In Vodafone International Holdings BV v. Union of India (2012), the Supreme Court held that the transfer of shares of a foreign company would not attract capital gains as the situs of a share would be the country where its registered office was situated, even though most of the assets of that company were in India. In other words, if there is a transfer of shares outside India, by an English company to another non-resident, there would be no liability to capital gains, even though all the assets of the British company were in India.
To overcome this decision, the Finance Act, 2012 amended the Income-tax Act, 1961 with retrospective effect from April 1, 1962. Explanation 5 to Section 9(1)(i) of the Income Tax Act, 1961 was inserted by the Finance Act, 2012. It created a legal fiction whereby if the value of such a British share is substantially derived from underlying assets located in India, then such share will be deemed to be situated in India. This change was made retrospective from April 1, 1962 and, in effect, the transfer of shares of a British company would be deemed to be a transfer of shares of an Indian company. This amendment is “retroactive” because a foreign share is treated to be an Indian share, thereby altering the factual situation by a deeming fiction. It is on this altered factual situation that income tax is demanded retrospectively.