The taxman’s controversial view that income could arise from share transfer between Indian arms of global companies and their foreign associates was struck down by the Bombay High Court for the second time in a little over a month on Tuesday, dispelling fears of a virtual tax on much-needed foreign direct investment (FDI). Iterating the principles laid down in its October 10 ruling in Vodafone India’s case that cross-border share transfers cannot lead to income and in the absence of an express provision to tax, the court relieved Shell India of a huge potential tax burden.
The court set aside the income tax department’s notices that sought to increase the income of the global energy giant’s Indian arm for two years — 2007-08 and 2008–2009 — by close to R18,000 crore. To seek the income addition, the taxman had applied the transfer pricing principle to Shell India’s issue of shares to its Dutch parent alleging an undervaluation.
Tuesday’s ruling by a division bench comprising of justices MS Sanklecha and SC Gupte reinforced the judicial view that cross-border share transactions can’t lead to income. The ruling almost made it certain that about two dozen other companies including some Essar Group firms, HSBC Securities and Capital Markets and Bharti Airtel which are fighting transfer pricing adjustments sought by the I-T department on similar grounds, too would get relief.
Official sources told FE that a decision on whether the government would appeal against the HC ruling on Vodafone (and now on Shell) in the Supreme Court would be taken soon. Although the Narendra Modi government has been vocal about a non-adversarial and investor-friendly tax regime, a likely Comptroller and Auditor General objection to a decision to refrain from appealing may also weigh on the government’s mind.
Welcoming the ruling, a Shell spokesperson said: “Shell has always maintained that equity infusion by a foreign parent company into an Indian subsidiary cannot be taxed as income. This is a positive outcome which should provide a further boost to the Indian government’s initiatives to improve the country’s investment climate.”
In their attempt to build a case of income suppression by the company, tax officials had claimed that Shell India’s issue of 8.7 crore shares at a face value of Rs 10 a share to Shell Gas should have actually been priced at Rs 183 a share. The department’s classification of the shortfall in share valuation as taxable income by invoking a 2012 amendment to Section 92(1) of the I-Tax Act had grabbed global headlines. In early October, the high court had struck down similar attempts by the tax department to add about Rs 5,000 crore to Vodafone India’s income for 2008-09 and 2009-10, saying the law does not expressly classify as income any discount/premium involved in international capital transactions between associated enterprises.
In what shows the government’s possible leniency on the issue, tax officers, whose mandate is to collect taxes, have now begun to talk about the need for capital inflows in the light of finance minister Arun Jaitley’s instruction to higher-ups in the department on November 7 that appeals in tax matters are to be decided “only on merit and not merely on the tax effect involved”.
Although tax authorities claimed the Shell dispute was different from Vodafone’s , the court did not find the argument valid, said sources present in the court.
“The decision of Bombay High Court confirms the concept that arm’s length principle for determination of price of a transaction should be applied only when there is income, expense or interest involved,” said SP Singh, senior director, Deloitte Haskins & Sells.
“It is a positive development which vindicates that India’s judiciary is independent and that it will not hesitate to exercise its powers to decide on writ petitions especially when tax authorities exceed their brief,” said Mukesh Butani, managing partner, BMR Legal.
Industry executives said raising a tax demand on what is essentially capital infusion was like taxing foreign direct investment. Re-characterising a capital receipt or its shortfall as income is a rare practice among tax authorities although there are a few countries that specifically provide for it in their statutes.
In the case of Vodafone India Services, the tax department considered the gap between the issue price and what it deemed as its fair value as income, holding it as the cost of fiscal benefit extended to the parent. The department also attempted to present this gap as a loan extended to the foreign parent on which the Indian unit stands to gain taxable interest income.