AAR Ruling - transfer of shares of Indian Subsidiaries of an American company without consideration in a scheme approved for bankruptcy proceedings in an American Court would not attract capital gains and consequently, transfer pricing provisions cannot be applied in such transactions [A.A.R. No. 788 of 2008 - Dana Corporation]
Facts:
Dana Corporation ("DC"), a company incorporated in USA filed for bankruptcy. DC owned shares in two US entities namely, Dana World Trade Corporation ("DWTC") and Dana Global Products, Inc. ("DGPI"). DC also had three subsidiaries in India. As part of the bankruptcy proceedings, a reorganization plan was submitted to the Bankruptcy Court in USA. A new holding company ("DHC") and a limited liability company ("DCLLC") were formed as part of the plan. Thereafter, DC transferred the equity shares held by it in two of the Indian Companies to DWTC and the shares of the other wholly owned Indian Company were transferred to DGPI. The transfer was without consideration in terms of the share transfer agreements.
As a part of bankruptcy transfers, an independent private equity concern infused capital into DHC in exchange for shares of DHC, additional shares of DHC were distributed as settlement for certain claims made against DC, DC transferred shares held in DWTC and DGPI to DHC and finally, DC merged into DCLLC as per the Articles of Merger. In effect, the indirect control over the Indian Companies was transferred to DHC. It was stated that the liabilities taken over by DHC from DC were more than the assets. The holding structure of this transaction can be illustrated as under:
Questions before the Authority for Advance Rulings ("AAR"):
The main question raised by DC through its successor company DCLLC ("Applicant") before the AAR is whether the transfer of shares of Indian Companies, by DC, is not taxable under the Income-tax Act, 1961 ("ITA").
Applicant's Contentions before the AAR:
The Applicant argued that the transfer of shares was without consideration, as specifically stated in the Transfer Agreement. Even if the transfer was only a part of the overall restructuring / reorganization of DC under Chapter 11 of US Bankruptcy Code, no consideration could be attributed to the transfer of shares. In the absence of consideration or indeterminability of full value of consideration, the computation provision in section 48 of the ITA fails and consequently, the charging provision under section 45 of the ITA cannot be invoked. It was also argued that the fair market value of the shares in question could not be taken as representing the amount of consideration for the transfer of shares. Further, since there is no income chargeable under the ITA, the transfer pricing provisions also cannot be made applicable.
Revenue's Contentions before the AAR:
The Revenue contended that there was consideration for the transfer of shares as a part of reorganization scheme and that it was immaterial that the consideration flowed from a third party. The taking over of the liabilities by DHC can be taken as the consideration for the transfer of shares. The expression 'transfer' includes even transfer by operation of law and/or under orders of Court. Once it is held that there was a transfer, income therefrom has to be calculated as provided under section 45 read with section 48 of the ITA and the provisions contained in Chapter X (sections 92 to 92F).
As the transfer of shares is for fair consideration (irrespective of whether the Applicant has identified the consideration for transfer of shares or not), it cannot be said that there is no income. Even if the consideration for transfer of shares is not identifiable or indeterminable, the arm's length price can be arrived at by taking resort to the transfer pricing provisions under the ITA as it is admittedly an international transaction between two or more related entities. Therefore, the computational provisions do not fail.
AAR's observations and the ruling:
Capital Gains - Transfer of shares
It is settled law that section 45 must be read with section 48 and if the computation provision cannot be given effect to for any reason, the charge under section 45 fails [Reliance was placed on the decisions of the Supreme Court in CIT v. B.C. Srinivasa Setty (128 ITR 294) and Sunil Siddharthbhai v. CIT (156 ITR 509)].
The AAR has held that the profits or gain envisaged by section 45 are not something which remain ambivalent or indefinite or indeterminable; if the profits or gains or the full value of the consideration cannot be arrived at, then it cannot be arrived at on a notional or hypothetical basis. The profits or gains to the transferor must be a distinctly and clearly identifiable component of the transaction.
As for the Revenue's argument that the liabilities taken over can be considered as consideration, the AAR has observed that one cannot find consideration for the transfer by means of conjectures and assumptions. When the entire assets and liabilities of DC have been taken over by DHC (which is neither transferor nor transferee) in order to reorganize the business, it is difficult to envisage that a proportion of liabilities constitutes consideration for transfer, notwithstanding the fact that such consideration was never defined nor identified. The recital in the Shares Transfer Agreement that the transfer was effected without consideration therefore reflects the correct position.
The AAR has, therefore, held that the facts on record judged in the light of reorganization plan lead to a reasonable inference that there was no consideration for the transfer or at any rate the consideration is indeterminable and therefore the charging provision - section 45 becomes inapplicable.
Application of Transfer Pricing Regulations
If no consideration had passed from or on behalf of the transferee companies to the transferor company and the charge under section 45 fails to operate for want of consideration or determinable consideration, obviously, the provisions in section 92 etc. do not come to the aid of the Revenue. It must be noted that section 92 is not an independent charging provision. The opening part of section 92 says that "any income arising from an international transaction shall be computed having regard to the arm's length price" The expression 'income arising' postulates that the income has arisen under the substantive charging provisions of the ITA. In other words, the income referred to in Section 92 is nothing but the income captured by one or the other charging provisions of the ITA. In such a case, the computation aspect is taken care of by Section 92 and other related provisions in Chapter X. Section 92 obviously is not intended to bring in a new head of income or to charge the tax on income which is not otherwise chargeable under the ITA.
Our view:
Although the AAR Ruling is applicable only in the case of an Applicant who has sought it, it nevertheless carries a persuasive value. This ruling reinforces the proposition that, the provisions of section 92, dealing with the evaluation of the income arising from an international transaction, whether it is at arm's length, comes into play only if such income is taxable under the provisions of sections 4 and 5 of the ITA. Thus, if there is no income or the income cannot be brought to charge under the ITA, then section 92 cannot come into play.
Hence, we believe this ruling could assist taxpayers in cases where no or indeterminable consideration flows from the transfer of assets, as such transfer could escape the charge of tax and consequently, would also escape the mischief of section 92.
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