Transfer pricing adjustment carried out in Shell/Vodafone case has been at the centrestage of every public discussion on Indian transfer pricing legislation. The incredulous stand taken by the tax authorities has evoked a strong response from investors and tax experts alike. It is for this reason that Vodafone’s transfer pricing litigation was being keenly followed.
The much-awaited decision of the Bombay High Court (HC) was finally pronounced on Friday (10 October 2014) wherein the HC ruled in favour of Vodafone (the Petitioner) bringing a lot of cheer amongst taxpayers.
Vodafone India issued equity shares to holding company at a premium. Revenue treated the shortfall on the premium amount as income and also computed notional interest on the same. Vodafone filed a writ challenging the assumption of jurisdiction on the ground that the said transaction does not give rise to any income. The Bombay HC held that issue of shares is a capital transaction and since there is no express legislation regarding capital receipt from a non-resident it failed to form part of income as is understood under Section 2(24) of the Income Tax Act,1961. Thus the HC quashed the order of previous authorities by ruling that no jurisdiction of Chapter X applies for issue of shares at a premium as it does not give rise to any income from an international transaction.
Below is a detailed analysis of the ruling
The petition is a sequel to the order dated 29 November 2013 passed by the HC in Writ Petition No.1877 of 2013 (Vodafone-III) filed by the Petitioner.
The basis of the challenge in Vodafone-III was that the issue of equity shares by the Petitioner to its holding company did not give rise to any income from international transaction, so as to attract the provisions of Chapter X of the Income Tax Act, 1961 (the Act) on the ground that arising of income on account of international transaction is a condition precedent for application of Chapter X of the Act.
It was a jurisdictional issue which was neither determined by the Transfer Pricing Officer (TPO) nor the Assessing Officer (AO). Thus, the dispute resolution panel (DRP) was directed to first decide only the jurisdictional issue raised by the Petitioner as preliminary issue.
The DRP considered the issue of jurisdiction and rejected the Petitioner's preliminary objection thereto by holding that AO has jurisdiction to invoke Chapter X of the Act. This petition essentially challenges the order passed by the DRP.
Facts of the case
1) the Petitioner is a wholly-owned subsidiary of Vodafone Tele-Services (India) Holdings Limited (holding company)
2) the Petitioner issued 2,89,224 equity shares of face value of Rs 10 each on a premium of Rs 8,509 per share to its holding company
3) the Revenue valued each equity share at Rs 53,775 and considered shortfall of Rs 45,256 per share as premium
4) the Revenue treated the total shortfall amount of Rs 1308.91 crore as deemed loan given by the Petitioner to its holding company and calculated periodical interest of Rs 88.35 crore thereon
Contentions of Petitioner
1) Section 92(1) of the Act: Pre requisite for application of this section is that the income should arise from an international transaction. In this case, no income arises from issue of equity shares
2) Section 2(24) (xvi) of the Act: Capital receipts are not income under the Act unless specifically provided for
3) The order of the TPO/DRP demonstrates that shortfall in premium on issue of shares is not taxable in as much as amount received by the petitioner on account of share premium has not been taxed
4) Explanation (i)(e) to Section 92B of the Act: If there is any impact of income on account of business restructuring /reorganising, then only such income would be subjected to tax as and when it arises whether in present or in future. In this case, such a contingency does not arise as there is no impact on income which would be chargeable to tax due to issue of shares
5) Section 92(2) of the Act: The objective is to ensure that profits are not understated nor losses overstated by disclosing higher cost or expenditure, than the benefit received. Hence it has no application in the present case
6) The view taken by Revenue that if the petitioner had got the extra premium he would have invested it somewhere and would have earned additional income is based on pure guesswork and is not admissible
Contentions of Revenue
1) Section 92(1) of the Act: Uses the word 'Any income arising from an International Transaction'. This indicates that the income of either party to the transaction could be subject matter of tax and not the income of resident only. Under Chapter X of the Act, real income concept has no application otherwise the words would have been 'actual Income'
2) Section 2(24) of the Act: Income as defined is inclusive definition and it does not prohibit taxing capital receipts as income
3) Section 2(47) of the Act: The issue of shares is a transfer within the meaning of term ‘income’. The forgoing of premium on the part of the Petitioner amounts to extinguishment/ relinquishment of a right to receive fair market value
4) Clauses (c) and (e) of the Explanation (i) to Section 92B of the Act: The meaning of international transaction as given would include even capital account transaction within its scope
