Vindicating the income tax department's stand, the Income Tax Appellate Tribunal (ITAT) has ruled that it has the jurisdiction to raise a tax demand in the Rs 8,500-crore transfer pricing tax dispute relating to the Indian subsidiary of Vodafone Group.

The tribunal, however, in a partial reprieve for Vodafone India, sent the case back to the tax authority for deciding the revised taxable amount of Vodafone India. The tribunal also did not accept the valuation arrived at by the tax department and asked it to revise the same.

"The assessee's (Vodafone India) appeal is partly allowed," said presiding officers Vijay Pal Rao and RC Sharma on Wednesday while pronouncing the operative part of the order. "According to us, this is an international transaction since the assignment of the call option took place." An email query to Vodafone did not elicit any response.

The dispute relates to a transaction involving the sale of its call centre business by Vodafone India to another India based company Hutchison Whampoa Properties and an assignment of call options to its group entity Vodafone International in 2007-2008.

The transaction attracted transfer pricing norms as there was no arm's length dealing between the two entities.

Transfer pricing involves related entities dealing at arm's length to ensure fair pricing of the asset that is transferred. In 2013, the tax department had issued a tax demand of Rs 3,700 crore to Vodafone India. However, the tribunal stayed the demand till the plea is decided and directed telecom company to deposit Rs 200 crore by February 15, which was deposited by the assessee.

The Mumbai ITAT in its 189-page order has held that the transaction of sale of call centre business was structured with the motive to "circumvent" the transfer pricing provisions of the act and the transaction was in essence an international transaction between two related parties and thus would be subject to the transfer pricing provisions.

As regards determination of arm's length price for the said transaction, the tribunal has directed the matter back to the transfer pricing officer and has ordered that the discounted cash flow (DCF) method should be considered as the most appropriate method for valuing the call centre business.

Discounted cash flow uses the time value of money wherein future cash flows are estimated and discounted to give their net present value.

"The ruling bestows undue hardship on taxpayers and is contrary to the principles of legitimate tax planning which have been time and again upheld by the Indian Courts," Rakesh Nangia, managing partner, Nangia, told ET. "A careful analysis of the judgment would reveal the extent to which the tribunal has taken the liberty in piercing the corporate veil while upholding the applicability of transfer pricing provisions for otherwise third-party transactions. In our view, this judgment could add to the already gloomy foreign investment scenario in India and would push back India as a promising investment destination."

On the main takeaway of the ITAT ruling, Samir Gandhi, partner, Deloitte Haskins & Sells, said: "Substance as against form will govern the determination of chargeability to tax -one has to be aware of provisions of lifting of the corporate veil in typical facts.

"In cross-border mergers and demergers, more focus has to be given to clauses in agreements & the legal language need to match with facts; interposed entity to be given considerable thoughts & economic substance & commercial justification. Valuation should not to be considered as mere compliance filing of form exercise -specialisation of valuation of business , options will play a part," said Gandhi.