issue arises as to whether Flipkart India will be allowed to carry forward the losses for the adjustment against income tax payable by the company.

As per Section 79 of the Income Tax Act, carry forward and set-off of losses cannot happen when more than 51 per cent of shareholding changes hands. However, Section 72A of the Act provides that if there is demerger and merger, the company can carry forward the losses. 

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. However these are mere speculations and it remains to be seen how the Flipkart- Walmart deal would be finally structured.

• Indian withholding tax requirements:

One of the significant challenge in such international transaction is meeting the Indian withholding tax requirements. If the transaction attracts indirect transfer provisions as provided under the Income Tax Act, 1961, Walmart Inc., will be required to with-hold taxes. The withholding provision would apply to Walmart or Amazon if they purchase directly from Flipkart’s non-resident investors such as Accel Partners or Tiger Global Management.

Subsequently, the rates at which the taxes are to be withheld, will be required to be ascertained keeping in view the rates in force under the domestic law and the relevant tax treaties of India with the jurisdictions of the sellers. With regard to uncertainty in tax position, parties could approach the Authority for Advance Ruling for determination of tax liability.

• Application of GAAR:

The deal can also come under the scope of India’s recently implemented General Anti-Avoidance Rule. The rule, applicable to all transactions made after April 1, 2017, enables Indian tax authorities to scrutinize and re-characterize transactions where the “main purpose” is to obtain a tax benefit.

The Flipkart acquisition will definitely be subject to GAAR scrutiny by the tax department. But the transaction must meet commercial substance requirement in order to meet GAAR requirements.

IV. Tax treaty Implications: 

The taxability of the foreign investors in Flipkart will depend on the country through which the money is routed and whether India has a tax treaty with those nations. The following scenarios can  be predicted under relevant tax treaties involving major stakeholders in the deal. 

• India-US tax treaty:

In case of players like eBay and SoftBank US, which are US-based players, Article 13 of the India-US treaty on capital gains taxation will get triggered.

According to Article 13 of Indo-US treaty,

Except as provided in Article 8 (Shipping and Air Transport) of this Convention, each Contracting State may tax capital gain in accordance with the provisions of its domestic law.

In the case of SoftBank US’s share transfer to Walmart, the withholding tax will be levied depending on the time in which they were held.

• India-Mauritius / India-Singapore tax treaty:

India-Mauritius tax treaty:

If the seller/transferor of such shares in Flipkart Singapore is a tax resident of Singapore/ Mauritius or any other country, which has a tax treaty with India that exempts capital gains from income tax in India, then the seller may claim treaty benefits.

However, the tax treaties between India and Singapore as well as India and Mauritius have been amended and exemption from capital gains tax in India were provided only till March 31, 2017. So any investment in Flipkart routed throughout these countries on or after April 1, 2017, would come within the scope of capital gains tax in India.

For instance Tiger Global, which had apparently invested in Flipkart Singapore through its Mauritius fund can trigger capital gains taxation under India-Mauritius tax treaty. Tiger Global may cite residency in a treaty-protected country to reduce the capital gains tax liability under treaty.

As Tiger Global arms are registered in Mauritius/Singapore and acquired their combined 21% stake in Flipkart before April 1, 2017, they could seek protection under a grandfathering clause under the tax treaty. Thus in such scenario Tiger Global would be exempt from taxes in India after the proposed Walmart deal.

India-Singapore tax treaty:

As some of the investors in Flipkart are based in Singapore, and shares of Singapore company are intended to be sold, a question will arise whether they are entitled to treaty benefit particularly in the context of limitation of benefits under India-Singapore tax treaty. 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.

For instance Japan’s SoftBank Vision Fund had pumped about $2.5 billion into Flipkart in August last year. In the case of SoftBank, which purchased its near-21% stake in the online retailer in August last year, a two-year (April 1, 2017, to March 31, 2019) transitional phase when the tax rates will be half India’s domestic rates could be available. However, if the Japanese venture capital firm chooses to carry out the stake sale indirectly to Walmart via a US-based arm, the tax relief would not be available to it.

If SoftBank indeed takes the US route for the transaction, then it might delay the deal till August 2019, to be the recipient of long-term, rather than short-term capital gains, which is taxed at a higher rate. Currently, India taxes short-term (held for less than two years) capital gains from unlisted shares at 15%, while similar long-term (over two years) is taxed at 20% with indexation.

