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Vodafone's Transfer Pricing Victory!

Published on Fri, Oct 10,2014 | 13:41, Updated at Fri, Oct 10 at 20:03Source : Moneycontrol.com 

In a landmark ruling, the Bombay HC today ruled in favor of Vodafone India in the share issuance- undervaluation case.  

Here’s a quick recap of the case- The Tax Department had sent Vodafone a Rs 3200 crore tax bill for allegedly undervaluing the shares Vodafone issued to its parent company. The Tax Department said that this difference in valuation was in fact a disguised loan subject to transfer pricing provisions. Vodafone argued that share premium is a capital receipt; not income and hence not taxable. It moved the Bombay High court citing lack of jurisdiction by the Department. The Bombay High Court did not rule on the merits. Instead, it sent Vodafone to the Dispute Resolution Panel (DRP), instructed the DRP to decide the matter within two months and also said that Vodafone could come back to the Bombay High Court if it finds the DRP's order to be patently illegal. The DRP ruled in favor of the tax department. The Firm’s coverage on DRP’s order can be found here.

Vodafone then moved the Bombay High Court against the DRP order. The court today ruled in favor of Vodafone saying there is no taxable income arising out of the transaction.

Remember, more than 20 such cases are pending at various stages of litigation. We spoke to leading tax experts for their quick reaction to the Bombay High Court judgment and the precedent it’s likely to set for similar cases.

Amit Rana VP- Tax, GE India

“The order again reinforces our faith in the Indian judiciary.  The Revenue made an irrational and excessive claim which thankfully has been nipped in the bud by the judiciary.  The Revenue case was fraught with flaws at multiple levels.  At an intuitive level, why should a company undervalue share issuance to its 100% parent.  Commercially, where is the income in a share issuance to a 100% parent that the Revenue was seeking to tax.  In case of more than one shareholder, the valuation could possibly have shifted value from one shareholder to another and created at least commercial income.  Of course, even then, I don't believe the law has the ware withal to tax such income, but at least there would be an economic argument.  More legalistically, it is extraordinary that shares issued at fair value do not trigger tax in the hands of the issuing company being a capital transaction not involving any transfer, but if it is non-arm's length (even assuming the Revenue was correct that Vodafone had indeed undervalued the shares), it can trigger a tax.  The Revenue case almost sought to turn the basic fabric of the law where 'income' is taxed, by attempting to tax cash flow (or the lack of it).”

Mukesh Butani, Managing Partner, BMR Legal (Representing Shell before Bombay HC)

"The Bombay High Court has held in its landmark judgment today that issuance of shares by an Indian company to its foreign parent is not exigible to chapter X of transfer pricing provisions.
The controversy dates back to an early 2013 period wherein the tax administrations over react to such transfer pricing adjustments. A group of tax payers faced similar adjustments, causing nervousness in the minds of foreign multinationals, thereby adding to their challenges for doing business in India.
Vodafone and Shell amassed strength to invoke the extraordinary writ jurisdiction and decided to appeal to the Bombay High Court directly, bypassing ordinary appeals process.
Last November, the Bombay High Court in the first round of dispute sent the matter back to the dispute resolution panel (DRP), urging them to examine the preliminary issue of such transactions and in particular, if there was any income arising there from. The tax administration subsequent to high court order held on to its view and confirmed the transfer pricing adjustments, to which a second writ petition was filed.
In today’s order, the High Court has come to the conclusion that share issuance does not give rise to any income arising and hence, there can be no question of an adjustment.
Today’s judgment vindicates the taxpayer’s stands and lends clarity to the vexed question of applicability of the transfer pricing law to share issuance.
The timing of Bombay High Court verdict is significant given Prime Minister Modi’s visits to Japan and United States rolling red carpet for investors. Undoubtedly, this will improve investor’s sentiments and I hope that the government gracefully accepts the courts verdict and India puts an end to the controversy, which in the first place should not have arisen."

Vijay Iyer, Partner & National Leader – Transfer Pricing, EY

“The recent ruling of the Bombay high court in case of the Indian subsidiary of Vodafone Group Plc involving transfer pricing dispute related to share capital infusion transaction is a significant judgement. The high court’s decision that the transfer pricing provisions should not applicable to share capital infusion transaction is very encouraging and should have persuasive impact on the tax disputes faced by other Indian taxpayers in respect of similar transactions.

Strictly speaking, the transfer pricing provisions should not be applicable on transactions which are in the nature of capital receipt and don’t have a bearing on the taxable of the hands of the taxpayer. The Income tax laws defines the term ‘international transaction’ as a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises. Thus, a transaction having a bearing on the profits, income, losses or assets is an important pre-condition for attracting the application of the transfer pricing provisions. Since transaction involving issuance of additional shares on account of capital infusion by a foreign shareholder in the Indian subsidiary does not have any bearing on the income of the Indian subsidiary, the same should not be subject to the transfer pricing provisions, as the entire exercise of determination of the arm’s length price in such case would be an academic exercise only.

