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Vodafone, issue of shares (transfer pricing) bombay high court

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Vodafone, issue of shares (transfer pricing) bombay high court

  1. 1. Vodafone India - Issue of Shares to Holding Company 1 Is it subject to Transfer Pricing Regulations? Stand of Taxpayer vs Stand of Revenue – By Nilesh Patel Former IRS Officer, CPA (USA)
  2. 2. Vodafone India - Issue of Shares to Holding Company 2 Verdict of Bombay High Court in Writ Petition No. 871 of 2014, dated 10-10-2014 – By Nilesh Patel Former IRS Officer, CPA (USA)
  3. 3. Nilesh Patel CPA(USA), Former IRS Officer This Analysis of the Bombay High Court’s Order dated 10th October 2014, in case of Vodafone India Services Pvt Ltd, has been made by Nilesh Patel. Nilesh has experience of about 18 years in the filed of Direct Taxes: 4 years as an independent Transfer Pricing and International Tax Consultant in Mumbai, 2 years as a Senior Manger (Corporate Tax) with Deloitte, 1 year as a US Tax Professional with a US CPA Firm and 11 years as a Indian Revenue Service (IRS) Officer. Nilesh is a Certified Public Accountant (CPA) licensed by California Board of Accountancy and M.Tech. from Indian Institute of Technology (IIT), Powai, Mumbai.
  4. 4. Website: www.taxwize.in For any queries related to this Analysis you may Contact Nilesh Patel – CPA (USA), IRS (Former) at the Email ID: Nilesh@taxwize.in Contact
  5. 5. Vodafone India – High Court Order on Issue of Shares 5 Sr. No. Particulars Slide Nos. 1 Introduction 8 - 12 2 Facts 1: Issue of Shares by an Indian Company (Vodafone India) to a Non-Resident Holding Company (Vodafone Holdings) 14 - 24 3 Facts 2: Filing of Return of Income and Form 3CEB 25 - 29 4 Assessment Proceedings: Reference by Assessing Officer (AO) to the Transfer Pricing Officer (TPO) 30 - 34 5 Assessment Proceedings: Order passed by the Transfer Pricing Officer (TPO) 35 - 42 CONTENTS
  6. 6. Vodafone India – High Court Order on Issue of Shares 6 Sr. No. Particulars Slide Nos. 6 Assessment Proceedings: Draft Assessment Order passed by the AO under Sec. 144C (1) 43 - 46 7 Objections before Dispute Resolution Panel (DRP) 47 - 49 8 First Writ Petition (No. 1877 of 2013) to Bombay High Court 50 - 51 9 Order passed by High Court 52 - 57 10 Order of DRP on Preliminary Jurisdictional Issue 58 - 64 11 Basis of DRP’s Order 65 - 73 12 Second Writ Petition (No. 871 of 2014) before the Bombay High Court 74 - 74 CONTENTS
  7. 7. Vodafone India – High Court Order on Issue of Shares 7 Sr. No. Particulars Slide Nos. 13 Hearing before the High Court 75 - 75 14 Submissions of the Taxpayer 76 - 81 15 New Grounds of Revenue – raised by Solicitor General 82 - 86 16 Submissions of the Revenue in support of DRP’s Order 87 - 92 17 Rejoinder of the Taxpayer 93 - 93 18 Analysis of the Order of the Bombay High Court in Writ Petition (No. 871 of 2014) 94 - 101 19 Findings of the Bombay High Court 102 - 163 20 Final Order of the High Court 164 - 167 21 Way Forward – implication of the High Court’s verdict 168 - 177 CONTENTS
  8. 8. 8 Introduction Last Friday (10th October 2014), in the case of Vodafone India Services Pvt Ltd, the Bombay High Court pronounced its eagerly awaited verdict on taxability – under the Transfer Pricing Regulations – of the arm’s length price of consideration (or premium) received, or receivable, on issue of shares by an Indian Company to its Non-Resident Holding Company. Transfer Pricing adjustment of Rs. 1397 Crores was involved in this case; the High Court ruled in Taxpayer’s favour. What facts and arguments persuaded the High Court in favour of the Taxpayer? What litigation strategies were adopted by the Taxpayer and the Revenue during hearing before the High Court?
