We are pleased to
release a Tax Alert which summarizes the decision on 10 October 2014 of the
Bombay High Court (HC) in the case of Vodafone India Services Private Limited
(Taxpayer). The issue before the HC was whether the Indian transfer pricing
(TP) provisions are applicable to the Taxpayer’s issue of shares to its
associated enterprise (AE) and whether the Indian Tax Authorities have
jurisdiction under the Indian Tax Laws (ITL) to tax a short-fall between the
alleged fair market value (FMV) of the shares and the issue price of the equity
shares.
In the instant case, during the financial year (FY) 2008-09 the Taxpayer issued 289,224 equity shares of face value of INR 10 each at a premium of INR 8,519 (approx. US$ 142) per share to its AE in accordance with the methodology prescribed for capital issues by the Government of India under the exchange control regulations. However, during the course of audit proceedings, the Tax Authorities proceeded to compute the arm’s length price (ALP) of the equity shares and enhanced the value of each share to INR 53,775 (approx. US$ 896). The Tax Authorities treated the difference in the value of shares as income of the Taxpayer and also, made a “secondary adjustment” by treating the short receipt of consideration for issue of shares as a deemed loan by the Taxpayer to its AE and charged a notional interest on the same. Accordingly, a TP adjustment of INR 13.97 billion (approx. US$ 232.88 million) was determined.
The HC in this case, examined the nature of share issue transactions and held that ”income” arising from an international transaction is a condition precedent for application of TP provisions. 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 received or over reporting of interest paid or claiming of depreciation. The HC found substance in the Taxpayer’s case that neither its capital receipts on issue of equity shares to its AE nor the alleged short-fall between the FMV of its equity shares and the issue price of the equity shares can be considered as income within the meaning of the expression as defined in the ITL and hence not subject to TP provisions in India. Further, the HC held that the entire exercise of taxing the short receipt of consideration for issue of shares fails, as the consideration received for issue of shares itself is not taxable under the provisions of ITL.
Ruling in favor of the Taxpayer, the HC concluded that in the present facts, issue of shares at a premium by the Taxpayer to its nonresident AE does not give rise to any income from the reported international transaction and thus, Indian TP provisions are not applicable in such a case.
A recent controversy faced by some taxpayers in India has been on whether TP provisions are attracted when shares are issued by an Indian company to its AE and whether issuance of shares at a price lower than the fair market value can result in a TP adjustment. The approach of the Tax Authorities in making TP adjustments on transactions involving issue of shares to AEs has been one of the concerns expressed by several foreign investors.
In general, Indian TP provisions apply to income arising from an international transaction. Even if allotment of shares is regarded as an international transaction, as consideration received is not regarded as income subject to tax, TP provisions may not apply to such transactions. Further, the HC ruling acknowledges that mere reporting of an international transaction on abundant caution would not make the same taxable as there is no ”income” arising from such international transaction.
The HC’s ruling upholding this view may be welcomed by foreign investors as it is expected to address one of the TP challenges they were facing in India in recent times. The HC in its ruling recognizes there is a conscious intention of the Parliament not to tax amounts received from a nonresident for issue of shares as it would discourage capital inflow from abroad. This ruling, which comes in the backdrop of the Government’s initiatives for encouraging foreign investment, can play a significant role in providing certainty to foreign investors.
In the instant case, during the financial year (FY) 2008-09 the Taxpayer issued 289,224 equity shares of face value of INR 10 each at a premium of INR 8,519 (approx. US$ 142) per share to its AE in accordance with the methodology prescribed for capital issues by the Government of India under the exchange control regulations. However, during the course of audit proceedings, the Tax Authorities proceeded to compute the arm’s length price (ALP) of the equity shares and enhanced the value of each share to INR 53,775 (approx. US$ 896). The Tax Authorities treated the difference in the value of shares as income of the Taxpayer and also, made a “secondary adjustment” by treating the short receipt of consideration for issue of shares as a deemed loan by the Taxpayer to its AE and charged a notional interest on the same. Accordingly, a TP adjustment of INR 13.97 billion (approx. US$ 232.88 million) was determined.
The HC in this case, examined the nature of share issue transactions and held that ”income” arising from an international transaction is a condition precedent for application of TP provisions. 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 received or over reporting of interest paid or claiming of depreciation. The HC found substance in the Taxpayer’s case that neither its capital receipts on issue of equity shares to its AE nor the alleged short-fall between the FMV of its equity shares and the issue price of the equity shares can be considered as income within the meaning of the expression as defined in the ITL and hence not subject to TP provisions in India. Further, the HC held that the entire exercise of taxing the short receipt of consideration for issue of shares fails, as the consideration received for issue of shares itself is not taxable under the provisions of ITL.
Ruling in favor of the Taxpayer, the HC concluded that in the present facts, issue of shares at a premium by the Taxpayer to its nonresident AE does not give rise to any income from the reported international transaction and thus, Indian TP provisions are not applicable in such a case.
A recent controversy faced by some taxpayers in India has been on whether TP provisions are attracted when shares are issued by an Indian company to its AE and whether issuance of shares at a price lower than the fair market value can result in a TP adjustment. The approach of the Tax Authorities in making TP adjustments on transactions involving issue of shares to AEs has been one of the concerns expressed by several foreign investors.
In general, Indian TP provisions apply to income arising from an international transaction. Even if allotment of shares is regarded as an international transaction, as consideration received is not regarded as income subject to tax, TP provisions may not apply to such transactions. Further, the HC ruling acknowledges that mere reporting of an international transaction on abundant caution would not make the same taxable as there is no ”income” arising from such international transaction.
The HC’s ruling upholding this view may be welcomed by foreign investors as it is expected to address one of the TP challenges they were facing in India in recent times. The HC in its ruling recognizes there is a conscious intention of the Parliament not to tax amounts received from a nonresident for issue of shares as it would discourage capital inflow from abroad. This ruling, which comes in the backdrop of the Government’s initiatives for encouraging foreign investment, can play a significant role in providing certainty to foreign investors.
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