India: Vodafone Victorious In Multi Million Transfer Pricing Battle, Yet Again!

Last Updated: 21 October 2014
Article by Ashish Sodhani and Rajesh Simhan
  • Bombay High Court holds that shares issued at a premium by a resident entity to a non-resident entity is a capital account transaction and does not give rise to any income;
  • Income arising from an International Transaction between AEs must satisfy the test of 'income; as provided under the ITA and fall under any of the charging provisions. In the absence of income, no international transaction can arise;
  • 'Income' as defined under the ITA cannot be given a broader meaning to include notional income within its ambit;
  • Transfer pricing provisions under the ITA are not a code by itself but only a machinery provision to compute ALP.

Recently, the Bombay High Court ("Court") in the case of Vodafone India Services Pvt. Ltd. v. Union of India1held that shares issued at premium by a resident entity to a non-resident entity didn't give rise to income and there is no 'international transaction' to trigger transfer-pricing provisions as provided under the Income Tax Act, 1961 ("ITA").

BACKGROUND

Vodafone India Services Pvt. Ltd. ("Vodafone"), a wholly owned subsidiary of a non-resident company, Vodafone Tele-Services (India) Holdings Limited ("Hold Co") issued 2,89,224 equity shares of the face value of INR 10/- each on a premium of INR 8,509/- per share to the Hold Co in the Assessment Year ("AY") 2009 – 10 ("Transaction"). The fair market value of the issue of equity shares was determined at INR 8,519/- per share in accordance with the methodology prescribed under the Capital Issues (Control) Act, 1947.

During the scrutiny assessment proceedings, the Assessing Officer ("AO") referred the Transaction to the Transfer Pricing Officer ("TPO") for calculation of its Arm's Length Price ("ALP"). The TPO, rejecting the price at which the shares were issued, determined the ALP at INR 53,775/- per share. It also held that (i) the Transaction was an International Transaction2 and would be governed by transfer pricing provisions as provided under the ITA; and (ii) the amount of deficit caused by the issuance of shares at a lower premium will be considered as a loan ex tended by Vodafone to the Hold Co and the interest on such loan would therefore have a bearing on the profit of Vodafone. The TPO, thus, made a total adjustment of USD 229.22 million which included interest at the rate of 13.5% p.a. on the deficit amount that was re-characterized as a loan given by Vodafone to the Hold Co. However, the TPO left it on the AO to determine whether any income has arisen to Vodafone on account of the Transaction.

Vodafone in its submissions to the AO, inter alia, stated that that the transaction of issuing shares cannot be governed by transfer pricing provisions as provided under the ITA as no income arises and / or is affected by it. However, the AO without dealing with submissions on this point passed a draft assessment order adding the entire amount of USD 229.22 million as determined by the TPO to Vodafone's income.

Post this, Vodafone filed objections to the draft assessment order with the Dispute Resolution Panel ("DRP"). In the objections, Vodafone made it clear that its submissions did not deal with the issue of jurisdiction but was restricted only to computation / valuation / quantification of ALP in respect of the Transaction. On the issue of jurisdiction, Vodafone filed a separate petition in the Court. The Court accepting the view that a jurisdictional issue arises for consideration, directed that Vodafone should submit its objections on the jurisdictional issue to the DRP within two weeks and the DRP would decide the issue of jurisdiction before considering issue of valuation / quantification of ALP within two months from the date on which the Vodafone files its objections with the DRP on the issue of jurisdiction. ( Click here for our hotline on this issue)

After objections were filed with the DRP on the issue of jurisdiction, the DRP passed its order holding that the deficit caused due to under charging or premium should be considered as income arising from the issue of shares and transfer pricing provisions should apply to such a transaction. The reasons given by DRP were:

  • 'Income' as defined under the ITA should be construed broadly embracing all types of receipts or incomings. International Transaction as defined under the ITA includes capital financing like purchase of marketable securities and in case a narrow meaning is given to 'income', then purchase of marketable securities, could never come within the ambit of the definition of income. Similarly, a transaction of business restructuring or reorganization is considered as an International Transaction under the ITA and even when there is no formal transfer of source of income or tangibles, the AO has been given the power to tax the income forgone under the transfer pricing provisions;
  • Since the issue of shares by Vodafone was not at ALP as determined by the TPO, it resulted in lesser premium being garnered by Vodafone. This income could have been used by Vodafone to enhance its potential income. Thus, even if 'income' is not given a broad meaning, the AO has jurisdiction to invoke transfer pricing provisions as the share premium forgone has impacted potential income; 

Aggrieved by the order of the DRP, Vodafone filed a petition in the Court.