  9. 9. 9 Introduction One of the grounds on which the Dispute Resolution Panel (DRP) had rejected the Taxpayer’s objections on taxability of consideration or premium, on issue of shares to its holding company, was this: If the Taxpayer had received full premium at arms’ length price (ALP), then the Taxpayer would have earned income by investing such premium - income, therefore, does arise in terms of Sec. 92 (1). How did the Taxpayer meet this ground before the High Court? And what was the decision of High Court on this ground of DRP?
  10. 10. 10 Introduction In course of hearing before the High Court the Solicitor General, representing the Revenue, made an ingenious argument: The Taxpayer, by issuing shares at a price below fair market value, had passed on benefit to its holding company. Sec. 92 (2) read with Sec. 92 (1) lays down that the cost of any benefit passed on by the Taxpayer to its Associated Enterprise (Holding Company) should be determined at arm’s length price. Hence, Transfer Pricing Regulations were applicable to the issue of shares by the Taxpayer to its Holding Company. How did the Taxpayer rebut this argument? And what was the High Court’s response?
  11. 11. 11 Introduction We have made this thorough analysis of the High Court’s Order. In this Analysis, we answer the foregoing questions. Besides, we also present to you the following:  Full reasoning of the High Court  Contention of the Taxpayer  Contentions of Revenue  Contentions of the Solicitor General during hearing before the High Court  Grounds on which the DRP rejected Taxpayer’s contentions.
  12. 12. 12 Introduction Similar issue is involved in a number of cases, including the well- known case of Shell India, where Transfer Pricing adjustment of about Rs. 15,000 Crores was made. We place this Analysis in your hands with the hope that it will add to your knowledge, and will act as a valuable reference. Nilesh Patel – CPA (USA), Former IRS Officer
  13. 13. 1. Issue of Shares by an Indian Company (Vodafone India) to a Non-Resident Holding Company (Vodafone Holdings) 13 Facts 2. Filing of Return of Income and Form 3CEB
  14. 14. 14 Facts 1. Issue of Shares by an Indian Company (Vodafone India) to a Non-Resident Holding Company (Vodafone Holdings)
  15. 15. Vodafone Holdings Vodafone India Foreign 15 Holding Company India Vodafone Holdings (Vodafone Tele- Services Holdings Ltd), a Non Resident Company, is the holding company of Vodafone India (Vodafone India Services Pvt Ltd)
  16. 16. Vodafone Holdings Vodafone India Foreign 16 Vodafone India needed Funds India In FY 2008-09, Vodafone India needed funds for its telecommunications project in India. Telecommun- ications Project Funds
  17. 17. Vodafone Holdings Vodafone India Foreign 17 Vodafone India issues Shares India Telecommun- ications Project Funds Issue of Equity Shares In FY 2008-09, Vodafone India issued fresh equity shares to Vodafone Holdings (a Non Resident Company), because Vodafone India needed funds for its telecommunications project in India.
  18. 18.  How to value the equity shares issued by Vodafone India to Vodafone Holdings?  What should be the issue price of shares? Vodafone India - Issue of Shares 1 8 Questions
  19. 19.  The issue of equity shares by an Indian Company, to a Non-Resident Company, is regulated by the Regulations issued under FEMA (Foreign Exchange Management Act, 1999) Vodafone India - Issue of Shares 1 9 Answer
  20. 20.  The equity shares issued by Vodafone India to Vodafone Holdings should be valued, as prescribed by the Regulations issued under FEMA (Foreign Exchange Management Act, 1999) Vodafone India - Issue of Shares 20 Answer
  21. 21. The issue price of shares should be as determined under the Regulations issued under FEMA (Foreign Exchange Management Act, 1999)  Those Regulations ensure that shares are not undervalued  Those Regulations ensure that issue price of shares is commensurate with the value transferred to the shareholder Vodafone India - Issue of Shares 21 Answer
  22. 22.  Under FEMA the issue price of shares can be determined in accordance with the methodology prescribed by the Government of India under the Capital Issues (Control) Act, 1947 Vodafone India - Issue of Shares 22 Answer
  23. 23.  The Taxpayer (Vodafone India) adopted the methodology prescribed by the Government of India under the Capital Issues (Control) Act, 1947, and determined the issue price of shares at Rs. 8,519 per share: Face Value Rs. 10 + Premium Rs. 8,509 Vodafone India - Issue of Shares 23 Answer
  24. 24.  Is there no relevance of Transfer Pricing Regulations to determination of the issue price of shares?  For Answer, please see the analysis of Bombay High Court’s Order in the later part of this presentation. Vodafone India - Issue of Shares 24 Question
  25. 25. 25 Facts 2. Filing of Return of Income and Form 3CEB
  26. 26. Vodafone India and Vodafone Holdings are Associated Enterprises Vodafone – Return of Income & Form 3CEB 26
  27. 27. Vodafone India received money from Vodafone Holdings for subscription of shares  How to report the issue of shares, and the receipt of money on such issue, under the Transfer Pricing Regulations?  Should the issue of shares, and the receipt of money on such issue, be reported as International Transaction in Form 3CEB? Vodafone – Return of Income & Form 3CEB 27 Question
  28. 28. Vodafone India Form 3 CEB 28 Vodafone India – Form 3CEB AY 2009-10 Out of abundant caution, Vodafone India Reported the issue of shares and total consideration of Rs. 246.38 Crores in Form 3 CEB, as International Transaction. A Note, however, was appended to Form 3 CEB.
