Q. Which one of the following situations best reflects "Indirect Transfers" often talked about in media recently with reference to India? (UPSC Prelims 2022)
Answer: A foreign company transfers shares and such shares derive their substantial value from assets located in India
Notes: The correct answer is [D] A foreign company transfers shares and such shares derive their substantial value from assets located in India. This concept refers to the taxation of capital gains arising from the transfer of shares of a foreign entity that owns assets in India.

• Definition of Indirect Transfer (Statement D – Correct): An indirect transfer occurs when a foreign company sells shares of another foreign company, but the underlying value of those shares is derived substantially (at least 50% of the value) from assets located in India. Under the Income Tax Act (amended after the Vodafone case), such transactions are taxable in India.
• Investment and Foreign Taxes (Statement A – Incorrect): This describes standard Outward Foreign Direct Investment (OFDI) where taxes are paid to the host country. It does not involve the "indirect" transfer of Indian assets.
• Foreign Investment in India (Statement B – Incorrect): This describes standard Foreign Direct Investment (FDI) where a company pays taxes in its home country. This is a matter of Double Taxation Avoidance Agreements (DTAA) rather than indirect transfers.
• Tangible Asset Sale (Statement C – Incorrect): This is a direct sale and repatriation of proceeds by an Indian company, which is a standard cross-border capital transaction.

The issue of indirect transfers gained significant media attention due to the retrospective tax disputes involving Vodafone and Cairn Energy. In 2021, the Indian government passed an amendment to scrap the retrospective nature of these tax demands to improve the investment climate and provide tax certainty.