The on-going transfer pricing litigation on share issue transaction has been a drain on India's reputation and has been a dampener on the foreign direct investment into the country in last few years. With this decision of the Bombay high court, it is likely expectation that the on-going controversy around the share issue transaction will get settled and hopefully, the Revenue will not take the dispute further to the Supreme Court and let the High Court decision prevail. This would have a positive impact on the overall tax environment in India and should encourage Multinationals to infuse additional equity in the Indian subsidiaries for on-going business expansion plans without any hassle.”

Fereshte Sethna & Anuradha Dutt, Partners, DMD (Represented Vodafone before Bombay HC)

“Today's judgment, in the Vodafone transfer pricing case, relating to attempts by the Indian Tax Department to render exigible to tax an alleged share premium, computed by the Transfer Pricing Officer on heretofore unknown principles, is indeed path breaking, and carries with it all of the reverberations of the 20 January 2012 verdict of the Supreme Court of India in another Vodafone case, from the standpoint of signalling to foreign investors that the rule of law prevails in India. In the garb of applying transfer pricing provisions in Chapter X of the Income Tax Act, assertions were leveled by the Indian Tax Department that their computation of share premium on share capital subscribed to by a wholly owned parent company of an Indian subsidiary constituted 'incomings' and was taxable in India, which has been unequivocally struck down. The judgment will impact several other pending cases on the issue, including Shell, which has also waged a battle against the Tax Office on a similar attempt in relation to capital financing of its Indian subsidiary. The judgment is timely, given the Prime Minister of India Shri Narendra Modi's bona fide endeavors to woo foreign investors, on the premise of stability and certainty within the realm of foreign direct investment generally.”

Aseem Chawla, Partner, MPC Legal

“The immediate newsflash does suggest the fact that the Hon’ble Bombay High Court has held in favour of Vodafone suggesting that the instance of issuance of shares at premium per se does not yield “income”.   The same, therefore, would not result in application of Transfer Pricing provisions.

For the purposes of application of Transfer Pricing provision, one of the essential pre-requisites is that there must be an international transaction between associated enterprises (related parties).   In the absence of income, no “international transaction” according to the Hon’ble Bombay High Court were to arise.

In terms of the provisions of the Income Tax Act, the definition of income is inclusive in nature, but it cannot be stretched to consider any receipt, which does not partake the nature of income.  Investment in shares per se, definitely does not partake the nature of income – whether real or notional.

The said High Court decision should help clearing the air in respect of several transfer pricing disputes being contested by the Tax authorities where items which are essentially capital in nature and do not fall within the realms of income have become  a subject-matter of controversy.”

Sanjay Sanghvi, Partner- Tax, Khaitan & Co.

“Very pragmatic and fair ruling! Yet another burning tax controversy put to rest! It is fundamental to the applicability of ‘Transfer Pricing’ provisions that in the absence of ‘income’, these provisions would not apply.  ‘Shares subscription’ is a capital account transaction which does not result into any ‘income’ as such. In the absence of any ‘income’, there is no ‘base erosion’ so as to warrant applicability of TP provisions. Hence, the Court has very rightly ruled that Transfer Pricing provisions  will not apply.  I am sure MNCs operating in India and other Indian Corporates who have invested abroad, would cherish this ruling. It will be very interesting to read the judgment.”

SP Singh, Senior Director, Deloitte Haskins & Sells

“Transfer pricing regulations provide that income, expense and interest should be determined having regard to the arm’s length principle. A question has arisen whether arm’s length methodology should be applied for valuing any international transaction or it should be done only if the transaction is in the nature of income, expense or interest. In the case of Vodafone the matter reached Honourable Bombay High Court.

Tax authorities observed that the price at which shares were issued was much lower than the price determined by them as the arm’s length price. The difference was taxed in the hands of the subsidiary. Further, this difference was also considered as “loan” by the Indian subsidiary to its parent and interest was imputed on that and added to the income of the Indian subsidiary.

The Hounarable High Court is reported to have decided that in the absence of income nature a transaction cannot be considered as “international transaction” to which transfer pricing regulations would apply.

While one will have to wait for the decision to provide specific comment it appears inline with the tax law as well as economics. As there is no specific provision which would enable tax authorities to tax infusion of shares as income in the hands of an Indian subsidiary on account of difference in valuation. Further, it is a common understanding that infusion of share is an act of investment and is in nature of “capital” and not “income”. Thus, legally as well as economically there appears no justification to impute income in infusion of shares. The decision will set to rest a lot of controversies and would go a long way in encouraging foreign investments. The government must consider all aspects before going in appeal before the Supreme Court of India and ensure certainty to taxpayers.”

(Watch this space for more reactions)

 
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