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Vodafone Share Issuance: Capital Receipt Or Taxable Income?

Published on Sat, Oct 11,2014 | 12:45, Updated at Tue, Oct 14 at 08:20Source : CNBC-TV18 |   Watch Video :

Rs 3200 crores- as amounts go; this is an un-noteworthy tax battle. After all we’ve been spoiled by billion dollar claims. But this Vodafone victory is landmark for other reasons; more so because it will seem sweeter to Shell, Essar, HSBC, StanChart and over 20 other companies fighting similar battles with revenue.

This week, the Bombay High Court ruled in favour of Vodafone – in a transfer pricing case that involved the issue of shares to a foreign parent. Revenue claimed the shares had been undervalued, the difference amounted to a loan by the Indian company to the foreign parent and that this international transaction was subject to transfer pricing norms. The revenue claimed tax on the difference in share value. Vodafone argued that a share issuance is a capital receipt and not an income subject to tax. And Vodafone won. The Bombay High Court ruled that there is no taxable income arising from such a share issuance transaction.

VODAFONE WINS!

In 2009 Vodafone issued shares to foreign parent @ Rs 8519/ share

Revenue argued undervaluation, claimed value of Rs 53775/ share

Revenue said shortfall of Rs 1308 cr is income, to be treated as deemed loan

VODAFONE WINS!

Revenue argued
- Undervalued share issuance amounts to loan
- Shortfall in share value + interest on loan = Rs 1397 cr adjustment

Vodafone argued capital receipt is not taxable

VODAFONE WINS!

‘The issue of shares to the holding company is a capital account transaction, therefore, has nothing to do with income’

‘We find that in the present facts issue of shares at a premium by the Petitioner to its non resident holding company does not give rise to any income from an admitted International
Transaction. Thus, no occasion to apply Chapter X of the Act can arise in such a case.’

Bombay High Court
- Chief Justice Mohit Shah
- Justice MS Sanklecha

While we await the judgment fine print, there’s no denying that this is good news for Vodafone and even better news for shell – which is fighting a Rs 15,000 crore similar tax claim by the tax department. Joining me to discuss this momentous decision with Mohan Parasaran - Former Solicitor General of India & Rahul Mitra, National Leader- Transfer Pricing, PwC. 

Menaka: Rahul, What you make of this decision and what kind of relief it will offer to the several other companies involved in similar such matters?

Mitra: This decision if not anything else it brings back the confidence of the foreign investors of putting money in into in India. The adjustments which were made by the revenue officers had put lot of doubt in the minds of foreign investments on whether their share capital would be subject to taxation. In fact to put it very briefly transfer pricing provisions are there to quantified income but not to create an income. So any deficiency in terms of share issue what the revenue said they was under valuation could have at least gone to swell up the share premium account which could have never been taxed as-as income. So the ruling doesn’t come as a surprise it is a relief for foreign investors and it will certainly go to improve the overall image of the country going forward.

VODAFONE WINS!

Revenue argued
- Undervalued share issuance amounts to loan
- Shortfall in share value + interest on loan = Rs 1397 cr adjustment

Vodafone argued capital receipt is not taxable

Menaka: Why do you day that this was an expected decision because from what I understand at the Dispute Resolution Panel (DRP) level many of these cases in fact went against the assesses?

Mitra: That’s the difference between the revenue and the judiciary. So if you can please read within the lines what I meant.

Menaka: Mr. Parasaran, It is not just the number of similar cases involved here or even the amounts which in the case of Shell is seriously mind-boggling a Rs 15,000 crore amount. It’s the very fact that many tax experts in this country thought that India was becoming the first country in the world in attempting to tax a capital receipt. Therefore would you agree having represented government in the past that, what the Bombay High Court has ruled today is only fair and will help improve the investment image of India?

VODAFONE WINS!

‘The issue of shares to the holding company is a capital account transaction, therefore, has nothing to do with income’

‘We find that in the present facts issue of shares at a premium by the Petitioner to its non resident holding company does not give rise to any income from an admitted International
Transaction. Thus, no occasion to apply Chapter X of the Act can arise in such a case.’

Bombay High Court
- Chief Justice Mohit Shah
- Justice MS Sanklecha

Parasaran: Entirely agree because see now it will bring back the investors confidence and what I was seeing in my experience actually the revenue had a very engineers mind in taxing many transactions. Many transactions were in fact not on the face of it taxable but so far as this transaction is concerned as Rahul pointed out it is highly doubtful. But if you look at these statutory provisions they look quite ambiguous and that led to the taxing authorities to actually find out a way to issue show cause notices in the light of the ambiguity post by the definition of an International transaction even seeking to bring in even transactions like capital financing and also by definition in Section 92B(e) restructuring of a company was also sought to be taxed. Therefore notional income of a company was also sought to be actually brought in the ambit of ALP and that actually is not accepted generally in international tax jurisprudence.

Section 92(1)
Any income arising from an international transaction shall be computed having regard to the arm's length price

Section 92B: Meaning of International Transaction
(c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee…or any other debt arising during the course of business

(e) a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise…

Menaka: If I remember correctly so when you were a lawyer to the government in your earlier avatar you did have to represent the government in some of these cases in the early stages in the Bombay High Court especially before the matter had gone to the DRP. Did you find it difficult at that point to be convinced by the revenues case?

Parasaran: I did in fact as a solicitor general in my heart of hearts I found it very difficult to defend. In fact the Bombay High Court commented the last round that the solicitor general actually did not go into the merits of the matter I argued on technicalities. However to be honest I found there was some merit based on the ambiguous legal provisions and that led to enormous litigation. But now the Bombay High Courts judgment will be an eye opener but we are now more concern about bringing in foreign investments at this juncture.

Menaka: I also want to ask you whether you think that this will broadly apply to the 20 odd cases or 20 odd companies that are fighting similar cases. The facts may vary minorly in each of these cases but the principle at heart of each of these cases is almost the same. So do you think that this Bombay High Court decision that is gone in favour of Vodafone will give heart to companies like Shell, Essar, Standard Chartered, HSBC that are all fighting in similar matters?

Parasaran: This will of course be a trend setter…of course Shell stands on a slightly different footing on facts. This judgment of course will be the beginning and will be of a great use to all the other 20 odd cases.

Mitra: We first need to see the judgment in its proper fine print to understand as to whether the principle should apply. However on first blush, I mean without any of us having an opportunity to read the judgment so I don’t see any reason as to why the principles with the Bombay High Court could have enunciated in the Vodafone case, why the same should not apply to all the other cases.

Menaka: So what happens from here on legally Rahul because from what I understand from my colleagues who cover the Bombay High Court that the Shell matter was likely to be heard next week. So how does this proceed from here on if the Bombay High Court is already ruled in the Vodafone matter that such a capital receipt does not amount to a taxable event? Would they simply apply the same thing to Shell or will Shell go through all the rigours of protracted hearings etc and then arrive at a decision of source?

Mitra: I personally feel, unless the facts of Shell or any other cases are significantly different which once again as an outsider we don’t feel they are, well I don’t think there will be too much of a detailed argument in all over again to be done by Shell or any other companies. So, The Bombay High Court should be applying the same principles in those other cases. 

Menaka: you indicated that you sought that the facts of Shell might be distinguished from this very case so you think that those matters will have to go through protracted hearings before arriving at a decision or do you think that principally the Bombay High Court will apply the same rationale to all those similar matters as well.

Parasaran: I don’t think the High Court is going to blindly apply Vodafone because facts would vary from case to case. However, the underline principles in Vodafone might greatly help Shell as well. There, it was a case of business restructuring but all this jurisprudence is the same. We will have to see the revenue might again bring in the concept of actually base erosion and profit shifting. If those things come in, the matter will be argued for sometime but the hearing may not be as detailed as one would have thought originally.

Mitra: What the interesting point would be or the fulcrum of the judgement would be the devoid of the peculiar unique facts which any of the other cases might have, if the underlined transaction which is the subject matter dispute is undervaluation of shares and if you shared all the other facts or all the other issues that might be involved that Mr. Parasaran was saying that there could be some business restructuring or whatever it is and at which none of us are really privy to, so to the extent the issue is broadly on the undervaluation of issue of shares then the principles of Bombay High Court should apply. This is something which we really need to see as to what the Bombay High Court really said on the basic issue of a undervaluation of share vis-a vis the applicability of transfer pricing on a particular item of not a notional income because in transfer pricing you also tax a notional income or let say an excessive expenditure. But the important thing is which could never have been considered to be a taxable income in the first instance whether can it at all be taxed. So those underlined principle are the most important thing which one would like to read from the Bombay High Court ruling.

Menaka: Mr. Parasaran, One issue is whether this can apply uniformly apply across all companies that are involved in similar matters, the other issue is that this is not necessarily the last word said in this battle. Revenue could very well choose to appeal this decision in the Supreme Court. Now many of the tax experts I have spoken to through the day, believe or would like to believe that given this stance that this new Prime Minister and his Finance Minister have taken to make India a more tax friendly investment destination they are hopeful that revenue will not agitate this further. What is your point of view sir on this?

Parasaran: What I feel is that the very fact that this government did actually send its own solicitor general to fight out this case quite forcefully before the Bombay High Court. The department also will be quite keen to take it up to the Supreme Court. This matter definitely involves a substantial question of law according to the revenue and therefore this matter will be taken up in appeal up to the Supreme Court. This is all the more… because of the fact that the government did not micro manage as I said earlier these particular provisions either during the budget nor has the Finance Minister of the government have made any comments qua this provisions at any point of time.

 
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