On Wednesday (May 9), taking advantage of the time difference between Japan, India, and the US, SoftBank chief Masayoshi Son seized a moment that was to go down in history as belonging to Walmart president and CEO Doug McMillon by announcing the biggest ecommerce deal in the history of the world — the Flipkart-Walmart deal.

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.

However, a deal done on paper is still subject to regulatory approvals. At least, that’s what India Inc learnt from Vodafone’s acquisition of and exit from the then Hutchison-Essar (Vodafone India). And, in case of Flipkart, as the deal is very complex, chances are that it might get challenged in the Supreme Court of India.

A lawyer, who has been very close to the developments on the deal, on condition of anonymity, told Inc42, “In this entire deal which saw Flipkart’s valuation at around $20.7 Bn, there is still no tax clarity as the treaties signed by India with Singapore and Mauritius changed last year.”

He further explained,

In this case, apart from domestic income tax laws, articles from a number of income tax treaties signed by India with the US, Singapore, Mauritius, South Africa, and a comprehensive agreement with China will also be invoked.

Technically speaking, Flipkart India’s shares haven’t been sold at all but, Flipkart Singapore. Speaking to Inc42, L Badri Narayana, partner at law firm Lakshmikumaran & Sridharan, said, “Flipkart India is a capital asset based in India, while Flipkart Singapore (Flipkart Pte Ltd) is the strategic shareholding company of Flipkart India. Flipkart Singapore also operates Flipkart Malaysia, Flipkart Middle East, and other companies outside India.”

The Tax Complexities Of The Walmart-Flipkart Deal

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%).

As far as the law is concerned, except for Sachin Bansal and Binny Bansal’s stakes, the majority of the shares sold to Walmart belong to non-resident shareholders. They are selling their shares in a Singapore-based company — Flipkart Pte Ltd, which owns an Indian company — to a non-resident (US) company, Walmart.

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 players 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, popularly known as the Vodafone tax, 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. Depending on the nature of the investment, the withholding tax in cases of such indirect transfers might vary from 10-20%.

However, in case of Sachin’s and Binny’s stake sale to Walmart, another section of the I-T Act will be invoked. Since the duo has 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.

How Tax Treaties With US, Mauritius Will Affect Investors

Badri further clarified, “In case of players like eBay and SoftBank US, which are US-based players, Article 13 of the Indo-US treaty will get triggered. Similarly, Tiger Global, which had apparently invested in Flipkart Singapore through its Mauritius fund, the Indo-Mauritius treaty will be applicable.”

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, depending on the time they were held, is likely to be 10%. In the case of Tiger Global’s share transfer to Walmart through its Mauritius fund, the deal papers are still not in the public domain, so the picture is not yet clear. As per the Indo-Mauritius treaty, there are chances that Tiger Global may not have to pay the withholding tax at all,” added Badri.

The tax treaty between India and Mauritius applicable in this case says: “Gains from the alienation of shares acquired on or after 1st April 2017 in a company which is resident of a Contracting State may be taxed in that State. However, the tax rate on the gains referred to in paragraph 3A of this Article and arising during the period beginning on 1st April, 2017 and ending on 31st March, 2019 shall not exceed 50% of the tax rate applicable on such gains in the State of residence of the company whose shares are being alienated.”

Hence, it will depend on explainability of the deal how does it invoke the treaty. “As India has signed treaties with almost all the countries involved in this deal, there is clarity pertaining to the double tax issue,” said the person quoted earlier in this article.

Walmart May Sell Part of Flipkart Stake To Other Investors

According to the official statement shared by Flipkart, Walmart’s investment includes $2 Bn of new equity funding, which will help Flipkart accelerate growth in the future. Walmart and Flipkart are also in discussions with additional potential investors who may join the round, which could result in Walmart’s investment stake shrinking after the transaction is complete. Even so, the company will retain a clear majority ownership.

Meanwhile, the Alphabet-Flipkart deal will actually occur between Walmart and Alphabet, or between two US companies involving a capital asset based in India.

The statement further stated that to finance the investment, Walmart intends to use a combination of newly issued debt and cash on hand. Upon closing the deal, Flipkart’s financials will be reported as part of Walmart’s international business segment. If the transaction were to close at the end of the second quarter of this fiscal year, Walmart expects a negative impact to its FY19 EPS (earnings per share) of approximately $0.25 to $0.30, which includes incremental interest expense related to the investment.

Since Flipkart Singapore holds more than 51% of Flipkart India, “as per Section 79 of the Income Tax Act, losses can’t be carried forward or set off while shareholders are changing hands,” said the first lawyer.

Compared to the Vodafone-Hutch Essar deal which occurred over 10 years ago in 2007, today’s laws and treaties are far clearer and conducive to international deals. With India having signed treaties with various countries, as the lawyers suggest, the tax complexities can be resolved. Also the Indian government, which is promoting investment in India with its tagline ‘Invest India’, won’t allow the Income Tax department to go aggressive, as was the case in the Vodafone deal.

The exact withholding tax figures relating to the Flipkart-Walmart deal will, however, be clear only once the acquisition filings come in the public domain.

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