CA Ram Bajaj
Introduction of Case – Vodafone India Services (P) Ltd. Is a wholly owned subsidiary of Vodafone Tele-Services (India) Holdings Ltd., a non resident company Mauritian entity. Vodafone Holding is AE (Associate Enterprise) of Vodafone India for the purpose of transfer pricing provisions under chapter X of Income Tax Act 1961. Vodafone India is engaged in providing service in relation to Telecommunication in india.
Fact of Case – During the AY 2009-10, Vodafone India issue equity share to Vodafone Holding at premium and the same is mentioned in 3CEB in tax audit report. The issue of share is as follws.
Total No. of Equity Share – 289224
Face Value Per Share – 10 Rs.
Premium per share – 8509 Rs.
Total Issue Price – 8519 Rs.
Total Consideration Received – 246.38Cr.
Apart from declaring share issue as an international transaction, Vodafone india by way of Note to Form 3CEB mentioned that the transaction of issue of equity shares did not affect the income of the Petitioner and was being reported only as a matter of abundant caution.
Vodafone Agrument Before AO/TPO – that transfer pricing don’t apply to a transaction of issuing equity shares to its holding Company as chapter X is not applicable to transaction of issue of shares as there is no income arises or affected by issue of shares, which is precondition for invoking the provision of chapter X of transfer pricing ALP.
TPO Conclusion – Transfer Pricing Officer (TPO) alleges that that the issue is at a price below the fair market value and therefore has resulted in the benefit to the AE, based on which the Assessing Officer (‘AO’) completed the Assessment. DRP decided that the AO has the jurisdiction to invoke transfer pricing provisions in the case of issue of shares at a price below the fair market value. Following the NAV method, the TPO arrived at ALP around 1555 Cr. And passed assessment order for the shortfall of Rs. 1555-246=1308 cr and same is assumed as deemed loan to AE and calculate interest @13.5% on deemed loan and make total adjustment for transfer pricing around 1397 cr at the hand of Vodafone india.
Appeal at Bombay High Court – Vodafone india challenge the decision of AO at high court that chapter X of Income Tax Act, 1961 is not applicable in issue of equity share to its holding company.
On the aforesaid facts, Mr. Harish Salve, learned Sr. Counsel appearing in support of the Petition, submits as under:—
(a) Chapter X of the Act is a special provisions relating to avoidance of tax. Section 92 of the Act provides for computation of income arising from International Transaction, having regard to ALP. Section 92(1) of the Act which applies to the the present facts, directs that any income arising from an International Transaction should be computed, having regard to the ALP. Thus, the sine-qua- non, for application of Section 92(1) of the Act is that income should arise from an International Transaction. In this case, it is submitted that no income arises from issue of equity shares by the Petitioner to its holding company;
(b) Chapter X of the Act is not designed to bring to tax all sums involved in a transaction, which are otherwise not taxable. The purpose and objective is not to tax difference between the ALP and the contracted/book value of said transaction but to reach the fair price/ consideration. Therefore, before any transaction could be brought to tax, a taxable income must arise. The interpretation in the impugned order to tax any amounts involved in International Transaction tantamount to imposing a penalty for entering into a transaction (no way giving rise to taxable income) at a value which the revenue determines on application of ALP;
(c) The impugned order itself demonstrates the fact that the share premium on issue of shares is per se not taxable. This is so as the amounts received by the Petitioner on account of share premium has not been taxed and only the amount of share premium which is deemed not to have been received on application of ALP, has alone been brought to tax ;
(d) The issue of shares by the Petitioner to its holding company and receipt of consideration of the same is a capital receipt under the Act. Capital receipts cannot be brought to tax unless specifically/ expressly brought to tax by the Act. It is well settled that capital receipts do not come within the ambit of the word ‘Income’ under the Act, save when so expressly provided as in the case of Section 2 (24) (vi) of the Act. This brings capital gains chargeable under Section 45 of the Act, to tax within the meaning of the word ‘Income’;