ORDER OF THE COURT

The Court quashing the order of the AO, TPO and DRP ruled in favor of Vodafone. The Court held that issue of shares at a premium by Vodafone to its Hold Co does not give rise to any income as it a capital account transaction and hence transfer pricing provisions should not apply to such a transaction. The Court came to this conclusion by giving the following reasons:

  • Meaning of 'income': 'Income' as defined under the ITA has a well understood meaning and it will not in its normal meaning include 'capital receipts' unless specified. Amounts received on issue of shares including premium is a capital account transaction and in the absence of express legislation, no amount received, accrued or arising out of a capital account transaction can be subject to tax as 'income'. Section 56 is the only provision under the ITA, which taxes premium received by a company from a resident in excess of the fair market value of the shares. However, in the present case, the premium has been received from the Hold Co, a non-resident. Further, income as defined under the ITA includes within its scope the provisions of Section 56 of the ITA which indicates the intent of the legislature to tax issue of shares to a resident, when the issue price is above its fair market value. Therefore, neither the capital receipts received by Vodafone from issue of shares to its Hold Co nor the deficit in the premium charged by Vodafone can be considered as 'income' as defined under the ITA. Further, the golden rule of interpreting a taxing statute is that the intent or purpose is irrelevant and the words of the taxing statute have to be interpreted strictly. Accordingly, by seeking aid of the intent of the legislature, the definition of 'income' cannot be given a broader meaning.
  • 'Income' does not include notional income: 'Income' cannot be given a broader meaning to include notional income within its ambit and issue of shares at a premium does not exhaust the universe of applicability of transfer pricing provisions as provided under the ITA. 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. and it is that income which has to be adjusted to the ALP;
  • Potential income cannot be subject to tax: Income which Vodafone could have made if it had not under valuated the price of its shares cannot be the basis of taxation. Transfer pricing provisions are invoked to ensure that that there is no manipulation of prices/consideration between Associated Enterprises ("AEs") and only after calculation of the ALP is the transaction charged to tax. The entire consideration received cannot be a subject-matter of taxation.
  • 'Income' is necessary for ALP to be applicable: ALP is meant to determine the real value of the transaction entered into between AEs. It is a re-computation exercise to be carried out only when income arises in case of an international transaction between AEs. It does not warrant re-computation of a consideration received / given on capital account. It permits re-computation of income arising out of a capital account transaction, such as interest paid/received on loans taken/given, depreciation taken on machinery etc. All the above are cases of income being affected due to a capital account transaction. However, in the present case, even though the issue of shares is a capital account transaction there is no income that arises out of the transaction and hence the shortfall of ALP as computed does not give rise to any income.
  • Transfer pricing provisions are only machinery provisions: The chapter under the ITA dealing with transfer pricing provisions is not a code by itself but only a machinery provision to compute ALP. It is a settled position that a charge to tax must be found specifically mentioned in the ITA and in the absence of a charging section i n the chapter it is not possible to read a charging provision into the chapter. Even income arising from an International Transaction between AEs must satisfy the test of 'income; as provided under the ITA and fall under any of the charging provisions. In the present case there is no charging provision to tax capital account transaction in respect of issue of shares at a premium.

CONCLUSION

The judgment is welcomed not only by Vodafone but also by 20 other companies which are stalled in similar tax-related dispute with the Indian Revenue Authorities. The Court while pronouncing its judgment has gone into the intent of the legislature when enacting transfer pricing provisions and has laid down that transfer pricing provisions were introduced under the ITA to get over transfer mis-pricing/manipulation/abuse. Transfer pricing provisions have not replaced the concept of income or expenditure as normally understood under the ITA but are existing to ensure that qua International Transaction between AEs, the profits are not understated nor losses overstated by abuse of either showing lesser consideration or higher expenses between AEs than would be the consideration between two independent entities, uninfluenced by their relationship.

The Court has once again clarified that taxing provisions cannot be read on the basis of intent but need to be construed strictly on the basis of what has been said. Further, what has not been provided under the ITA cannot be presumed to exist without there being an express provision for the same. While, the Central Board of Direct Taxes has said that they are reviewing the judgment and will then decide the next course of action, it is more certain than not that the Revenue will file an appeal with the Apex Court to finally decide the issue.

This is another multi-million battle that Vodafone has won, the first one being on the issue of indirect transfer of assets. Such high profile litigation being instituted against MNCs time and again definitely raises a question of intention of the Revenue Authorities in people's mind. The number of such litigations being instituted against MNCs creates further tension in the existing adversarial environment in India characterized by the large backlog of cases. Further, the new Government has always in its public statements stated that there will no 'tax terrorism' but cases like these tend to show what the real picture is. The Court in the judgment has itself recognized that the arguments which were raised by the tax authorities were bereft of any sanctity under law. Such kind of actions result in creating ambiguities where none exist and is an example of executive overreach of power. Government should be cognizant of the ramifications prior to filing any appeal and should stick to the stance of not introducing retrospective amendment to the existing law.

A trust based taxation system is the need of the hour. Further, it is imperative that certainty, fairness and stability should continue to serve as guiding principles and not the amount of tax that can be collected. It is necessary to guarantee and enforce internationally recognized taxpayer rights and safeguards have to be included to counter excessive discretion and corruption.

Footnotes

1.Writ Petition No. 871 of 2014

2. Section 92B of the ITA

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Ashish Sodhani
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions