On 10 October 2014, the Bombay High Court delivered a judgment in favour of Vodafone India Services Private Limited (Vodafone India) in a long-pending USD 490 million tax dispute. The Vodafone India intra-group transaction that had triggered this tax controversy pertained to the financial year 2008–2009.
Vodafone India, a wholly owned subsidiary of Mauritian entity Vodafone Tele-Services (India) Holdings Limited (Vodafone Mauritius), issued 289,224 equity shares of the face value of INR 10 (USD 0.16) each at a premium of INR 8591 (USD 140.7) per share in August 2008 to Vodafone Mauritius.
- The Indian tax authorities sought to tax this transaction by Vodafone India by applying the transfer pricing (TP) regulations. (Please see a brief background of these regulations below.)
- The primary ground was that Vodafone Mauritius subscribed to shares of Vodafone India at prices lower than the market price or fair price.
- Further, the Indian tax authorities maintained that this difference in valuation was in fact a disguised loan and thus subject to TP regulations.
- Vodafone India contended that share premium is a capital receipt and not income—and hence not taxable.
The fulcrum of the dispute thus centred around the issue of whether a foreign entity subscribing to shares in its Indian subsidiary leads to taxable income in the hands of the Indian subsidiary. Further, whether the application of the TP regulations was at all mandated in the facts of this case was also an issue before the court. By way of background, transfer pricing is the value at which multinational enterprises trade products, assets or services between their units in different countries. Whilst this is a routine part of doing business for a multinational enterprise, tax authorities globally have framed rules to prevent its abuse. Accordingly, rules require cross-border transactions between associated entities to be valued at an arm's length, as if the transaction was with an unrelated third-party company. In other words, the court needed to decide upon:
- whether share issuance leads to income for the issuer; and
- if carried out between associated enterprises, should it attract the TP regulations?
The Bombay High Court answered both these questions in the negative. The judgment clarifies that share issuance of the nature described above does not give rise to any income, and hence, there can be no question of applying the TP regulations. The vexed question of applying TP principles to share issuance has been laid to rest, and it can be anticipated that another 25 odd cases that are being litigated on a similar point before the courts will come to a near identical conclusion.
The Road Map Ahead for Foreign Investors
Internationally, funding a subsidiary by issuing shares is a common practice among multinational companies and is typically viewed as a capital transaction and out of the TP net. The verdict in this case has reaffirmed this aspect in the Indian context.
The mode of re-characterization employed by the tax authorities is neither provided for under exact provisions of Indian tax law nor can it conceivably arise directly from the issue of shares. Again, the clarity in this verdict is likely to be viewed as a welcome step.
Foreign investors who were in watch mode before infusing further equity into their Indian operations can take comfort from the fact that some clarity has been attained.
However, it is important to note that consequent to an amendment to the income tax law—with effect from 1 April 2013—the portion of consideration received for the issue of shares of a public unlisted company or private company to an Indian resident that is in excess of the fair market value of those shares, will be subject to tax in the hands of the companies under the head "income from other sources."
It remains to be seen whether the Indian tax authorities will file an appeal in the Supreme Court of India, but if the Attorney General's mission to reduce appeals from the government is anything to go by, this prospect appears unlikely to transpire.