Vodafone Case Summary: Bombay HC rules on the applicability of TP provisions to “issue of shares” to associated enterprises; holds share premium does not give rise to income
Section 92(1) of the Income Tax Act (“Act”) states that “Any income arising from an international transaction shall be computed having regard to the arm’s length price”. Further as per the explanation under section 92B of the act “the expression international transaction includes capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business. A recent controversy faced by some taxpayers in India has been on whether TP provisions are attracted when shares are issued by an Indian company to its Associated Enterprise (“AE”) and whether issuance of shares at a price lower than the fair market value can result in a TP adjustment/arise of any income in the hands of the Indian company. The Bombay High Court (“HC”) has pronounced a much awaited and anticipated ruling on this matter in Vodafone India Services Pvt. Ltd. Vs UOI ( Writ Petition No.871 of 2014)(Bombay High Court). The TP issue under consideration by the HC was whether the consideration for issue of shares to an AE should be computed based on the arm’s length price (“ALP”) and if the shares are issued for less than ALP can the difference be taxed as income in the hands of the taxpayer who issued the shares.
The HC in this case examined the nature of share issue transaction and ruled in favour of the taxpayer and held that since there is no ‘income’ arising out of ‘share issue’ transaction under general provisions of the tax law, TP provisions are not applicable.
We have summarised below the key findings of the Bombay High Court in the case Vodafone on applicability of transfer pricing provisions on issue of shares:
• Section 92(1) of the Act very clearly brings out that income arising from an International Transaction is a condition precedent for application of Chapter X of the Act.
• It cannot be disputed that income will not in its normal meaning include capital receipts unless it is so specified. The amounts received on issue of share capital including the premium are undoubtedly on capital account.
• Absent express legislation, no amount received, accrued or arising on capital account transaction can be subjected to tax as Income.
• Neither the capital receipts received by the Petitioner on issue of equity shares to its non-resident holding company nor the alleged short-fall between the so called fair market price of its equity shares and the issue price of the equity shares can be considered as income within the meaning of the expression as defined under the Act.
• Reporting of transaction in form 3CEB does not create the jurisdiction of TPO/ AO on the principle of that Assessee submitted it is out of abundant caution.
• While interpreting a fiscal/taxing statute, the intent or purpose is irrelevant and the words of the taxing statute have to be interpreted strictly.
• Reliance by the Revenue upon the definition of International Taxation in the sub clause (c) and (e) of Explanation (i) to Section 92B of the Act to conclude that Income has to be given a broader meaning to include notional income, as otherwise Chapter X of the Act would be rendered otiose is far fetch.
• The transaction on capital account or on account of restructuring would become taxable to the extent it impacts income. It is that income which is to be adjusted to the ALP price. It is not a tax on the capital receipts.
• The other basis in the DRP order is that as a consequence of under valuation of shares, there is an impact on potential income. The reasoning is that if the ALP were received, the Petitioner would be able to invest the same and earn income, proceeds on a mere surmise / assumption. This cannot be the basis of taxation. In any case, the entire exercise of charging to tax the amounts allegedly not received as share premium fails, as no tax is being charged on the amount received as share premium.
• Chapter X is invoked to ensure that the transaction is charged to tax only on working out the income after arriving at the ALP of the transaction. This is only to ensure that there is no manipulation of prices/consideration between AEs. The entire consideration received would not be a subject-matter of taxation.
• Revenue itself did not adopt the basis/grounds found in the DRP order viz. the short receipt of share premium being sufficient justification to invoke Section 92(1) in Chapter X of the Act. The ground found in the impugned order was substituted /replaced at the hearing with a new ground viz: cost of benefit passed by the Petitioner to its holding company on application of Section 92(2) of the Act.
• Manner resorted by the Revenue of reading provisions of Section 92(2) of the Act (i.e. to omit words in the Section, ignoring/rejecting certain words without any finding that in the absence of so rejecting, the provision would become unworkable) is certainly not a permitted mode of interpretation. It would lead to burial of the settled legal position that a provision should be read as a whole, without rejecting and/or adding words thereto.
• This rejecting of words in a statute to achieve a predetermined objective is not permissible. This would amount to redrafting the legislation which is beyond/outside the jurisdiction of Courts
• Section 92(2) would have no application in the transaction of issue of shares as there is no occasion to allocate, apportion or contribute any cost and/or expenses between the Petitioner and the holding company.
• The deemed income which was charged to tax under Section 42(2) of the 1922 Act was done away with under the Act. The charge of Income now has to be found in Section 4 of the Act. If it is income which is chargeable to tax, under the normal provision of the Act, then alone Chapter X of the Act could be invoked.
• The charge is on income as understood in the Act, and where income arises from an International Transaction, then the measure is to be found on application of ALP so far Chapter X of the Act is concerned. The arriving at the transactional value/ consideration on the basis of ALP does not convert non-income into income.
• It was contended by the Revenue that in view of Chapter X of the Act, the notional income is to be brought to tax and real income will have no place. The entire exercise of determining the ALP is only to arrive at the real income earned. In this case, the revenue seems to be confusing the measure to a charge and calling the measure a notional income. The high court held that there is absence of any charge in the Act to subject issue of shares at a premium to tax.
• The provisions of section 56(2)(vii)(b) indicates the intent of the Parliament to tax issue of shares to a resident, when the issue price is above its fair market value.
• Section 56 of the Act does provide that income of every kind which is not excluded from the total income is chargeable under the head income from other sources. However, before Section 56 of the Act can be applied, there must be income which arises.
• ALP 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 would be cases of income being affected due to a transaction on capital account, but which is not the present case.
• Section 56(1) of the Act would permit including within its head, all income not otherwise excluded, however, it does not provide for a charge to tax on Capital Account Transaction of issue of shares.
• It was contended by the revenue that income becomes taxable no sooner it accrues or arises or when it is deemed to accrue or arise and not only when it was received. The court held that charge-ability to tax is when right to receive an income becomes vested in the assessee. However, the issue under consideration is different viz: whether the amount said to accrue, arise or receive is at all income. The issue of shares to the holding company is a capital account transaction, therefore, has nothing to do with income.
• 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 Act, it is not possible to read a charging provision into Chapter X of the Act.
• There is no charge express or implied, in letter or in spirit to tax issue of shares at a premium as income.
• Income arising from International Transaction between A.E. must satisfy the test of Income under the Act and must find its home in charging sections i,e 4, 5, 15 (salaries), 22 (income from house property), 28 (profits and gains of business), 45 (capital gain) and 56 (income from other sources) of the Act.
• In B C. Srinivasa Shetti, there was charging provision but the computation provision failed and in such a case the Court held that the transaction cannot be brought to tax. The present facts are on a higher pedestal as there is no charging provision to tax issue of shares at premium to a non-resident, then the occasion to invoke the computation provisions does not arise.
• Revenue contended that taxing the income in the hands of the Petitioner even though the income has allegedly been earned by the holding company. However, none of the notices issued to the Petitioner in its representative capacity. Hence, the Petitioner had no occasion to challenge the jurisdiction of the Revenue on the above aspect. Therefore, the Court has no reason to examine the same
• 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. Thus, no occasion to apply Chapter X of the Act can arise in such a case.
Raghav Gupta
Partner | Transfer Pricing
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