The Bombay High Court on Friday ruled Vodafone is not liable to pay an income tax demand of Rs 3,200 crore in a case relating to transfer pricing, a verdict which comes as a big relief for the UK-based mobile service provider already locked in a big tax dispute with the Government.

The I-T Department had asked the company to pay additional income tax alleging that it had undervalued its shares in the subsidiary Vodafone India Services while transferring them to the parent company in Britain. The transaction took place in FY10. Transfer pricing is the practice of arm's length pricing for transactions between Group companies based in different countries to ensure a fair price — one that would have been charged to an unrelated party — is levied.

A Division Bench headed by Chief Justice Mohit Shah and Justice M Sanklecha said "in our opinion there is no taxable income on share premium received on the issue of shares." The order in favour of Vodafone is being considered significant because some domestic companies too are involved in similar transfer pricing cases.

The tax authority had issued a show cause notice to Vodafone India on January 17, 2014 and later passed an order asking it to pay additional Rs 3,200-crore tax for allegedly undervaluing the shares of its Pune BPO. On January 27, Vodafone moved the High Court challenging the I-T order and contended that its transaction on transfer of shares was not taxable under the Indian tax laws.

Its counsel Haresh Salve argued that the share premium received on the issue of such shares was not taxable. He said the department's order amounted to levying tax on a "non- -existent income". It may be noted that many multinationals, including Shell India and Leighton India Contractors, are also fighting transfer pricing cases in various courts.

This is not the first time Vodafone has questioned a transfer pricing tax order. It has in the past dragged I-T Department to High Court over two other transfer pricing tax orders that raised a demand of Rs 3,700 crore and Rs 400 crore on Vodafone India. Both these cases are pending.

Vodafone is locked in a separate USD 2 billion dispute with the Government over its buying of Hong Kong-based Hutchison's stake in Hutchison-Essar. Welcoming the verdict, Vodafone, in a statement here said, "we have maintained consistently throughout the legal proceedings that this transaction was not taxable."

Allowing the petition filed by Vodafone, the High Court quashed the I-T Department's tax order as null and void and being without jurisdiction.

The orders include a reference dated July 11, 2011 by the Assessing Officer to Transfer Pricing Officer to determine the arms-length price (ALP) of issue of shares at a premium by the petitioner to its holding company, a non-resident entity. The HC also set aside another I-T order dated February 11, 2014 on the preliminary issue of jurisdiction to tax issues of shares at a premium to its holding company.

The judges opined, "We find that 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." The issue arose as Vodafone India, a wholly owned subsidiary of Vodafone Tele-Services (India) Holdings Ltd, needed funds for its telecommunication services project in India from its holding company during FY 2008-09 (AY 2009-10).
On August 21, 2008, the petitioner (Vodafone India) issued 2,89,224 equity shares of the face value of Rs 10 each at a premium of Rs 8,509 per share to its holding company.

This resulted in the petitioner receiving Rs 246.38 crore from its holding company on issue of shares between August and November 2008. The fair market value of the issue of equity shares at Rs 8,519 per share was determined by the petitioner in accordance with the methodology prescribed under the Capital Issues (Control) Act, 1947. However, according to Assessing Officer and Transfer Pricing Officer, the petitioner ought to have valued each share at Rs 53,775, as against Rs 8,519 under the Act, and on that basis shortfall in premium to the extent of Rs 45,256 per share resulted in shortfall of Rs 1,308.91 crore.

Both AO and TPO held this amount of Rs 1,308.91 crore as income. Further, they said Rs 1,308.91 crore is required to be treated as deemed loan given by Vodafone to its holding company and periodical interest thereon is to be charged to tax as interest income of Rs 88.35 crore in FY 2008-09 (AY 2009-10).

Vodafone argued the Act does not tax the inflow of capital into the country. Nor does the Act create any legal fiction to treat such alleged shortfall in capital receipt on issue of equity shares by an Indian company to its non-resident holding company as income.