  29. 29. Vodafone India Form 3 CEB 29 Vodafone India – Form 3CEB AY 2009-10 “The company has issued 289224 equity shares of Rs.10/- each fully paid at a premium of Rs.8500 per share aggregating to total consideration of Rs.2,46,38,99,016. As per Section 92(1) of the Income Tax Act, 1961 any income arising shall be computed having regard to the arm's length price. This transaction of issue of equity shares does not affect income of the Company. However, out of abundant caution, the same is reported here.” Note appended to Form 3 CEB
  30. 30. 30 Assessment Proceedings Reference by Assessing Officer (AO) to the Transfer Pricing Officer (TPO) Order passed by the Transfer Pricing Officer (TPO)
  31. 31. 31 Reference by Assessing Officer (AO) to the Transfer Pricing Officer (TPO) Assessment Proceedings
  32. 32. Reference by the AO to TPO  The AO referred all International Transactions reported in Form 3CEB, to the TPO, for determination of the Arm’s Length Price (ALP) [see Sec. 92CA (1)] Vodafone India – Assessment Proceedings 32
  33. 33. Reference by the AO to TPO  The AO is not required to give an opportunity of hearing to the Taxpayer, before making reference to the TPO, for determination of the Arm’s Length Price (ALP) [Aztec Software & Technology Services Ltd vs ACIT [2007] 107 ITD 141 (Bangalore)(Special Bench)]  Therefore, before the AO, the Taxpayer was not able to raise the plea that issue of shares is not covered by the Transfer Pricing Regulations enshrined in Chapter X of the I. T. Act, 1961 [Preliminary Jurisdictional Issue] Vodafone India – Assessment Proceedings 33
  34. 34. Reference by the AO to TPO  The following is the basis for the plea that issue of shares is not covered by the Transfer Pricing Regulations enshrined in Chapter X of the I. T. Act, 1961:  The language or text of Sec. 92 (1) provides that any income arising from an International Transaction shall be computed having regard to the Arm’s Length Price.  The consideration for issue of shares is a Capital Receipt; it is not income, which is taxable. Vodafone India – Assessment Proceedings 34
  35. 35. 35 Assessment Proceedings Order passed by the Transfer Pricing Officer (TPO)
  36. 36. Order passed by the TPO (on Preliminary Jurisdictional Issue)  For the first time the Taxpayer got the opportunity to raise the plea that issue of shares is not covered by the Transfer Pricing Regulations enshrined in Chapter X of the I. T. Act, 1961 [Preliminary Jurisdictional Issue] Vodafone India – Assessment Proceedings 36
  37. 37. Order passed by the TPO (on Preliminary Jurisdictional Issue)  As already stated the basis for the foregoing plea is:  Sec. 92 (1) provides that any income arising from an International Transaction shall be computed having regard to the Arm’s Length Price.  The consideration for issue of shares is a Capital Receipt; it is not income, which is taxable . Vodafone India – Assessment Proceedings 37
  38. 38. Order passed by the TPO (on Preliminary Jurisdictional Issue)  TPO did not consider the Preliminary Jurisdictional Issue raised by the Taxpayer (Vodafone India) Vodafone India – Assessment Proceedings 38
  39. 39. Order passed by the TPO (on Preliminary Jurisdictional Issue)  According to the TPO, he or she only has the authority to compute ALP; he or she has no authority to decide the taxability of a transaction referred by the AO  On this point please see: Veer Gems vs ACIT [2011] 15 taxmann.com 355/351 ITR 35 (Gujarat HC); CIT vs Cushman and Wakefield (India) Pvt Ltd [2014] 46 taxmann.com 317 (Delhi HC); CIT vs EKL Appliances Ltd [2012] 24 taxmann.com 199/209 Taxman 200/345 ITR 241 (Delhi HC); Honda Siel Cars India Ltd vs ACIT [2011] 129 ITD 200 (ITAT Delhi) Vodafone India – Assessment Proceedings 39
