In this post, I will discuss
judgement of High Court of Bombay in the case of Vodafone India Services Pvt. Ltd. v. Union of India & Ors[1]
wherein it ruled that transaction of issuance of shares cannot be subjected to Transfer
Pricing (TP) provisions of Income Tax Act. The judgement is important for Nokia,
Shell India, WNS and 24 other companies who have the similar dispute with the
Revenue.
It is important to state that High
Court restricted its judgement to jurisdictional issue and did not go into
merits of the case. In the next post, I will deal with hypothetical stimulation
of arguments on merits of the case. In this regard, two issues will be
discussed viz. first, whether Revenue
was right in making the addition of notional interest by treating the addition
on the subscription of the shares as deemed loan. Second, whether the Discounted
Cash Flow (DCF) is the most appropriate method for the valuation of the shares
or Net Asset Value (NAV).
Coming back to discussion on the
judgement.
Facts of the Case
In August 2008, Vodafone India
Services Private Limited (V-India),
a wholly owned subsidiary of Mauritian entity Vodafone Tele-Services (India)
Holdings Ltd. (V-Mauritius),
issued 289,224 equity shares of face value of Rs. 10 each (applying NAV) at a
premium of Rs. 8,591 per share to its holding company. On the issuance of these shares, V-India
received a total consideration of Rs.246.38 crores from its holding company.
According to Assessing Officer (AO)
and Transfer Pricing Officer (TPO) ought to have valued each equity share at
Rs.53,775/- (applying DCF) and on that basis shortfall in premium to the extent
of Rs.45,256/- per share resulted into total shortfall of Rs.1308.91 crores.
Both the AO and the TPO on
application of the Transfer Pricing provisions in Chapter X of the Income Tax
Act, 1961 held that this amount of Rs.1308.91 crores is income. Further, as a consequence of the above, this amount of
Rs.1308.91 crores was treated as deemed
loan given by the V-India to its holding company and notional interest thereon was charged to tax as interest income.
Vodafone India challenged the jurisdiction
of AO or TPO under Article 226 of the Constitution.
Issue
Whether AO or TPO has jurisdiction
to apply Transfer Pricing provisions in the present case. The answer to this
issue boiled down to the question whether share subscription generates any income
under Section 92 of the Income Tax Act.
V-India’s Arguments
1. ‘Income’
as under Section 92 must be interpreted as per Section 2(24)
To tax a receipt, requirement of Section
2(24) which defines income must be satisfied. The term ‘income’ as noted in
Section 92 cannot be interpreted in isolation of Section 2(24).
2. Capital
Receipt is not taxable except expressly provided
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’.
3. Present
transaction does not attract Section 45
Section 45 is applicable in case of
transfer of property. However,
issuance of shares is creation of
property.
4. Section
56(2)(viib) is not attracted
Definition
of ‘Income’ in Section 2(24)(xvi) of the Act includes in its scope amounts
received arising or accruing within the provisions of Section 56(2)(viib) of
the Act. However, reliance in the present case cannot be placed as it is
applicable only with respect to issue of shares to a resident.
Further,
Section 56(2)(viib) taxes consideration received in excess of fair market
value the shares and not the alleged short-fall in the issue price
of equity shares.
5. Sub-section (c) and (e) of Explanation (i) to Section 92B is not attracted
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.
6. Section
92(2) is not attracted
Section
92(2) deals with costs or expenditure allocated or apportioned between two or
more Associated Enterprises. Section 92(2) only ensures that profits are not
understated nor losses over stated by disclosing higher cost or expenditure,
then the benefit received.
7. Assumption that short-fall money could have been
invested and thereby generated income is not sustainable
Revenue’s Arguments
1. Subject
matter of tax is cost incurred by V-India in passing of benefit
to V-Mauritius
The
subject matter for meaning of income under Chapter X is not share premium but
is the cost incurred by V-India in passing on a benefit to its
holding company by issue of shares at a premium less than arm’s length
price. The accruing benefit to V-Mauritius here is its valuation in the
international market by taking undervalued shares of V-India., by increasing
the real net worth of the V-Mauritius.
2. Reading
92 with its corresponding provision in 1922 Act implies that profit which one would have normally made but
did not make because of one’s close association with a non-resident are to be
taxed [Mazagaon Dock Ltd. v. CIT, (1958) 34 ITR 368].
3. Total income includes prospective income
‘Any income’ in Section 92(1) is
not restricted to actual income. It includes income which could accrue by premium
not received by V-India.
4. Charging
Section is inherent in Chapter-X, therefore ‘income’ as in Section 92 has
different connotations then income as in Section 2(24).
5. Passing
of benefit is covered under Section 56(1)
Even if
there is no separate head of income under Section 14 of the Act in respect of
International Transaction, such passing on of benefit by the Petitioner to its
holding company would fall under the head ‘Income’ from other sources under
Section 56(1) of the Act.
6. ‘Income’
for TP provisions must be given broad interpretation
Charging provision
(§ 4) creates charge in respect of the total Income. In the Scope of
total income, Section 5 include all Income from whatever source which is
received or accrues or arises or deemed to be received, accrued or arisen would
be a part of the total Income. Thus, income is to be interpreted in a broad
context.
Decision
The
Court found based on the interpretation of section 2(24) of the IT Act that “income
will not in its normal meaning include capital receipts unless it is so
specified, as in Section 2(23)(vi) of the Act.” An issue of shares is a
transaction on the capital account, the premium cannot be treated as income.
The Court drew a contrast with Section 56(2)(viib) of the Act where a capital
transaction is deemed by legal fiction to amount to income. However, that
provision applies only to premium received from a resident and that too where
that premium is in excess of the fair market value of the shares. Further, Section
56(2)(viib) governs an actual receipt of the excess of amount, whereas in the
present case there is only an imputed amount of the difference without any
actual receipt. Thus, issuance of share in international transaction does not
find its place in any charging provision of the statute.
Court rejected argument of Revenue that for the
purposes of TP provisions ‘income’ should be interpreted in isolation of
Section 2(24). It held that even income arising from international transaction must
satisfy the test of 'income under the Act and must find its home in one of the heads
of income in the charging provisions viz.
Sections 4, 5, 15, 22, 28, 45, 56. Further, Chapter-X of the Act is a machinery
provision to arrive at the arm’s length price of a transaction, it does not
have any specific head of income.
Analysis
To be very precise, investor-friendly, legal
certainty, adherence to plain and strict interpretation, rejection of object
and purpose of the statute are the ornaments of the judgements. The Court appropriately
reiterated that in a taxing statute it
is not possible to assume any intention or purpose of the statute more that
what is stated by the black letter. It is not the economic results sought to be
obtained by making the provision which is relevant in interpreting a fiscal
statute. Further, treating issuance of shares as income without backing of any
express provision would have amounted to filling the casus omissus which is impermissible.
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