There have been relatively high profile cases on the above where writ petitions have been filed before the Bombay High Court challenging the jurisdiction of the transfer pricing officer (TPO) to make TP adjustment on issue of shares. In addition, some aggrieved taxpayers have simultaneously filed their objections against the draft order with the dispute resolution panel (DRP) with regard to valuation/quantification issue. We have highlighted below the following points of contentions put forth by both parties.
l Whether TP provisions are applicable to capital transactions. Taxpayer had contended that the issue of shares as well as premium on shares, if any, are capital transactions and in the nature of capital receipts as per the provisions of Indian Income-tax Act, 1961, and TP provisions should not be applied to capital receipts, which are not taxable under the Act. The revenue authorities rejected this argument stating that the transaction of issue of shares to an AE would amount to an international transaction, relying on retrospective amendment to Section 92B of the Act, which includes, inter alia, capital financing transactions. Further, the revenue authorities, while quoting the meaning of the term international transaction under Section 92B which states that transactions having a bearing on the profits, income, losses or assets, argued that transaction of issue of shares has a bearing on the assets and, hence, is within TPOs jurisdiction to examine the arms length price (ALP).
l Basis of valuation. Taxpayer had contended that the valuation was in accordance with the exchange control norms (as they existed in 2009), which mandate that the issue price of shares should not be below the price determined under CCI guidelines. The revenue authorities had rejected this premise of valuation and stated that as per TP provisions, ALP must be determined using the most appropriate method under Section 92C(1).
l Re-characterisation of transactions. The revenue authorities have treated such undervaluation of the shares as loan and calculated notional interest on the same. In this context, taxpayers have contended that re-characterisation of transactions is not permissible under TP provisions. However, the revenue authorities have argued that the TPO is mandated not only to benchmark explicitly referred transactions but also to benchmark hidden or implicit transactions. Thus, there is no re-characterisation of the transaction by the revenue authorities. There are two separate transactionsissue of shares (which is explicit) and providing financial facility by way of deemed loan (which is implicit).
It is believed the high court has observed that in case it is found that in an international transaction there is no income or potential of any income arising and/or being affected on determination of the ALP, then the entire exercise of applying TP to determine an ALP would become more academic and largely redundant. This comment seems positive, especially in the current environment where a mechanical reference to TPOs for any international transaction without regard to the legitimacy of such reference seems to be resulting in unnecessary onerous litigation for taxpayers.
While rulings on certain cases have been currently stayed by the high court and in others the court has remitted the matter back to the DRP to decide preliminary issues of jurisdiction, it is believed that the DRP in Mumbai has confirmed share valuation TP adjustment in one of the cases stating the same to be income and asserting that whether income is capital or revenue has no bearing for purpose of application of Chapter X dealing with TP.The DRP has apparently stated that even if income is not chargeable to tax, ALP has to be determined as per Chapter X. In addition, the DRP seems to have also sustained the secondary adjustment by treating the shortfall as deemed loan and hence interest thereon has been computed and added to the income.
It is widely believed that imposing secondary adjustment is not valid under TP provisions of India in the absence of any express enabling provision contained in the Indian tax laws. Hence, the validity of the above is still a question.
Considering that there are no specific valuation guidelines on share valuation explicitly provided for in the Indian TP regulations, coupled with the manner in which the revenue authorities and the DRP have been auditing these transactions, clarificatory guidance in the form of circulars/amendments and/or a higher court analysing this matter in detail seems to be the need of the hour to settle this currently controversial and vexed issue relating to share capital where the issue on a consolidated basis would amount to thousands of crores of proposed adjustment.
Rohan K Phatarphekar
The author is head, Transfer Pricing, KPMG India, Global Transfer Pricing Services