It is a global practice that prices at which goods, services and intangibles are transacted between Indian companies and their overseas associates are subjected to scrutiny under transfer pricing rules (with the intent to ensure that these deals are done on an arm's-length basis). India, however, has insisted that share transactions and the resultant capital receipts too can be audited and tax demands raised if arm's length principle is violated.
India's recent attempts to tax share subscription by groups like Vodafone and Shell in their Indian arms, treating alleged undervaluation of shares as loans to parents that bear interest income to the local subsidiaries, is being bitterly contested by the companies.
Official sources said New Delhi was working closely with the OECD on its global tax reform proposals under the (Tax) Base Erosion and Profit Shifting (BEPS) action plan aimed at tackling aggressive tax avoidance by MNCs.
If India has its way, recharacterisation of capital transactions as loans, on which interest income is to be taxed, could get wider acceptance among other major economies, all of which are now seeking ways to combat aggressive tax planning.
India's tax department recently asked a series of companies including local arms of Shell and Vodafone to pay taxes on the share subscription by their overseas parents, treating the difference between the value of the transaction and a higher arms length price attributed by the officials as loans to the overseas parents, on which, the department claims, taxable interest income would accrue to the Indian subsidiaries. The department has used this novel method to demand tax on close to 30 transactions, said industry sources.
OECD's BEPS action plan will have best practices and proposals for bridging the gaps in national tax laws as well as in tax treaties, currently exploited by companies to artificially lower their tax burden. The 34-member OECD has also said that all G20 countries, including India and China, are committed to implementing the BEPS project. The US too has listed income-shifting by companies to low tax countries as a major concern.
This seems to be an important development the government showing resolve in aggressively defending its position of trying to tax FDI. However it remains to be seen how developed nations which are net exporters of investments react to this proposal since apparently these kind of aggressive tax positions are unfair to the investor companies, said Amit Maheshwari, Partner, Ashok Maheshwari & Associates.
Experts said that these are secondary transfer pricing adjustments, where alleged undervaluation of shares are not directly treated as income foregone, but are recharacterised as a loan to demand tax on the interest income. There are some countries that make secondary adjustments, but they do have explicit provisions for it in their national tax laws, while India does not have an explicit provision for it, they said.
An official of the Income Tax Department, however, said that the law does say that all international transactions have to be on arms length basis. Companies criticise the move as taxing foreign capital inflow.