  40. 40. Order passed by the TPO (on ALP of Shares)  The TPO included the Transfer Pricing adjustments made for prior years (AY 2007-08 and 2008-09) in the Net Asset Value  On that basis the TPO worked out the ALP of shares at Rs. 53,775 per share; the Taxpayer had worked out the price of shares at Rs. 8,519 per share. Vodafone India – Assessment Proceedings 40
  41. 41. Order passed by the TPO (on ALP of Shares)  The TPO made transfer pricing adjustment for the deficit of Rs. 45,256 (53,775 – 8,529) per share.  Total adjustment of Rs. 1308.91 Crores was made on this ground of valuation of shares, issued by Vodafone India to its holding company. Vodafone India – Assessment Proceedings 41
  42. 42. Order passed by the TPO (on ALP of Shares)  Yet another Transfer Pricing adjustment was made by the TPO:  The shortfall in the value of shares was treated as deemed loan given by Vodafone India to its holding company.  Interest of 13.50% per annum was charged on the deemed loan of Rs. 1308.91 Crores for 6 months – adjustment on account of interest thus worked out to Rs. 88.35 Crores. Vodafone India – Assessment Proceedings 42
  43. 43. 43 Assessment Proceedings Draft Order passed by the Assessing Officer (AO) under Sec. 144C (1)
  44. 44. Draft Assessment Order passed by the AO under Sec. 144C (1)  After receiving the Order of the TPO the AO issued a show- cause to the Taxpayer. Vodafone India – Assessment Proceedings 44
  45. 45. Draft Assessment Order passed by the AO under Sec. 144C (1)  In response the Taxpayer submitted that the issue of shares is not covered by the Transfer Pricing Regulations enshrined in Chapter X of the I. T. Act, 1961, because:  the consideration for issue of shares is a Capital Receipt, which is not taxable as income  Sec. 92 (1) provides that any income arising from an International Transaction shall be computed having regard to the Arm’s Length Price.  When no income arises the provisions of Sec. 92 (1) and Chapter X are not applicable Vodafone India – Assessment Proceedings 45
  46. 46. Draft Assessment Order passed by the AO under Sec. 144C (1)  The AO did not consider the Preliminary Jurisdictional Issue raised by the Taxpayer (Vodafone India).  The AO stated that he or she is bound to follow the Order passed by the TPO on computation of ALP.  On this point please see Veer Gems vs ACIT [2011] 15 taxmann.com 355/351 ITR 35 (Gujarat HC); CIT vs Cushman and Wakefield (India) Pvt Ltd [2014] 46 taxmann.com 317 (Delhi HC) Vodafone India – Assessment Proceedings 46
  47. 47. 47 Objections before the Dispute Resolution Panel (DRP), under Sec. 144C (2)
  48. 48. Objections against the Draft Assessment Order passed by the AO under Sec. 144C (1)  The Taxpayer filed objections to DRP (under Sec. 144C (2)) on the issue of computation of ALP of shares issued to the holding company.  However, objections on the Preliminary Jurisdictional Issue were not filed before the DRP. Why? Vodafone India – Objections before DRP 48
  49. 49. Objections against the Draft Assessment Order passed by the AO under Sec. 144C (1)  The Taxpayer did not file objections to DRP on the Preliminary Jurisdictional Issue, because the Taxpayer wished to raise that issue before the High Court, by way of a Writ Petition.  Had the Taxpayer filed objections to the DRP even on the Preliminary Jurisdictional Issue, the High Court might have dismissed the Writ Petition on the theory of ‘Alternate Remedy Available’. Vodafone India – Objections before DRP 49
  50. 50. 50 Writ Petition (No. 1877 of 2013) to Bombay High Court This is the first Writ Petition. (Later, a second Writ Petition was filed.)
