Multinationals who are involved in cross border transactions that have a nexus with India now need to exercise care following a recent decision of the Bombay High Court particularly where there is a use of tax havens. The use of a tax haven also prevents the application of the benefit of any double tax agreement that might otherwise be available.

In a recent case, a Netherlands company acquired a Hong Kong company’s interest in a Cayman Island’s holding company.

Such a transaction would appear to have no nexus with India. However the Cayman Island holding company held a majority stake in a company whose operating assets consisted of significant telecom operations in India.

India has capital gains withholding tax. The Indian Tax Authorities argued that the Netherlands company should have withheld tax from the purchase price of the acquisition of the interest in the Cayman Island holding company from the Hong Kong company for the capital gain made by the vendor on the sale of its indirect interest in the Indian capital assets through its ownership of the share in the Cayman Island holding company.

The Netherlands company argued that the rights and entitlements that flow out of the holding of a share in a company cannot be dissected from ownership of that share and therefore since this share was a capital asset located outside India, the Indian domestic law withholding tax provisions did not apply.

The court rejected this argument as “complete fallacy”. They held that the rights and entitlements that flow from the holding of a share in a company were themselves capital assets and were therefore “property of any kind”. The Court held that the transfer of the share in the Cayman Island company also involved the transfer of rights and entitlements of local Indian partners and hence the transaction required a complex contractual arrangement in India which was sufficient to establish a nexus with Indian tax jurisdiction. The Court also held that the essence of the transaction was a change in the controlling interest of the Indian telecom operations which constituted a source of income in India thus providing a sufficient nexus to India.

Therefore the purchaser should have withheld tax from the purchase price of the share in the Cayman Island company.