(e) Attention was drawn to the definition of `Income’ in Section 2(24) (xvi) of the Act which includes in its scope amounts received arising or accruing within the provisions of section 56(2) (viib) of the Act. However, it applies to issue of shares to a resident. Besides, it seeks to tax consideration received in excess of the fair market value of the shares and not the alleged short-fall in the issue price of equity shares. Thus, this also indicates absence of any intent to tax the issue of shares below the alleged fair market value as in this case;
(f) The impugned order proceeds on an assumption, surmise or conjecture that in case the notional income i.e. the amount of share premium forgone was received, the Petitioner would have invested the same, giving rise to income. It is submitted that no tax can be charged on guess work or assumption or conjecture in the absence of any such income arising; and
(g) The impugned order places reliance upon the meaning of International Transaction as provided in sub-section (c) and (e) of Explanation (i) to Section 92B of the Act to conclude the Income arises. It is submitted that Explanation (i)(c) to Section 92B of the Act only states that capital financing transaction such as borrowing money and/or lending money to AE would be an International Transaction. However, what is brought to tax is not the quantum of amount lent and/or borrowed but the impact on Income due to such lending or borrowing. This impact is found in either under reporting/ over reporting the interest paid/interest received etc., Similarly, Explanation (i)(e) to Section 92B of the Act, which covers business restructuring would only have application if said restructuring/ reorganizing impacts income. If there is any impact of income on account of business restructuring/reorganizing, then such income would be subjected to tax as and when it arises whether in present or in future. In this case, such a contingency does not arise as there is no impact on Income which would be chargeable to tax due to issue of shares.
Department Submission –
The issue of Chapter X of the Act being applicable is no longer res integra as identical provision as found in Section 92 of the Act was available in Section 42(2) of the Income Tax Act, 1922 (1922 Act). The Supreme Court in Mazagaon Dock Ltd. v. CIT  34 ITR 368 upheld the action of revenue in seeking to tax a resident in respect of profit which he would have normally made but did not make because of his close association with a non-resident. Further, the Court observed that it is open to tax notional profits and also impose a charge on the resident. The aforesaid provision of Section 42(2) of the 1922 Act were incorporated in its new avtar as Section 92 of the said Act. It was thus emphasized that the legislative history supports the stand of the respondent-revenue that even in the absence of actual income, a notional income can be brought to tax;
Section 92(1) of the Act uses the word ‘Any income arising from an International Transaction’. This indicates that the income of either party to the transaction could be subject matter of tax and not the income of resident only. Further, it is submitted that for the purpose of Chapter X of the Act, real income concept has no application, otherwise the words would have been ‘actual Income’. Therefore, the difference between ALP and the contracted price would be added to the total Income;
Chapter X of the Act is a complete code by itself and not merely a machinery provision to compute the ALP. Chapter X of the Act applies wherever the ALP is to be determined by the A.O. It is the hidden benefit in the transaction which is being charged to tax. Therefore, the charging section is inherent in Chapter X of the Act;
Ruling of High Court- Thus to get over transfer mis-pricing/manipulation/abuse that the market based transfer pricing was introduced, known as ALP. Therefore, it is clear that Chapter X of the Act now existing was to ensure that qua International Transaction between AEs, the profits are not understated nor losses overstated by abuse of either showing lesser consideration or higher expenses between AEs than would be the consideration between two independent entities, uninfluenced by relationship. It did not replace the concept of Income or Expenditure as normally understood in the Act for the purposes of Chapter X of the Act. The objective of Chapter X of the Act is certainly not to punish Multinational Enterprises and/or AEs from doing business inter se. However, we are conscious of the fact that in fiscal statutes, whatever may be the intent of the Parliament, the Courts have to construe the statute strictly on the basis of what is stated in the Act. We are governed by the off quoted passage of Rowlatt J. to the following effect:
” In a taxing Act, one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about tax. There is no presumption as to tax. Nothing is to be read in nothing is to be implied. One can only look fairly at the language employed”.
