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To attract FDI, transfer pricing issues need to be resolved in 'Budget 2014'
July, 22nd 2014

The battle between various ministries continues on permissible levels of foreign direct investments in ‘sensitive’ sectors like defence or railways, but there is another battle on-going in the arena of foreign direct investments and it relates to transfer pricing.

An early resolution, via suitable amendment in the Finance Bill 2014 which will be tabled in next week, is what foreign investors are hoping for.

Issue of share capital by Indian companies to their parent or group companies has been embroiled in a transfer pricing controversy. When the news first broke out, more than a year ago, Zenobia Aunty was aghast. “Tax and accountancy laws clearly distinguish between a revenue item and a capital item. A revenue item is taxable, a capital item is not,” she had muttered. Her research findings revealed that no other country subjected income from share capital to tax.

A transfer of shares resulting in capital gains is taxable in the hands of the seller (the Vodafone matter when the buyer was held culpable for non-deduction of tax at source, is another issue altogether). However, issue of new share capital doesn’t result in any income in the hands of the issuing company; such receipt is considered to be capital in nature and not taxable.

Yet, issue of share capital has been brought into the transfer pricing ambit, here’s how: If the company in India, had issued share capital to its parent at Rs. 10, the tax authorities challenged and revised the valuation, say at Rs. 100. The difference of Rs. 90 was then re-characterised as a taxable receivable in the hands of the Indian company.

Former Finance Minister, P. Chidambaram in a reply to Lok Sabha last April had said: “In financial year 2012-13, 27 cases of undervaluation of share sale by Indian companies to their related parties were detected and subjected to appropriate transfer pricing adjustments, in accordance with the provisions of the Income tax Act, 1961.”

News-reports have in the past captured the ongoing cases filed by Shell, Vodafone, Essar group and a few others, which are currently in various stages of litigation. Cumulatively, the quantum of litigation runs into several thousand crore.

To illustrate: In 2009, Shell India issued 87.63 crore shares to two overseas companies at the par value of Rs. 10 each. The tax department using the discounted cash flow mechanism of valuation pegged the value per share at Rs. 183. The short receipt of Rs. 15,200 crore was sought to be taxed in the hands of Shell India. In case of Vodafone, the tax department challenged the valuation undertaken by Vodafone India Services private Limited while issuing shares, in 2009, to its Mauritius group company and the differential in this case amount to nearly Rs. 1,300 crore. Subsequently Essar group found itself facing a similar situation. Issue of shares by three Essar group companies to their parent companies were held to be undervalued by the tax department.

Noted advocate, Harish Salve’s plea in the Bombay High Court, while arguing the Shell and Vodafone matter, was avidly tweeted by tax professionals. He said: “When premium received is not taxable, how can premium not received be ever taxed?” In other words, how can the notional income – being the differential as computed by the tax authorities be subject to tax?

The Economic Times (March 19, 2013 edition) had reported the views of the Law Ministry (under the UPA government): TPOs are empowered to impute additional income, a process known as adjustments, if they come to the conclusion that shares of a local company have been transferred or issued at below market price.

Countries such as Singapore, in the best interest of their investors, have provided for safe harbour norms on disposal of equity shares. Understandably, safe habour norms, which lay down the range within which a price between related parties is considered to be at an arm’s length has not been provided in respect of issue of new shares, because it is not treated a taxable revenue incidence.

The government is keen to attract foreign direct investments. For India to be deemed as attractive, the issue of taxation of a notional differential on issue of share capital by the Indian company to its overseas parent or group companies needs to be put to rest once and for all.

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