5) A conjoint reading of Section 92(1) of the Act along with Section 92(2) of the Act: indicate that what is being brought to tax is not share premium but the cost incurred by the Petitioner in passing on a benefit to its holding company by issue of shares at a premium less than ALP
6) The order of the TPO/DRP demonstrates that premium on issue of share is not taxable in as much as amounts received by petitioner on account of share premium have not been taxed
7) The Petitioner itself had submitted to the jurisdiction of Chapter X of the Act by filing/submitting Form 3-CEB, declaring the ALP
8) Under the Act, the income is taxable when it accrues or arises or when it is deemed to accrue or arise and not only when it is received. Therefore, even if an amount is not actually received, yet in case income has arisen or deemed to arise, then the same is chargeable to tax. Thus, income forgone is also subject to tax
9) Chapter X of the Act is a complete code by itself and not merely a machinery provision to compute the ALP and applies wherever the ALP is to be determined by the A.O
10) The passing on of benefit by the Petitioner to its holding company would fall under the head 'Income' from other sources under Section 56(1) of the Act
High Court’s observation
1) No express legislation on capital account transaction: Section 92(1) of the Act brings out that income arising from an international transaction is a condition precedent for application of Chapter X of the Act. Income will not in its normal meaning include capital receipts unless it is so specified, as in Section 2(24)(vi) of the Act. In such a case, capital gains chargeable to tax under Section 45 of the Act are defined to be income
2) The amount received on issue of share capital including the premium is on capital account. Share premium have been made taxable under Section 56(2) (viib) of the Act and the same is enumerated as Income in Section 2(24) (xvi) of the Act. However, what is brought into the ambit of income is the premium received from a resident in excess of the fair market value of the shares. In this case, what is being sought to be taxed is capital not received from a non-resident i.e. premium not received on application of arm’s length price (ALP). Therefore, absent express legislation, no amount received, accrued or arising on capital account transaction can be subjected to tax as income
3) Thus neither the capital receipts received by the Petitioner on issue of equity shares to its holding company, nor the alleged shortfall can be considered as income as defined under the Act
4) Charge and measure of tax entirely different: The tax can be charged only on income (charge of tax) and in the absence of any income arising, the issue of applying the measure of ALP to transactional value/consideration itself does not arise. Chapter X of the Act ensures that the transaction is charged to tax only on working out the income after arriving at the ALP of the transaction. This is only to ensure that there is no manipulation of prices/consideration between associated enterprises (AE). The entire consideration received would not be a subject-matter of taxation
5) Transaction on capital account or on account of restructuring would become taxable to the extent it impacts income: Under the sub clause (c) and (e) of Explanation (i) to Section 92B of the Act, the transaction on capital account or on account of restructuring would become taxable to the extent it impacts income i.e. under-reporting of interest or over-reporting of interest paid or claiming of depreciation etc. It is that income which is to be adjusted to the ALP price. It is not a tax on the capital receipts. Determination of the ALP is only to arrive at the real income earned i.e. the correct price of the transaction
6) Income pre requisite for applicability of Section 56(1): The said section provides that income of every kind which is not to be excluded from the total income is chargeable under the head income from other sources. However, before Section 56 of the Act can be applied, there must be income which arises and as already pointed out the issue of shares at a premium is on capital account and gives rise to no income
7) Section 92(2) has no relevance in the present issue of fact: Section 92(2) of the Act deals with a situation where two or more AEs enter into an arrangement whereby they are to receive any benefit, service or facility then the allocation, apportionment or contribution towards the cost or expenditure is to be determined in respect of each AE having regard to ALP. This has no applicability in the present case where there is no occasion to allocate any cost or expense between the petitioner and the holding company
8) General findings
the petitioner submitted the Form 3CEB as abundant precaution
issue of shares to the holding company is a capital account transaction and has nothing to do with income
Ruling: The High Court quashed the order of previous authorities by ruling that no jurisdiction of Chapter X applies for issue of shares at a premium as it does not give rise to any income from an admitted international transaction.
(Grant Thornton is an international accounting and business advisory network.)