  51. 51. Just two days after filing objections before the DRP under Sec. 144C (2), the Taxpayer filed the first Writ Petition (No. 1877 of 2013) before the Bombay High Court  In the Writ Petition the Taxpayer raised the Preliminary Jurisdictional Issue  Preliminary Jurisdictional Issue is: the issue of shares, and resulting receipt of consideration, is not covered by the Transfer Pricing Regulations enshrined in Chapter X of the I. T. Act, 1961 Vodafone – Writ Petition to High Court (A) 51
  52. 52. 52 Writ Petition (No. 1877 of 2013) to Bombay High Court Order dated 29th November 2013 of High Court
  53. 53. Order dated 29-11-2013 of High Court in Writ Petition No. 1877 of 2013  The High Court accepted the plea of Vodafone India (the Taxpayer/Petitioner) that a jurisdictional issue of application of Chapter X of the Act does arise and the same was not considered either by the TPO or by the AO  The Taxpayer is entitled to have its preliminary objection dealt with - not a single authority has so far dealt with this issue. Vodafone – Writ Petition to High Court (A) 53
  54. 54. Order dated 29-11-2013 of High Court in Writ Petition No. 1877 of 2013  As the Taxpayer had already filed its objections, (excluding the issue of jurisdiction) to the Draft Assessment Order, before the DRP under Section 144C(2) of the Act, and it was pending -  the High Court directed the DRP to first decide only the jurisdictional issue raised by the Taxpayer as preliminary issue, within two months from the date on which the Taxpayer filed its objection on the question of jurisdiction. Vodafone – Writ Petition to High Court (A) 54
  55. 55. The High Court disposed of the Writ Petition No. 1877 of 2013 with the following directions:— (A) The petitioner shall within two weeks from the date of High Court’s Order submit before the DRP its preliminary objections, to Draft Assessment Order and the TPO's order, by raising jurisdictional issues. Vodafone – Writ Petition to High Court (A) 55
  56. 56. The High Court disposed of the Writ Petition No. 1877 of 2013 with the following directions:— (B) The DRP shall decide the issue of jurisdiction before considering issue of valuation / quantification raised by the petitioner in its objections filed before the DRP - this of course subject to the additional grounds on jurisdiction being filed by the Petitioner within two weeks from today. The DRP shall decide the issue of jurisdiction as a preliminary issue within two months from the date on which the petitioner files its objections on the question of jurisdiction. Vodafone – Writ Petition to High Court (A) 56
  57. 57. The High Court disposed of the Writ Petition No. 1877 of 2013 with the following directions:— (C) If the decision of the DRP on the above preliminary issue is adverse to the petitioner, it would be open to the petitioner to challenge the order of the DRP on the preliminary issue in a writ petition if a case is made out at that stage that the decision of the DRP is patently illegal, notwithstanding the availability of alternative remedy of filing an appeal before the Income Tax Appellate Tribunal. Vodafone – Writ Petition to High Court (A) 57
  58. 58. 58 Order of DRP on Jurisdictional Issue
  59. 59. In accordance with the Order of High Court the Taxpayer filed objections before the Dispute Resolution Panel (DRP) on the Preliminary Jurisdictional Issue. Vodafone India – Order of DRP 59
  60. 60. Taxpayer’s Objections before the DRP: (i) Chapter X of the Act will not apply as the issue of equity shares by the Petitioner to its holding company does not give rise to any income; Vodafone India – Order of DRP 60
  61. 61. Taxpayer’s Objections before the DRP: (ii) Chapter X of the Act will not apply as no expenditure is incurred that impacts computation of the taxable income; and Vodafone India – Order of DRP 61
  62. 62. Taxpayer’s Objections before the DRP: (iii) Chapter X of the Act will not apply as issue of shares is transaction on capital account and thus does not impact computation of income. Vodafone India – Order of DRP 62
  63. 63. The DRP passed an Order against the Taxpayer – rejecting the objections. Vodafone India – Order of DRP 63
  64. 64. The DRP held that the AO has the jurisdiction to tax the issue of shares by the Taxpayer - to its holding company at a premium, to the extent the premium is not received - the AO has the jurisdiction to tax the issue of shares under Chapter X of the Act, as income does arise in the above International Transaction. Vodafone India – Order of DRP 64
  65. 65. What is the basis of DRP’s Order? Vodafone India – Order of DRP 65
