Analyzing impact of Vodafone IV Bombay HC ruling on expanded scope of Sec 92B

October 30,2014
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Mr. Sudhir Nayak, (Partner, Sudit K Parekh & Co)

As we all know, issue of Equity Shares (ES) to non-resident parent company has always been a hotbed for controversy under Indian transfer pricing (TP) regulations. The scope of international transaction as widened by the Finance Act 2012 w.r.e.f. 01.04.02 includes even capital financing and business restructuring or re-organisation.

The controversy relating to issue of ES to overseas AEs by the Indian taxpayer has been addressed by the Mumbai High Court (Mumbai HC) recently in the case of Vodafone India Services Private Limited (Vodafone India/taxpayer) [TS-308-HC-2014(BOM)-TP]. As of now, similar subject has been litigated by two dozen taxpayers also. It seems that this ruling may put to rest the TP controversies relating to issuance of ES.

The controversy in Vodafone India's case is where the tax authorities have held that ES having face value of INR 10 per share issued to its non-resident parent company, Vodafone Mauritius at INR 8,519 per share (which is based on valuation guidelines under Capital Issues (Control) Act), is not at Arm's Length Price (ALP). Tax authorities have re-determined the ALP of said ES at INR 53,775 per share adopting Net Assets Value based valuation and accordingly, made a primary adjustment to the tune of INR 13.09 billion. Tax authorities further re-characterised the said shortfall in receipt of premium as deemed loan given to the parent company and a secondary adjustment on account of notional interest of INR 0.88 billion was also made to the taxable income of taxpayer.

The assessee had filed a Writ petition against Draft Assessment order challenging the jurisdiction to make TP adjustment on issue of ES.

Existence of Income is imperative for TP

Mumbai HC has ruled that income arising from an international transaction is a condition precedent for application of Chapter X of the Act. Section 92(1) of the Act provides that income (including allowance for expenses) arising from an international transaction shall be computed having regard to the ALP. Thus, scheme of TP essentially required three elements all which have to be cumulatively satisfied:

  1. Existence of an international transaction between the taxpayer and its AEs;
  2. Existence of income arising from/expense due to such international transaction; and
  3. Such income/expense shall be computed having regard to the ALP of the transaction.

Share premium received from Non resident is not income:

The term 'income' is not defined under Chapter X of the Act. Therefore, meaning of the word 'income' should be construed from the definition of income provided under section 2(24) of the Act.

Income defined under section 2(24) of the Act includes any consideration received (share premium in the present case) for issue of shares exceeding fair market value (FMV) of shares referred to in section 56(2)(viib) of the Act. However, what is made taxable under section 56(2)(viib) of the Act is the consideration received exceeding the FMV on account of issue of shares to a resident.

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