• How investors can claim tax treaty benefit?

An entity claiming residency in Singapore/Mauritius needs to prove “substance” in the claim by passing the motive and expenditure tests. The motive test is to prove that the primary purpose of deal (via the treaty protected country) is not to obtain the tax exemption. The expenditure caveat (investment threshold) is relatively easy to surmount.

As India has signed treaties with almost all the countries involved in this deal, there is clarity in tackling issues of double taxation /double non-taxation.

V. Similarity with Vodafone case?

Tax experts are drawing parallels between the current deal and the 2007 Vodafone deal. Vodafone’s tax saga began when the company acquired India-based telecommunications company Hutchinson Essar Ltd., the mobile operator, through a Cayman Islands-based subsidiary.  Vodafone’s acquisition of Hutchison Whampoa’s telecom assets in India got into a row when India’s Income Tax Department, in September 2007, issued a notice to Vodafone saying it was liable to pay tax for the transaction. The I-T department’s argument was that the Cayman Islands transaction was essentially a transfer of an Indian asset and, therefore, Vodafone should have deducted tax (also called withholding tax) when it paid Hutchison for the deal.

Vodafone had contested it in courts on the basis that no tax was due in any event as the deal was concluded in the Cayman Islands. Finally, in 2012, the Supreme Court ruled in Vodafone’s favour, holding that tax authorities do not have jurisdiction on an overseas transaction. Later, former finance minister Pranab Mukherjee introduced amendments in the Income Tax Act, allowing authorities to levy taxes on companies retrospectively for acquiring assets in India, even if the deal was concluded overseas.

The indirect transfer provision of the Income Tax Act, 1961—aimed at taxing capital gains arising from indirect transfer of shares deriving substantial value from Indian assets—was introduced to tax precisely such structures in the aftermath of Vodafone case. The tax authority has also taken an aggressive stance when applying the provision on Indirect transfer of share, in situations when an incoming shareholder, like Walmart, is evidently attempting to gain access to the Indian market.

The present structure of the deal has the potential to give rise to the same withholding tax that caught Vodafone case, which might be hurtful to the investor’s sentiments involved in the deal. For instance Flipkart will most likely enter into a deal where Amazon or Walmart purchase shares directly from the existing investors. The deal would be subject to a 20 percent capital gains tax, because shares are considered movable property, which is a capital asset.

For secondary purchase, Flipkart is liable to capital gains tax subject to treaty protection and the purchaser has to withhold tax for payment to a non-resident.

The withholding provision would apply to Walmart or Amazon if they purchase directly from Flipkart’s non-resident investors such as Accel Partners or Tiger Global Management. Thus the tax compliance will be heavily tilted towards the taxpayer due to amended provision under the domestic tax law, in the aftermath of Vodafone case.

VI. Conclusion

The $16-billion Flipkart-Walmart deal is already under pressure for meeting regulatory approval by the government. On the other hand the government is also considering bring in a new law or relax existing norms related to multi-brand retail business.

As discussed in the article, tax implications must be taken into consideration when structuring such deal, which has a huge impact on the investment climate.   The proposed transaction may open up tax litigations for Flipkart India/its shareholders, be it the issue of taxability of capital gains arising to shareholders from such transaction or the issue of carry forward of existing tax losses of Flipkart India.

Especially Walmart Inc, as a buyer, would seek to minimise its tax burden in every way possible under the deal. Walmart can claim protection under the commercial indemnity clause, in which case it will seek indemnities for any future tax demands that may be made. The indemnity will be useful if the tax department decides to deny the treaty benefit by, for instance, applying GAAR rules. Walmart could try and obtain a nil-tax-liability order from the Authority for Advance Ruling (AAR) before going ahead with the deal.

As of now the exact details of the Flipkart-Walmart deal will, however, be clear only once the acquisition filings come in the public domain. In-spite of all the speculations, Indian laws and tax treaty network has improved since Vodafone case, with an aim to provide a conducive environment for international deals. Also the Indian government, which is promoting investment in India with its tagline ‘Invest India’ will ensure certainty in tax treatment for the investors. Thus, it is to be seen in the future, as regards the development of the deal and its reaction to all the above-mentioned tax implications.

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