  66. 66. The basis of DRP’s Order/Reasoning given by DRP Sec. 92 (1) of the Act, mandates computation of income arising out of International Transaction be determined, having regard to the ALP. The term 'Income' has not been defined in Chapter X of the Act unlike International Transaction. Therefore, the term 'Income' is to be construed in a broad manner embracing all types of receipts or incomings. Vodafone India – Order of DRP 66
  67. 67. The basis of DRP’s Order/Reasoning given by DRP Sec. 2 (24) of the Act defines income in an inclusive manner, and capital receipts which would otherwise not be covered by the term 'Income' would also stand included in the definition. Therefore, all incomings would fall within the concept of income. The broader meaning of the term “Income” should be accepted because a broader interpretation of the word 'Income' would advance the object of Chapter X of the Act, and would be purposive interpretation of the statutory provision. Vodafone India – Order of DRP 67
  68. 68. The basis of DRP’s Order/Reasoning given by DRP The definition of International Transaction as given in Sec. 92B of the Act and in particular in Explanation (i)(c) of Sec. 92B provides that the expression 'International Transaction' includes capital financing like purchase of marketable securities. If the normal meaning of Income as canvassed by the Taxpayer is adopted, then purchase of marketable securities, could never give rise to Income, rendering the provision otiose. Vodafone India – Order of DRP 68
  69. 69. The basis of DRP’s Order/Reasoning given by DRP The clause (e) to Explanation (i) of Sec. 92B of the Act includes a transaction of business restructuring or reorganization entered into as an International Transaction. This provision enables the AO to bring to tax income forgone while restructuring /reorganizing the business. In such a case, though there is no formal transfer of source of income or tangibles, yet the income forgone would be notional income liable to tax under the provisions of Chapter X of the Act. Vodafone India – Order of DRP 69
  70. 70. The basis of DRP’s Order/Reasoning given by DRP The Taxpayer not receiving the ALP on the issue of shares, resulted in lesser premium being garnered by the Petitioner. The result is: the Taxpayer having less liquid funds available at its command which in turn could have reduced its debts - or the excess funds could have been invested to earn income. Vodafone India – Order of DRP 70
  71. 71. The basis of DRP’s Order/Reasoning given by DRP Thus, the amount not received could have enhanced the Taxpayer’s potential income. In view of the above, the share premium forgone has impacted potential income. Thus, there are appropriate reasons giving rise to application of Chapter X of the Act to the transaction of issues of share. Vodafone India – Order of DRP 71
  72. 72. Summary of DRP’s findings a. On a broader and harmonious construction of the term “income” in Section 92(1), AO has jurisdiction to invoke Chapter X as share premium is an income arising from issue of shares b. Even if the term “income” is not given a broad interpretation, the AO has jurisdiction to invoke Chapter X as there is income potentially arising or affected by the short receipt of share premium Vodafone India – Order of DRP 72
  73. 73. The Taxpayer filed second Writ Petition (No. 871 of 2014) before the High Court challenging the adverse Order passed by the DRP, on the jurisdictional issue.  Though alternative remedy of filing an appeal before the Income Tax Appellate Tribunal (ITAT) was available, the Taxpayer chose to file Writ Petition on the ground that the decision of the DRP is patently illegal.  On this ground, the High Court had permitted - in the Order passed in the first Writ Petition - High Court had permitted the Taxpayer to file a second Writ Petition. Vodafone India – Order of DRP 73
  74. 74. 74 Writ Petition No. 871 of 2014 before the Bombay High Court
  75. 75. Hearing before the High Court Vodafone – Second Writ Petition (No. 871 of 2014) 75
  76. 76. Submission of the Taxpayer (Petitioner) a) For application of Sec. 92 (1) it is a must that income should arise from an International Transaction. In case of the Taxpayer no income arises from the issue of equity shares to the holding company. a) The word “Income” should be understood as defined in Sec. 2 (24). A fiscal statute has to be strictly interpreted – meaning of ordinary words cannot be expanded to give purposeful interpretation. Vodafone – Second Writ Petition (No. 871 of 2014) 76
