The Finance Act, 2012 inserted an Explanation 5 to section 9(1)(i) to clarify that an asset or capital asset, being any share or interest in a company or entity registered outside India, shall be deemed to be situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.Further, the Finance Bill, 2015 clarified the meaning of the term "substantially", thereby putting to rest the never ending controversy and providing a stable taxation regime. However, apprehensions have been expressed about the applicability of the Explanation 5 to the transactions not resulting in any transfer, directly or indirectly of assets situated in India. It has been pointed out that such an extended application of the provisions of the Explanation 5 may result in taxation of dividend income declared by foreign company outside India, in respect of shares deriving substantial value from assets located in India. This may cause unintended double taxation and would be contrary to the object and purpose of amendment made by the Finance Act, 2012.
TheExplanation 5sought to clarify the source rule of taxation in respect of income arising from indirect transfer of assets situated in India.Thus, declaration of dividend by foreign company outside India does not have the effect of transfer of any underlying assets located in India. Therefore, CBDT has clarified that dividends declared and paid by a foreign company outside India in respect of shares which derive their value substantially from assets located in India would not be deemed to be income accruing or arising in India by virtue of provisions of the Explanation 5 to Section 9(1)(i).