16 October 2014 | Volume 7 Issue 9
Application of transfer pricing provisions to tax difference in share issue premium – Bombay High Court provides much-awaited clarity

On 10 October 2014, the Bombay High Court (HC) pronounced its much-awaited verdict on the issue of share premium in the case of Vodafone India Services Pvt Ltd[1] (taxpayer). The Revenue had slapped a transfer pricing adjustment of INR 13.97 billion for alleged short receipt of premium on shares issued by the taxpayer to its holding company Vodafone Tele-Services (India) Holdings Limited (associated enterprise (AE)) during financial year (FY) 2008-09. The taxpayer is not the only one to have locked horns with the Revenue on this matter; other multinational enterprises (MNEs) such as Shell, IBM, Nokia, etc. are facing similar issues.
The summary and findings of the HC ruling in case of the taxpayer are discussed here:

During FY 08-09, the taxpayer had issued shares of face value INR 10 at a premium of INR 8,509 per share in accordance with the methodology prescribed under the Capital Issues (Control) Act, 1947. The assessing officer (AO)/transfer pricing officer (TPO) computed the arm's length price (ALP) of each share at INR 53,795 and accordingly arrived at a shortfall in the premium of INR 45,256 to be received from the AE. This shortfall in premium was sought to tax by the TPO under the
transfer pricing regulations (TPR).  Furthermore, an imputed notional interest on the alleged shortfall in share premium was re-characterised as a loan extended by the taxpayer to its AE and notional interest thereon was also purported to be charged. Overall, it resulted into an adjustment/addition to the tune of INR 13.97 billion.
The taxpayer challenged the adjustments made by the Revenue in its first writ petition
[2] dated 29 November 2013 before the HC. In its writ, the taxpayer questioned the "jurisdiction" of the Revenue while making transfer pricing adjustments on the grounds that issue of shares being a capital account transaction did not give rise to any income, which was a condition precedent for invoking TPR. Against the writ filed, the HC issued directions to the Dispute Resolution Panel (DRP) to decide the taxpayer's preliminary issue of "jurisdiction". The DRP passed its order and upheld the jurisdiction of the AO/TPO in invoking transfer pricing provisions. The DRP held that the shortfall in share premium gives rise to an income from the share transaction by resorting to a wide interpretation of the term "income".
Aggrieved by the DRP's Order, the taxpayer filed second writ petition before the HC.

Taxpayer’s submissions 
Issue of shares and the consideration thereof is a capital receipt. It is not a cost or expenditure allocated/apportioned. TPR are special provisions pertaining to avoidance of tax and can be invoked only when "income" arises. It gets activated only when the profits are understated or losses are overstated. In case of capital receipt, "income" element is missing, as already submitted right from the time of filing of Form 3CEB. The TPR are not designed to tax all sums, especially a capital transaction, which is not "income".
Further, the word "income" in not defined under TPR, hence, a wider meaning assigned by the DRP itself is not permissible.
The taxpayer contested the action of the AO/TPO on the ground that if premium received itself is not taxed since it is a capital receipt, then the action of taxing premium not received is unjustified. Furthermore, the presumption that the differential share premium foregone would have been invested by the taxpayer, had it been received is simply guesswork or an assumption to tax something that is notional.
Lastly, even if the TPR provide to tax few capital transactions, the same pertain to financing activities, whereby the taxability would be determined on the quantum of income due to borrowing or lending and not the amount borrowed or lent.