The word income for the purpose of the Act has a well understood meaning as defined in Section 2(24) of the Act. This even when the definition in Section 2(24) of the Act is an inclusive definition. It cannot be disputed that income will not in its normal meaning include capital receipts unless it is so specified, as in Section 2(24) (vi) of the Act. In such a case, Capital Gains chargeable to tax under Section 45 of the Act are, defined to be income. The amounts received on issue of share capital including the premium is undoubtedly on capital account. Share premium have been made taxable by a legal fiction under Section 56(2)(viib) of the Act and the same is enumerated as Income in Section 2(24)(xvi) of the Act. However, what is bought into the ambit of income is the premium received from a resident in excess of the fair market value of the shares. In this case what is being sought to be taxed is capital not received from a non-resident i.e. premium allegedly not received on application of ALP. Therefore, absent express legislation, no amount received, accrued or arising on capital account transaction can be subjected to tax as Income. This is settled by the decision of this Court in Cadell Weaving Mill Co. v. CIT  249 ITR 265 was upheld by the Apex Court in CIT v. D.P Sandu Bros. Chember (P.) Ltd.  273 ITR 1. This Court has in Cadell Weaving Mills Co. (supra) inter alia, observed as under:—
‘It is well settled that all receipts are not taxable under the Income tax Act. Section 2(24) defines “income”. It is no doubt an inclusive definition. However, a capital receipt is not income under section2(24) unless it is chargeable to tax as capital gains under Section 45. It is for this reason that under section 2(24)(vi) that the Legislature has expressly stated, inter alia, that income shall include any capital gains chargeable under section 45. Under Section 2(24)(vi), the Legislature has not included all capital gains as income. It is only capital gains chargeable under Section 45 which has been treated as income under Section 2(24). If the argument of the Department is accepted then all capital gains whether chargeable under section 45 of not, would come within the definition of the word “income” under section2(24). Further, under section 2(24)(vi) the Legislature has not stated that “any capital gains” will be covered under the word income. On the contrary, the Legislature has advisedly stated that only capital gains which are chargeable under Section 45 of the Act could be treated as income. In other words, capital gains not chargeable to tax under section 45 fall outside the definition of the word “income” in section 2(24) of the Act. It is true that section 2(24) of the Act is an inclusive definition However, in this case, we are required to ascertain the scope of Section 2(24)(vi) and for that purpose we have to read the sub section strictly. We cannot widen the scope of sub section by saying that the definition as a whole is inclusive and not exhaustive. In the present case, the words “chargeable under section 45” are very important. They are not being read by the Department. These words cannot be omitted. In fact, the prior history shows that capital gains were not chargeable before 1946. They were not chargeable between 1948 and 1956. Therefore, whenever an amount which is other wise a capital receipt is to be charged to tax, section 2(24) specifically so provides.’
In view of the above, we find considerable substance in the Petitioner’s case that neither the capital receipts received by the Petitioner on issue of equity shares to its holding company, a non-resident entity, nor the alleged short-fall between the so called fair market price of its equity shares and the issue price of the equity shares can be considered as income within the meaning of the expression as defined under.
Similarly, the reliance by the revenue upon the definition of International Taxation in the sub clause (c) and (e) of Explanation (i) to Section 92B of the Act to conclude that Income has to be given a broader meaning to include notional income, as otherwise Chapter X of the Act would be rendered otiose is far fetched. The issue of shares at a premium does not exhaust the universe of applicability of Chapter X of the Act. There are transactions which would otherwise qualify to be covered by the definition of International Transaction. The transaction on capital account or on account of restructuring would become taxable to the extent it impacts income i.e. under reporting of interest or over reporting of interest paid or claiming of depreciation etc. It is that income which is to be adjusted to the ALP price. It is not a tax on the capital receipts. This aspect appears to have been completely lost sight of in the impugned order.
It was contended by the Revenue that in view of Chapter X of the Act, the notional income is to be brought to tax and real income will have no place. The entire exercise of determining the ALP is only to arrive at the real income earned i.e. the correct price of the transaction, shorn of the price arrived at between the parties on account of their relationship viz. AEs. In this case, the revenue seems to be confusing the measure to a charge and calling the measure a notional income. We find that there is absence of any charge in the Act to subject issue of shares at a premium to tax.
Conclusion – This much-awaited Bombay High Court’s ruling would go a long way in enhancing the confidence of Indian business community and the global investors on the Indian judiciary.. This decision will certainly play on the minds of overseas investors who are sitting on the fence and may provide them the much needed certainty on the Indian tax laws.By not taking this matter to the Supreme Court; the government may choose to send positive signals on stability in the Indian tax laws.