Indirect Transfer Provisions

A foreign investor can try to sidestep Indian tax by not selling Indian assets directly. Instead, they sell shares in an offshore holding company that owns those Indian assets.

Section 9 of the Income Tax Act closes that gap. It treats such a sale as an indirect transfer of the underlying Indian assets, and taxes it in India — even though the shares that actually changed hands were of a foreign company.

For an AIF with non-resident investors routed through an offshore feeder fund, this matters a great deal. Redeeming or transferring an interest in that feeder fund can, in some circumstances, itself be treated as an indirect transfer of the AIF's underlying Indian investments.

The 'substantially derives its value' test has two limbs, and both must be met on the 'specified date': the value of the foreign company's or entity's Indian assets must (i) exceed Rs 10 crore, and (ii) represent at least 50% of the value of all the assets it owns. Asset values are taken at fair market value on the specified date, without reducing them for any liabilities.

Reliefs the CBDT has clarified:

1. Indirect transfer provisions do not apply to dividends declared by a foreign company outside India, where the dividend does not itself transfer any underlying Indian asset. A distribution by an offshore feeder fund is not, by itself, caught.
2. Indirect transfer provisions do not apply to income a non-resident earns from redeeming or buying back its interest in an offshore feeder fund, where that income arises from the AIF's own transfer of Indian shares or securities, and that income is already chargeable to tax in India at the AIF level. This relief applies only where the redemption or buy-back proceeds to the non-resident do not exceed their pro-rata share of the total consideration the AIF itself realised on the transfer.
3. Separately, a 3 July 2019 CBDT circular clarifies that income earned by a non-resident from an offshore investment routed through a Category I or Category II AIF — treated as a deemed direct investment abroad by the non-resident — is not taxable in India at all under the Income Tax Act. A loss on such an offshore investment, being an exempt loss, cannot be set off or carried forward.

Compliance riding on top of any relief. Where a non-resident investor still needs treaty relief, obtaining a Tax Residency Certificate (TRC) and filing Form 10F, along with their own tax returns, remain necessary.

Sable Mauritius Ltd, an offshore feeder fund, pools money from non-resident investors and invests it entirely into Meridian AIF, a Category II AIF holding only Indian securities. Sable's Indian assets (its interest in Meridian) are worth Rs 40 crore, which is 100% of Sable's total assets — comfortably over both the Rs 10 crore and 50% thresholds — so a transfer of Sable's own shares by its shareholders would ordinarily be an indirect transfer of Indian assets.

An investor in Sable redeems units for Rs 6 crore, arising because Meridian itself sold Indian shares and realised Rs 60 crore in total, already taxed in Meridian's hands in India. Because Rs 6 crore is no more than that investor's pro-rata share of Meridian's Rs 60 crore realisation, the CBDT relief applies, and the redemption is not separately taxed again as an indirect transfer.

By contrast, if Sable's offshore feeder simply declares a dividend from its own retained cash, without any transfer of its interest in Meridian, that dividend is outside indirect transfer provisions altogether.

Chapter 12 (Taxation — India specific), section 12.5.3 (Taxation of various incomes in the hands of non-resident investor), sets out the Section 9 test, its two-limb Rs 10 crore / 50% threshold, and the CBDT reliefs for feeder-fund structures. Expect a question testing whether both limbs of the substantiality test are met, or on which CBDT relief applies to a feeder-fund redemption.

• Both the Rs 10 crore and the 50% conditions must be satisfied together — meeting only one does not trigger the indirect transfer provisions.
• Asset values are taken without deducting liabilities. A highly leveraged offshore entity does not escape the test by netting off debt.
• The feeder-fund redemption relief has its own cap — it only shelters proceeds up to the investor's pro-rata share of what the AIF itself realised and was taxed on; anything above that share is not protected by this specific relief.
• A dividend is not automatically safe merely because it comes from an offshore entity — the relief applies only where the dividend does not itself effect a transfer of the underlying Indian asset.