Tax Update - The Government not to appeal against the decision of Bombay High Court
International Business Articles
The Government not to appeal against the decision of Bombay High Court in case of Vodafone India holding the capital infusion as non-taxable transaction
Vodafone India, a wholly owned subsidiary of Mauritian entity Vodafone Tele-Services (India) Holdings Limited (Vodafone Mauritius), issued certain number of equity shares of the face value of INR 10 each at a premium of INR 8591 per share in August 2008 to Vodafone Mauritius. The Revenue contended that the fair value of shares was much higher and therefore, the difference between the fair value and the issue price would lead to tax consequences for the issuer by invoking the transfer pricing provisions.
By way of background, transfer pricing is the body of law which seeks to test and if found necessary, replace transaction value with arm’s length price in respect of intra-group transactions between multinational enterprises, thus seeking to eliminate any distortion in pricing and tax consequences which may arise due to the relationship between the parties. Whilst this is an ongoing part of doing business across jurisdictions for a multinational enterprise, the issue here was whether such provisions could be invoked in case of infusion of capital by a group company into another to bring the parties to tax.
The Court held that infusion of capital was a capital receipt in the hands of the company and did not constitute ‘income’ as defined under domestic tax law. Thus, having held that the receipt of capital was not income in the first place, such receipt could not be brought to tax under transfer pricing provisions. The Court went on to hold that transfer pricing provisions did not create a charge of income tax where none existed; in other words, if the receipt was per se not in the character of income, then transfer pricing provisions could not alter its character to bring it within the ambit of taxation.
Accordingly, neither the capital receipts received by the Company nor the alleged short-fall between the so called fair market price of its equity shares and the issue price of the equity shares can be considered as income under income tax law, even if the transaction was between related parties.
Internationally, funding a subsidiary by infusion capital at a premium is a commonly adopted business practice and is typically viewed as a capital transaction not giving rise to any tax consequences. Thus, the decision brought relief to several similarly placed multinationals. It is worthwhile to note that in the weeks following this decision, the Court granted similar relief to another multinational, Shell in a similar case.
While the decision is welcome and relieved Vodafone of nearly US$ 500 million in possible taxes, the investors were waiting with bated breath as to the next steps that the Revenue may take in such a case. Last time Vodafone got a substantial relief from apex Court in 2012, the Government swiftly responded with a retroactive amendment in law, seeking to nullify the court decision. In this case, it was expected that the Government will appeal the verdict in the apex Court and may also brace for another amendment in law to overcome this decision, should the apex Court also rule in favour of taxpayer. However, the Attorney General of India, (the law officer of the Government) has advised the Government against filing an appeal against this decision. It is also reported that the Chairman of CBDT, the apex direct tax body of the Government, is also of the view that this verdict needs to be respected in law.
It certainly comes as a refreshing news for investor community to hear that the Government is looking at ways and means to boost investor sentiment and more importantly, respect the settled law on taxing transactions, instead of going after multinationals simply on the basis of tax effect of a transaction. While the final decision on the issue may not have been taken yet, the Government seems intent on sending signals that this regime is more investor friendly and expects to encourage businesses by not seeking to unsettle the settled legal issues and attempting to provide certainty in taxation.
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