Important that govt not appeal Voda ruling in SC
When the taxman added R15,000 crore to Shell India’s FY09 income, arguing it had undervalued share sales to its Dutch parent, its chairperson had said the demands were ‘in effect, a tax on foreign direct investment’. And with good reason, since Shell BV—like Vodafone Plc—was merely infusing money into its local subsidiary, how could the taxman levy a tax on this? After all, there was no income that was being generated. This ‘tax’ on FDI is what the Bombay High Court ruled yesterday—while the case pertained to an alleged under-pricing of R3,200 crore by Vodafone India when it got capital from Vodafone Plc, the same principle will apply to all FDI. Including Vodafone, around 27 companies are believed to be affected by the taxman’s interpretation of the law—transfer-pricing adjustments for just the top five firms add up to around R26,000 crore.
What complicated the case was that, much like the original R10,000 crore tax notice on Vodafone Plc on its $11.2 billion purchase of Hutch’s India operations, this too was based on a retrospective amendment of the law. In 2012, the finance ministry changed Section 92(1) of the Income Tax Act and the taxman used this to argue it could include share transactions in transfer-pricing—having done this, it used various benchmarks to show how the shares were undervalued. Without getting into the legality of the retrospective amendment, the court ruled that even the amended section could not be used to tax what were effectively capital transactions. Given this, the question of whether the premium at which the shares were subscribed to was a fair one or not was, the court argued, irrelevant.
While the foreign investor community will no doubt cheer the verdict, it is not clear yet whether the government will challenge the case all the way up to the Supreme Court as has been the norm so far. In that sense, this case will test the government’s resolve. While both the finance minister and the prime minister have given assurances they will run an investor-friendly government, the pressures to challenge such rulings are immense. For one, since the ruling will cause a (completely notional, though) revenue loss, the government may be too scared to not challenge it in the Supreme Court. Related to this, the CAG may pass adverse remarks, so challenging this may be part of a play-it-safe strategy where the government is not seen to be favouring industry. What is worrying is that, apart from the gas-price hike that seems to have been delayed due to the same reason of the government not wanting to be seen to be favouring industry, it has caved in to similar pressures in the case of the telecom industry. Government policy on 3G intra-circle roaming, as this paper has pointed out several times, was quite irrational and was hurting investors. So, when the TDSAT came down heavily on the previous government, you would think the current government would be content to leave it at that, and not just to score political capital. After all, challenging the verdict would cause uncertainty among telcos and even affect the next telecom auction. Despite this, the present government has gone and challenged the TDSAT verdict in the Supreme Court. Apart from looking at the adverse impact it will have on investor sentiment, while deciding on whether to challenge the Vodafone ruling, finance minister Arun Jaitley would do well to look at the taxman’s dismal record in winning cases.