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Vodafone HC Order: Boost For Make In India Campaign?

Published on Tue, Oct 14,2014 | 08:11, Updated at Tue, Oct 14 at 08:11Source : 

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

The recent decision of the Bombay high court in the transfer pricing (TP) dispute involving alleged under valuation of shares issued by the Indian subsidiary of Vodafone group to its foreign parent is a huge relief for foreign investors who were being burdened with an unnecessary tax controversy, litigation costs and compliance burden for bringing in the foreign direct investment (FDI) in the country.

This decision couldn’t have been timelier than anticipated in light of the major national initiative – Make in India, launched by the Hon’ble Prime Minister Narendra Modi recently. ‘Make in India’ initiative, which aims to transform India into a global manufacturing hub, requires significant FDI in building up best-in-class manufacturing infrastructure in the country. An investor friendly tax environment and certainty around the administration of tax laws of country is critical for attracting billions of dollars of FDI in the country.

The on-going TP litigation on transactions involving share capital infusion has been a huge drain on India's reputation and significantly impacted the FDI into the country in last few years. As per the annual report and statistics released by Ministry of Finance recently, TP adjustments in cases which underwent TP audits increased exponentially in last two years i.e. INR 700 billion in FY 2012-13 and INR 596 billion in FY 2013-14 from INR 445 billion in FY 2011-12. A significant portion of this increase in adjustments in the last two years is attributable to TP disputes related to pricing of transactions involving share capital infusion.

TP is the value at which companies’ trade products, services or assets between group enterprises operating in two or more different countries. TP provisions requires that the TP of transactions between two group enterprises should be at arm’s length i.e. at a price that would have been charged between two unrelated parties operating under uncontrolled conditions for similar transactions.

Strictly speaking, TP provisions ought not to apply on transactions involving capital receipt and which don’t have a bearing on the taxable income of a taxpayer. The Indian 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 TP provisions. Since the transaction involving issuance of shares by an Indian subsidiary to its foreign shareholder on account of capital infusion does not give rise to any income in the hands of the Indian subsidiary, the same ought not be subject to TP provisions, as the entire exercise of determination of the arm’s length price in such case would be an academic exercise only.

The Indian revenue authorities however adopted a contrary view and argued that the alleged under valuation of shares issued by the Indian subsidiary to its foreign parent and non-receipt of the premium to the extent not received is an ‘income’ arising from an international transaction related to issuance of shares and is accordingly subject to the TP provisions. The revenue authorities further argued that the amount not received (i.e. alleged under valuation of shares) could have increased the potential income of the Indian subsidiary and accordingly non-receipt of the same has impacted the income of the Indian subsidiary and accordingly give rise to the applicability of TP provisions in such cases.  This position of the revenue authorities was subsequently upheld by the Dispute Resolution Panel (DRP) in an application filed by the Indian subsidiary of Vodafone group on the jurisdictional issue related to applicability of TP provisions on transactions involving share issuance on account of share capital infusion. Subsequently, a writ petition was filed by the Indian subsidiary of Vodafone group in the jurisdictional high court of Bombay against the order passed by the DRP.

While passing the recent order, the Bombay has held that the share issued at premium is a capital transaction and do not give rise to income and hence, there is no ‘international transaction’ to trigger TP provisions. The high court has held that if there is an income which is chargeable to tax under the normal provision of the Indian tax laws, than only TP provisions could be triggered. The high court re-enforced the otherwise stated position that Chapter X related to TP provisions is a computational provision under the Indian tax laws laid down with the objective of ensuring that the transactions between the group entities, which have bearing on the taxable income of the taxpayer, are undertaken at arm’s length price. The provisions of Chapter X cannot be invoked in case of transaction which is otherwise not liable to tax under any of the charging provisions of the Indian tax laws.  An amount received on issue of shares is admittedly a capital account transaction not separately brought within the definition of ‘income’ under the Indian tax laws, except in certain specific cases. Thus such capital account transaction not falling within a statutory exception cannot be brought to tax within Chapter X separately.

This well-reasoned order of the Bombay high court provides much sought after clarity on the contentious issue related to applicability of TP provisions on share issue transaction and is of great relevance to the foreign investors. This decision should have persuasive impact in resolving similar tax disputes being faced by other tax payers. Though the position of the revenue authorities seemed unsustainable from the outset, it caused a lot of stress to foreign investors and significantly dampened the foreign investment climate in the country in last few years. If the revenue authorities do not appeal to the Supreme Court and let the High Court’s decision prevail, this matter might reach finality and shall provide a huge impetus for fast-forwarding FDI in the country. This will further provide stimulus to ‘Make in India’ initiative of the Prime Minister and the overall investment climate in the country.

(Views expressed are personal)


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