In these cases, the TP officers (TPOs) have alleged that the Indian company issued shares to its overseas group company at a price less than the market price (as determined by the TPO). This has created space for TP adjustments to the total income of the companies based on the gaps between the actual issue prices and the alleged market prices. In addition, TPOs have treated such a shortfall as an interest-free loan given by the Indian company to its overseas shareholder and imputed notional interest on such shortfall in the hands of the Indian issuing company.
Companies like Vodafone and Shell face huge TP additions on this account. Vodafone filed a writ petition before the Bombay High Court against such TP additions challenging the applicability of TP provisions on the issue of shares. While remanding the matter to the lower appellate authorities, the High Court observed that the lower tax authorities had not examined the fundamental objection of Vodafone that share infusion did not give rise to income and, therefore, was not covered under Indian TP regulations. The controversy remains unresolved.
This approach of the taxman has been contested by the companies on various grounds. Section 92 of the Income-Tax Act, 1961, requires that any income, expense, allocation or interest from international transactions must satisfy the arms length test. Any shortfall in the value of shares issued would impact only the share capital of the company and there would be no impact on the profit-and-loss account or taxable income of the company.
The alleged undervaluation of shares does not get covered under any provision of the I-T Act as income or deemed income. Therefore, the fundamental argument in such cases is that when there is no impact on the taxable income of the company, the share transactions fall outside the purview of TP provisions and hence no TP adjustment can be made.
It is a fact that if a company would have issued shares at the TPO-computed market price, the receipts would have been deemed share capital/share premium and not attributed as income. As per the circumstances and the law, the issue of shares at less than market price would not change the characterisation of the shortfall to income.
There are several rulings from the Authority for Advance Rulings (AAR) and certain tax tribunals which hold that in the absence of income liable to tax, the question of applicability of TP provisions does not apply. The re-characterisation of shortfall in issue price as an interest-free loan is not permitted under Indian tax laws. The legal position equally applies to other capital transactions like buy-back of shares, with no room for Indian Revenues jurisdiction.
Globally, concerns have been raised over the TP dispute on share infusion. With the Indian Revenue adopting measures like advance pricing arrangements which are to be concluded in the shortest possible time, introduction of safe harbour rules, etc, to generate taxpayer confidence, controversies such as this one create uncertainty. In the upcoming Budget, taxpayers expect the government clarifies that such transactions are not covered in the TP ambit.
Tarun Arora & Chhavi Poddar
Arora is partner and Poddar is senior manager, Deloitte Haskins & Sells LLP