US retail giant Walmart Inc., which in May announced a 77% acquisition of shares of ecommerce leader Flipkart for $16 billion, has agreed to pay a withholding tax of up to $2 billion to Indian tax authorities, said two sources with knowledge of the development.

It will be the biggest such tax payment, if the deal goes through and the tax is accepted.

Walmart has made the offer in a communication to the income tax department to avoid any delay in regulatory approvals of the Walmart-Flipkart deal.

A withholding tax, also called a retention tax, is typically deducted at source and paid by a buyer in a transaction rather than the seller. The tax is paid in advance and is later retrieved from the seller.

“We take seriously our legal obligations, including the payment of taxes to governments where we operate. We will continue to work with Indian tax authorities to respond to their inquiries,” a Walmart spokesperson said in an emailed response to FactorDaily’s questions.*

In this instance, the withholding tax will cover the tax on capital gains to be paid by investors in Flipkart, such as venture capital and private equity firms SoftBank, Tiger Global, Naspers, Accel Partners, among others, who have seen the value of their investments balloon since Flipkart’s first funding in 2009.

Not only are several of such beneficiaries in the transaction registered overseas in tax havens such as Mauritius, Flipkart India is itself registered as a subsidiary of Flipkart Pvt Ltd in Singapore. The involvement of foreign jurisdictions triggers withholding tax, if applicable.

“Walmart will do a conservative but true estimate of it and pay,” said the first source. “This is a very important deal for Walmart and it doesn’t want anything to come in the way.”

The withholding tax can be up to $2 billion, or over Rs 13,760 crore, said the second source, who is closely following the deal. The first source pegged it lower at around $1.5 billion, adding the figure might vary at the conclusion of the deal.

One reason why the tax calculation hasn’t been completed is that SoftBank’s closure on the deal hasn’t been done. “The company wants to avoid the short-term capital gain tax, which if it closes now will be about $400 million,” said the first source.

Both the sources wanted to stay anonymous given that the deal is yet to get regulatory approvals in India.

India ahoy

The India investment – the largest acquisition by Walmart – is an important bet for the US retailer for the growth opportunity Asia’s third-largest economy offers. According to IBEF, a foundation to promote Indian brands under the Union commerce ministry, the Indian ecommerce market is expected to reach $200 billion by 2026, a five-fold growth from $39 billion in 2017.

The other reason for Walmart doubling down on India is that its biggest rival back in the US, Amazon, is among the top two ecommerce players here. Flipkart and Amazon together command a 70% share of the Indian ecommerce market.

“Amazon can’t have a free run (in India)… once it starts making money here, it will reinvest in the US, where Amazon and Walmart are fighting a bloody battle,” said the first source in reference to Walmart’s strategic reasons behind the India deal announced May 9.

The $16-billion deal “is quite a commitment considering Walmart’s own business in India is tiny… And, Walmart had already factored in the tax liability while signing the deal. It’s a futuristic bet for Walmart,” said the second source.

Walmart runs a business-to-business wholesale operation in India, which is building the agri-supply chain and selling to neighbourhood or kirana stores. Its revenues in this operation is just $500 million. It sees the Flipkart deal as a way to jumpstart its India footprint with a focus on grocery and fresh produce, which ties in well with its B2B business here.

Taxman in touch

In May, the income tax department had sent a letter to Flipkart and Walmart seeking the valuation of the deal, the shareholding of different investors in the companies, and other details. The department had asked the companies to approach the Authority of Advance Rulings to get details of the tax liability.

An official in the tax department, on the condition of anonymity, confirmed that the companies have shared the details of the agreement. “We will access the tax liability… There are other stakeholders apart from Flipkart and Walmart,” the official said.

Flipkart India is majority owned by Singapore-registered Flipkart Pvt Ltd, which means that Walmart is buying 77% of a company in Singapore in this deal. However, the tax official quoted above said that Flipkart’s assets and region of operations are in India. “The value of the business is entirely based on the operations in India, which makes it tax liable,” said the official.

According to Section 9(1) of the Income Tax Act, if any foreign company has more than 50% of its assets in India, from which it derives value, it will be considered an Indian Indian entity and be taxed.

“An indirect transfer is taxable according to the current rules. Walmart doesn’t have treaty protection… the tax benefits of being in locations like Singapore and Mauritius is fading away,” said Girish Vanvari, founder of Transaction Square, a boutique tax, regulatory and advisory firm.

Other experts said that the law had changed since the contentious Vodafone plc-Hutchison Telecom deal of 2007, where the British telecom giant is still in dispute with Indian authorities on a Rs 11,000-crore tax claim. “It is a very different situation from the Vodafone case… When the Vodafone deal happened there was no law. Today, there are provisions… everything is taxable,” Anuradha Dutt, co-founder and managing partner of DMD Advocates, who represents Vodafone, said. “Walmart as a buyer will have to pay… .”

Still, Walmart has nothing to lose. “The money that will be paid as withholding tax can be retrieved later (from other parties) when the deal closure is done,” said the second source.

Visuals by: Rajesh Subramanian

* See update.

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