Recently, a long standing dispute between Vodafone and the tax authorities has been put to rest by the Bombay High Court (HC). The HC, in its landmark judgment in the case of Vodafone India Services Pvt. Ltd. v Union of India and Others (Writ Petition No 871 of 2014), has ruled in favor of Vodafone and held that a transaction of ‘issue of shares’ at a premium does not give rise to any ‘income’, and therefore, would not be subject to the provisions of the Indian Transfer Pricing Regulations (TP Regulations). Similar cases relating to other multi-national companies operating in India are currently pending before various forums in the country, and this judgment may have a bearing on deciding the fate of such pending cases.
Vodafone India Services Pvt. Ltd. (Taxpayer), an Indian company, and a wholly owned subsidiary of Vodafone Tele-Services Holdings Company (Holding Company), a non- resident company, required funds for its telecommunication services project in India from the Holding Company. The Taxpayer issued certain equity shares of face value of INR 10 each at a premium to the Holding Company. The fair market value of the issue of equity shares was determined by the Taxpayer in accordance with the methodology prescribed by the Government of India under the erstwhile Capital Issues (Control) Act, 1947.
However, as per the tax authorities (including the transfer pricing officer), the Taxpayer had issued its shares to the Holding Company at a lower value than what had been arrived at by the tax authorities. Accordingly, the difference between the subscription price and the premium as computed by the tax authorities (Shortfall) was deemed as a loan granted by the Taxpayer to the Holding Company, and in the view of the tax authorities, periodical interest thereon should have been liable to be taxed as interest income.
The Taxpayer filed a Writ Petition against this action of the tax authorities. However, the HC directed the Dispute Resolution Panel (DRP) to adjudicate upon the applicability of TP Regulations to the above facts. The DRP ruled in favor of the tax authorities. Subsequently, the Taxpayer filed another Writ Petition before the HC challenging the order of the DRP.
The HC ruled in favor of the Taxpayer by holding that TP Regulations would not be applicable in the absence of an ‘income’ element in the transaction. The HC was guided by the following passage of Rowlatt J. in arriving at this decision:
“In a taxing Act, one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about tax. There is no presumption as to tax. Nothing is to be read in nothing is to be implied. One can only look fairly at the language employed.”
Important points for consideration arising from the HC’s judgment, including key observations made by the HC in the present case have been summarized below:
- Chapter X of the Income-tax Act, 1961 (IT Act) dealing with the TP Regulations is to ensure that qua ‘international transactions’ between ‘associated enterprises’ (AEs), the profits are not understated nor losses overstated by abuse of either showing lesser consideration or higher expenses between AEs. The objective of the TP Regulations is certainly not to punish multinational enterprises and / or AEs from doing business with each other.
- A plain reading of the relevant provision of the IT Act very clearly brings out that ‘income’ arising from an ‘international transaction’ is a condition precedent for application of the TP Regulations.
- The word ‘income’, for the purposes of the IT Act, has a well understood meaning and it cannot be disputed that ‘income’ will not in its normal meaning include capital receipts unless it is so specified (e.g. capital gains). The amount received on issue of share capital including the premium is undoubtedly a capital account transaction; and in the absence of an express legislation, no amount received, accrued or arising on a capital account transaction can be subjected to tax as ‘income’.
- Neither the capital receipts received by the Taxpayer on issue of equity shares to the Holding Company, a non-resident entity, nor the Shortfall could be considered as ‘income’ within the meaning of the word ‘income’ under the IT Act.
- Merely because the Taxpayer had disclosed the transaction of issue of shares in the TP Report would not subject such transaction to TP Regulation (and hence, to tax).
- While interpreting a fiscal / taxing statute, the intention or purpose is irrelevant and the words of the tax statute have to be interpreted strictly. In the absence of the provision by itself being susceptible to more than one meanings, it is not permissible to forgo the strict rules of interpretation while construing a taxing statute.
- Reliance placed by the tax authorities on the definition of ‘international transaction’ in order to conclude that ‘income’ had to be given a broader meaning to include ‘notional income’, since the TP Regulations would otherwise be rendered otiose, was not tenable. The transaction on capital account or on account of restructuring would become taxable to the extent it impacts income i.e. under reporting of interest or over reporting of interest paid or claiming of depreciation, etc. It is that ‘income’ which is to be adjusted to the arms’ length price.
- The argument of the tax authorities to the effect that as a consequence of under valuation of shares there was an impact on potential ‘income’ was also not acceptable. In any case, the entire exercise of charging to tax the amounts (allegedly) not received as share premium fails, as no tax was being charged on the amount received as share premium.
- The argument of the tax authorities that passing on the benefit to the Holding Company by issuing shares at a lower value was a cost incurred by the Taxpayer which was being brought to tax and also the unique way of reading the relevant provision as suggested by the tax authorities was rejected. The HC held that such a manner of reading a provision by 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 and would tantamount to redrafting the legislation - which is beyond the jurisdiction of courts.
- TP Regulations are not independent charging provisions under the IT Act. There are separate charging provisions under the IT Act. TP Regulations are ‘machinery provisions’ to arrive at the arms’ length price of a transaction between AEs. Further, chargeability to tax arises when the right to receive income becomes vested in the taxpayer. Issue of shares to the Holding Company was merely a capital account transaction, and therefore, had nothing to do with ‘income’. In the absence of a specific charging provision under the TP Regulations, it is not possible to read a charging provision into the TP Regulations.
Accordingly, the HC held that in the present facts, issue of shares at a premium by the Taxpayer to its non-resident holding company did not give rise to any ‘income’ from admitted ‘international transactions’.
The judgment of the HC reflects a pragmatic and fair view under the circumstances of this case. Once again, the judiciary has come to the rescue of the taxpayers, precluding a far-fetched position that was adopted by the tax authorities. Some of the key takeaways arising from this judgment have been summarized below:
- The existence of ‘income’ is a sine qua non for applicability of ‘transfer pricing’ provisions. ‘Share subscription’, being a capital account transaction, could not have, on its own, resulted into any ‘income’ in the hands of the Taxpayer. Hence, the HC has very rightly ruled that TP Regulations would not apply to the facts of this case.
- The HC re-emphasized the strict rule of interpretation to be followed in tax cases and the limitation on courts to redraft legislations while adjudicating on their applicability. This ruling of the HC is also important insofar as it clarifies that capital receipts are not subject to income tax unless specifically covered under a particular charging provision.
- A capital account transaction (such as issue of shares) does not ipso facto result in erosion of the tax base of the country. Hence, viewing from this perspective as well, the addition to ‘income’ made by the tax authorities was not warranted.
This ruling is expected to provide a major relief to other multinational companies who have been embroiled in similar tax controversies in India. As per publically available information, the CBDT has issued a statement that it is in the process of reviewing this judgment and will then decide the way forward. However, given that the ruling represents the correct position of law on the subject, one hopes that the tax authorities accept this ruling and do not seek to challenge it before the Supreme Court of India.