New Delhi's well-publicised claim to usher in a non-adversarial tax regime is yet to trickle down to tax offices across the country. Even if salaried individuals are spared of scrutiny notices, many companies are grappling with demands they find strange and irrational. And, it's more than holding back tax refunds.

Several wholly-owned Indian subsidiaries of foreign companies that have received capital infusion from parent have been slapped with notices from the income tax (I-T) department which is asking these companies to justify the transaction. The tax office is describing such share subscription by a foreign parent as "unexplained cash credit" for which the Indian unlisted firm must pay tax on the fund it receives.

While tax laws allow the department to enquire the identity of an investor, source of fund and genuineness of a deal, tax practitioners argue that there is little ground to question the authenticity of a deal if the investor has a standing and the formalities with the Reserve Bank of India are fulfilled.

"Under section 68 of the Income Tax Act, if the Indian subsidiary has established the identity of the foreign investor and the capacity to invest, then valuation and genuineness of the transaction should not be tested," said senior chartered accountant Dilip Lakhani. According to Bejal Ajinkya, partner at the law firm Khaitan & Co, despite the Bombay High Court in the Vodafone and Shell cases making it clear that a shareholder is free to invest at the price of his calling, an income tax is sought to be levied on such transactions.

Capital Structure Questioned

This kind of capital transaction cannot have any income tax implication, he added. Interestingly, since the transfer pricing issue has been put to rest by the finance ministry, the tax department is questioning the transaction as "unexplained cash credit" and imposing a 30% tax on share premium received from the foreign shareholder.

"This," felt Ajinkya, "could be a dampener for the government's "make in India" push, especially where capital investment is at the core of any manufacturing activity. It's a similar story for outbound capital flow - where some of Indian companies have
invested in their overseas subsidiaries.
No respite to investors from tax tangles: Companies find some demands irrationalNo respite to investors from tax tangles: Companies find some demands irrational
Here, the tax office is challenging the equity structure; it's re-characterising the overseas 'equity' investment as 'deemed loan' from the Indian parent. "The taxman is questioning the capital structure by stating that the Indian company is investing at a premium and hence the premium is a deemed loan, leading to a transfer pricing mark-up for an interest due to the Indian company.

It is about time that the finance ministry issues a clarification announcing freedom to Indian companies to capitalise their foreign subsidiaries as per their requirement and end this unnecessary dispute that will strangulate the ability of Indian conglomerates from being truly multinational," said Ajinkya.

The tax office is demanding tax on interest income on the deemed loan, based on State Bank of India's prime lending rate. Here, the taxman is invoking international transfer pricing rules and disregarding the Vodafone matter because (unlike Vodafone) these cases relate to outbound remittance.

"Whenever any Indian holding company invests in its foreign subsidiary, it's by way of share capital and such transactions cannot be construed as a loan," said Lakhani. According to tax circles, close to 30 companies have been impacted by these tax demands.