Revenue's contentions
The Revenue's contentions were two-fold: 1) what was contained in the TPO and DRP's Order that was not argued before the court and 2) the new arguments presented by the Revenue Counsel before the court.
The TPO had contended that TPR are a separate code in itself and difference between the ALP and transaction price would give rise to income. In the present case, the taxpayer has foregone its premium, which would amount to relinquishment of a right, hence amounts to transfer within the meaning of other provisions
[3] of the Act, to trigger chargeability. Hence, non-receipt of premium to the extent not received is subject to TPR and ALP needs to be computed and the difference is taxable. Accepting the contentions of the TPO, the DRP passed an order whereby it accepted that "income" needs a broader interpretation to capture within its ambit short receipt of premium as well and the AO/TPO was within its jurisdiction to make this adjustment. These arguments where though not debated by the Revenue before the HC.
The Revenue Counsel had a new ground of argument and contended that the adjustment is proposed by a conjoint reading of the TPR, which indicates that under the current facts, what is proposed to tax is the cost incurred by the taxpayer (by issuing the shares at lesser value than the ALP of INR 53,775) in passing on a benefit to its AE by issuing shares at less than ALP thereby increasing the real net worth of the AE. Further, the TPR are a complete code, with inherent charging provisions and the AO/TPO can rely on them to compute the inherent benefit in a transaction.
The TPR propose to charge "any income", thereby the assessee's submission as regards "real income" has no merit. Also, the taxability triggered either on accrual or receipt, and the difference in ALP though foregone is accrued to the taxpayer and hence taxable. 

HC ruling
  1. On jurisdiction to apply transfer pricing provisions
  • Relying on its earlier writ petition order, the HC ruled that mere disclosure of an international transaction by taxpayer out of abundant caution does not give jurisdiction to AO/TPO to invoke TPR. There must be an "income" arising out of an international transaction to invoke the said provisions.[4] 
  1. On the interpretation of "income" and whether receipt of share premium is income
  • Transfer pricing provisions under the Act do not define "income chargeable to tax". Hence, the same needs to be interpreted under normal provisions of the Act. The action of the DRP to widen the definition of "income" is far fetched and hence outside the purview. 
  • Income under normal provisions of the Act does not include capital receipt unless specified.[5] 
  • Issue of share capital including premium is a capital account transaction. Another provision[6] under the Act seeks to tax premium received in excess of the fair market value of shares by resident. However, in the instant case, the premium not received from AE is sought to tax, which in the absence of express provisions under the Act cannot be taxed.
  • Issue of share capital and alleged shortfall in premium cannot be considered as income within the meaning of the Act. The intent of the TPR is not to punish MNEs from doing business and courts are bound to adhere to a strict interpretation of the Act, thereby not divulging from the express provisions of not taxing a capital receipt. Capital account transactions are within the statutory exception and cannot be brought to tax. 
  1. On the issue of cost incurred by the taxpayer and passing of the benefits to the AE
  • This argument of the Revenue was completely brushed aside to be otiose since it resulted into redrafting the TPR.
  1. Other important observations
  • Four factors are essential for a taxing statute: subject of tax, person liable to pay tax, rate at which tax is to be paid, and the measure or value on which the rate is to be applied.

    The subject matter to tax is "income" which is different from measure to tax, i.e. "ALP" and once the share premium is classified as capital receipt, it cannot be characterised as "income" to bring it under the purview of TPR.

  • Also, the other provisions of the Act, referred to by the Revenue pertain to residents and in case the same are extended to non-residents, it would result in discouraging the capital inflow from abroad.
  1. The conclusion of the HC ruling
    Finally, the HC ruled that the issue of shares at a premium by the taxpayer to its AE does not give rise to any income and hence application of transfer pricing provisions does not arise.
[1] Writ Petition No. 871 of 2014
[2] Writ Petition No. 1877 of 2013 (Vodafone III)
[3] Section 2(47) of the Act
[4] Conditions under Section 92(1)
[5] Cadell Weaving Mill Co. vs. CIT [249ITR265], CIT vs. D.P. Sandu Bros. Chember (P) Ltd. [273ITR1]
[6] Section 56(2)(viib)
SKP's Comments
The ruling is a welcome move, ending the avoidable tussle between taxpayers and the Revenue on the issue of whether TPR apply to the difference in share issue premium while issuing shares to a non-resident. This would certainly provide much-needed relief to foreign investors and boost foreign investments into India. In fact, the observation made by the HC on the applicability of TPR only in cases where income arises and not otherwise may set a useful precedent for taxpayers locked in disputes on such other transactions not giving rise to any income.

Also, decisions in case of other taxpayers are expected in November where the Revenue is trying to distinguish facts of those cases from this one. While one should wait for the final word from the court on those cases, it is expected to be on similar lines.

We only hope that the new Government, which has promised an investor-friendly tax regime, walks the talk and does not appeal against the said ruling before the Supreme Court nor makes any retrospective amendments.

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