The Bombay High Court’s landmark ruling in favour of Vodafone India Services (VISPL) will likely set free around 26 other companies including Shell India, HSBC Securities and five Essar Group companies (see box) who have similar transfer pricing disputes with the taxman in connection with shares sold by them, mostly to their global parents.
The court ruled on Friday that transferring the shares did not lead to any income, so the question o`f imposing a tax did not arise. Some of these cases have been ‘listed for direction’ by the HC after Diwali — since the court has given a ruling on the principle that share premiums cannot be added to income, tax experts expect other rulings to be similar.
In its 53 page order, the HC said, “It is well settled position in law that a charge to tax must be found specifically mentioned in the Act. In the absence of there being a charging Section in Chapter X of the Income Tax Act, it is not possible to read a charging provision into Chapter X of the Act... In the present facts, issue of shares at a premium by the Petitioner to its non-resident holding company does not give rise to any income from an admitted International Transaction.”
“Vodafone has maintained consistently...that this transaction was not taxable. We welcome the decision today in the Bombay High Court,” a Vodafone Plc statement said, after the court ruling. Vodafone had earlier lost this case in the tax department’s Dispute Resolution Panel.
It is not certain if the government will appeal the case till the Supreme Court, though that has been the norm so far.
Mukesh Butani, managing partner, BMR Legal, observed that the high court had concluded the “share issuance does not give rise to any income arising and, hence, there can be no question of an adjustment”. Butani added that the judgment lent clarity to the vexed question of applicability of the transfer pricing law to share issuance.
In the Vodafone case, the taxman had added R3,200 crore to VISPL’s income, arguing that it had undervalued the shares it had sold to a Vodafone subsidiary in Mauritius — had the taxman won, VISPL would have had to pay a tax of around R1,000 crore. While VISPL received R246.38 crore for the shares in FY10, the taxman valued the shares at R53,775 each. VISPL had issued shares at a premium of R8,509 per share.
In the case of Shell India, which sold 87 crore shares at R10 to Shell Gas BV in March 2009, the taxman added R15,220 crore more to Shell India’s income; in a separate transfer pricing order the next year, R1,900 crore was added as interest on the income that Shell India would have earned had Shell BV paid the former the R15,220 crore extra. Taken together, this would have meant a tax outgo of around R5,000 crore from Shell India.
Though the original Vodafone tax demand was based on a retrospective amendment to the law in 2012, the court did not rule on the validity of the law since the company did not challenge this. After Section 92(1) of the Income Tax Act was amended, the taxman said the share sales came under its ambit. The court, however, ruled that even after amendment of Section 92(1), the premiums companies earned on share transfers could not be construed to be part of their ordinary income.
If all other cases go the Vodafone way, this means foreign firms will be free to infuse capital into local firms or subsidiaries without fear of the taxman questioning the valuation of the transaction. When the taxman had slapped a R15,200-crore transfer pricing adjustment on Shell India, its chairperson had said this was in effect a tax on FDI. If other judgments go the Vodafone way, and the government doesn’t challenge them in the apex court, this tax on FDI will be a thing of the past.
Tax experts welcomed the Bombay HC's order. Girish Vanvari, co-head of tax at KPMG in India, said it had resolved the row arising from view of the revenue authorities that capital infusion through transfer pricing provisions should be taxed. “The HC has stated that the shares issued at premium does not give rise to income and that absent income, there is no ‘international transaction’ to trigger transfer pricing provisions,” Vanvari said.
The view was echoed by Vijay Iyer, partner and national leader, transfer pricing, EY: “This is a huge relief for foreign investors who were being burdened with unnecessary transfer pricing controversy, litigation costs and compliance burden for bringing in foreign direct investment. The position of the revenue authorities seemed unsustainable from the outset but it caused a lot of stress to foreign investors.”
According to SP Singh, senior director, Deloitte Haskins & Sells, “The order appears in line with the tax law as well as economics as there is no specific provision which would enable tax authorities to tax infusion of shares as income in the hands of an Indian subsidiary on account of difference in valuation. Further, it is a common understanding that infusion of share is an act of investment and is in nature of ‘capital’ and not ‘income’. The government must consider all aspects before going in appeal before the Supreme Court and ensure certainty to taxpayers.”