Transfer pricing twists for the Budget
The Bombay High Court, in its landmark judgments in the cases of Vodafone India and Shell India, held that issue of shares, being a capital transaction, does not attract transfer pricing (TP) provisions under the Indian income tax law. The court observed that investment in shares does not fall within the ambit of the definition of ‘income’ and, thus, such investment cannot be brought to tax. These resulted in deletion of TP adjustments of R166 billion. Refreshingly, the government accepted recommendations of Attorney General Mukul Rohatgi and directed the revenue authorities to refrain from challenging the rulings before the Supreme Court. The press release of the government states this controversy to be a “major correction of a tax matter which has adversely affected investor confidence.”
The government would stand to lose potential tax revenue of at least R55 billion from these taxpayers, let alone other cases having identical point of dispute. It is anticipated that the ratio laid down in these judgements would potentially be used by taxpayers for a variety of transactions impacted by these decisions. The government has decided not to challenge these judgments, but it may consider an amendment to address the collateral fallout arising from these decisions.
In case of closely held companies, where outbound investments are at higher than the fair market value of the shares of the investee company, such excess (subject to a small threshold) is taxed in the hands of the investor company. Since income could arise to the taxpayer on subscription to shares of an overseas associated enterprise, such outbound investments can attract TP provisions. The government may clarify this position in the Budget to prevent taxpayers from taking unwarranted advantage of the Vodafone and Shell decisions for all share issue transactions.
Transactions of business restructuring or reorganisation are included within the purview of TP regulations, irrespective of whether or not they have a bearing on the profit, income, losses or assets of the associated enterprises. Issue of shares, pursuant to an investment holding restructuring, amalgamation or demerger may be considered part of business restructuring and subjected to TP. The government may clarify that a business restructuring transaction involving issue of shares is subject to TP provisions if such business restructuring gives rise to ‘income’.
The court held that an element of ‘income’ was a prerequisite for the applicability of TP provisions since they are merely ‘machinery provisions’ and not ‘charging provisions’. To negate this, the government can consider amending the TP provisions to provide that all transactions entered into by a taxpayer with its associated enterprises ought to be undertaken at ALP, irrespective of an element of ‘income’. Such amendments could work well to counter the argument which taxpayers can take for non-applicability of TP provisions to any transactions that do not impact taxpayers’ income.
A charging provision can be introduced within the TP provisions, which has the effect of taxing all TP adjustments, whether on revenue or capital transactions. Inserting such a charging provision could make TP provisions a complete code. The current tax law has examples of regulations considered as complete codes on a standalone basis: the tonnage tax scheme for shipping companies is a case in point.
The government would like to receive information about intra-group transactions. Clarificatory amendments could be made to provisions relating to reporting and documentation requirements, thereby including transactions not impacting the taxable income also within the compliance requirements.
The finance minister would be under pressure to fulfil expectations of the business and investor community. While all of the above scenarios are in the realm of possibilities and probabilities, one can only wait and watch what the minister could spring out in what is considered as one of the most eagerly awaited Budgets in recent history.
The author is managing partner & head, Direct Tax, BDO India LLP.
