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No issue in share issue: rules Bombay High Court
Last year the Indian Revenue Authorities (RA) sought to tax the alleged under-valuation of new shares issued by Indian subsidiaries of multinationals. The RA had invoked domestic transfer pricing (TP) provisions to make an adjustment to the issue price of shares allotted to overseas group companies, and had further alleged that such adjustment is taxable in the hands of the issuing company.
The RA also treated the alleged undervalued amount as receivable from the overseas allottee and imputed interest thereon, notwithstanding that the domestic tax laws do not permit such imputation. Writ petitions had been filed by Vodafone India and Shell India against such adjustments and the Bombay High Court (HC) has recently given its verdict as favourable to the taxpayer on the petitions.
The HC heard the counsels of the taxpayers and the RA at length and has ultimately quashed the adjustments made by the RA. In a detailed order, the HC has upheld the following important principles under Indian domestic tax laws:
- Transfer pricing provisions do not replace the scope of income or expenditure as normally understood in the domestic tax law. The provisions were inserted only to avoid suppression of profits declared in India. Therefore, something which is not income cannot become income by applying transfer pricing
- Absent any income in the transaction, transfer pricing provisions are not applicable to such a transaction
- Transfer pricing provisions are only computational and not provisions which create liability to tax
- Receipt of share capital is not revenue in nature (except in certain specified circumstances) and transfer pricing provisions cannot be applied to tax such receipts
Consequently, the HC has held that transfer pricing provisions could not have been invoked in these cases to determine an arm’s length price of the shares and in any case the alleged shortfall in share capital, not being revenue in nature, could not be brought to tax by invoking such provisions.
Not surprisingly, the RA frequently changed its arguments for defending the adjustment. The HC, recognising of the shifting stance of RA, has rejected all arguments as a reflection of the RA’s desperation to collect revenues, which would have run into billions of US dollars.
As the issue has been decided in favour of taxpayers, the dispute raised by RA regarding valuation methodology, assumptions etc and imputation of notional interest becomes academic.
The reasoned and well-articulated decision brings cheer to stressed tax directors of MNC groups. More than 25 MNC groups were embroiled in disputes with RA on this issue and several more could have been impacted. Had the HC not intervened in a timely manner, it may have become a significant risk for impacted MNCs given tax demands based on the viewpoint of the RA. Possibly, interim amounts would still have been required to be paid to the exchequer, as courts are reluctant to give unconditional relief from payment of taxes. In most cases now, other affected taxpayers should be able to get requisite relief citing the Bombay HC ruling.
Given its stated intent of having a non-adversarial tax regime, the new government has decided that the RA will not challenge the Bombay High Court’s ruling in the Supreme Court. The government has accepted the views of the Attorney General of India, the highest law officer of the country, on the correctness of the decision of the Bombay HC.
With the annual Fiscal Budget 2015 around the corner, multinationals should keep a close watch on any legislative amendments proposed therein which may have a bearing on the issue. Until then, taxpayers are entitled to challenge any similar action proposed by RA, on the strength of the Bombay HC’s decision, fortified by the decision of the government not to challenge it further. Irrespective, multinational group companies in India should consider solutions, supported by robust documentation, going forward for fresh share issuances.
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