  77. 77. c) Chapter X of the Act is not designed to tax all sums involved in a transaction, which are otherwise not taxable. The purpose and objective is not to tax difference between the ALP and transaction-value, but to reach the fair price/consideration. Therefore, before any transaction could be brought to tax, a taxable income must arise. d) The DRP’s Order itself shows that share premium on issue of shares is not taxable – the share premium received by the Taxpayer has not been taxed, only the deficit of share premium has been taxed. Vodafone – Second Writ Petition (No. 871 of 2014) 77
  78. 78. e) When shares are issued, they come into existence for the first time only when the shares are allotted. Thus, it is creation of property for the first time. An issue of shares is a creation of shares – it is different from transfer of an existing property. So, Sec. 45 will not apply. f) Receipt of consideration on issue of shares is a capital receipt. Capital receipts cannot be brought to tax, unless expressly brought to tax. Capital receipts do not fall within the ambit of the word “Income” unless specifically provided. For example, clause (vi) of Sec. 2(24) which brings to charge Capital Gains under Sec. 45. Vodafone – Second Writ Petition (No. 871 of 2014) 78
  79. 79. g) Clause (xvi) of Sec. 2(24) incudes, within income, amounts received within the provisions of Sec. 56 (2)(viib). However, it applies to issue of shares to a resident. Besides, it seeks to tax consideration received in excess of the fair market value of the shares, not the alleged short-fall in the issue price of shares. This indicates the absence of any intent to tax the issue of shares below the alleged fair market value. h) DRP’s Order proceeds on an assumption, surmise or conjecture that had the Taxpayer received the notional income – the amount of share premium foregone – the Taxpayer would have invested the same, giving rise to income. No tax can be charged on guess work or assumption. Vodafone – Second Writ Petition (No. 871 of 2014) 79
  80. 80. i) 1. Explanation (i)(c) to Sec. 92B of the Act only states that capital financing transaction such as borrowing money and/or lending money to AE would be an International Transaction. However, what is brought to tax is not the quantum of amount lent and/or borrowed but the impact on Income due to such lending or borrowing. This impact is found in either under reporting/ over reporting the interest paid/interest received. Vodafone – Second Writ Petition (No. 871 of 2014) 80
  81. 81. i) 2. Similarly, Explanation (i)(e) to Sec. 92B of the Act, which covers business restructuring would only have application if said restructuring/ reorganizing impacts income. If there is any impact of income on account of business restructuring/reorganizing, then such income would be subjected to tax as and when it arises. Vodafone – Second Writ Petition (No. 871 of 2014) 81
  82. 82. Submission of the Revenue (Respondent) The Revenue sought to support the DRP’s Order on completely new grounds, grounds completely different from the grounds stated in the DRP’s Order Vodafone – Second Writ Petition (No. 871 of 2014) 82
  83. 83. New Grounds of Revenue (Respondent) Text of Sec. 92 (1) and 92 (2) Sec. 92. Computation of income having regard to arm's length price (1) Any income arising from an international transaction shall be computed having regard to the arm's length price. Explanation.—For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm's length price. Vodafone – Second Writ Petition (No. 871 of 2014) 83
  84. 84. Sec. 92. Computation of income having regard to arm's length price (2) Where in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility, as the case may be. Vodafone – Second Writ Petition (No. 871 of 2014) 84
  85. 85. New Grounds of Revenue (Respondent) The Solicitor General argued that Section 92(1) of the Act is to be read with Section 92(2) of the Act. A conjoint reading of two provisions would indicate that what is being brought to tax under Chapter X of the Act is not share premium but is the cost incurred by the Petitioner in passing on a benefit to its holding company by issue of shares at a premium less than ALP. This benefit is the difference between the ALP and the premium at which the shares were issued. Vodafone – Second Writ Petition (No. 871 of 2014) 85
  86. 86. New Grounds of Revenue (Respondent) The issue of shares by the Petitioner to its holding company, resulted in the following benefits to its holding company:- (i) cost incurred by the Indian Co. for a corresponding benefit given to the Holding Co. After all, the Holding Co. has actually got shares worth Rs.53,775/- each at a price of Rs.8,159/- each; (ii) benefit also accrues to the valuation of Holding Co. in the international market by taking undervalued shares of the subsidiary Co., by increasing the real net worth of the Holding Co. Vodafone – Second Writ Petition (No. 871 of 2014) 86
  87. 87. Submission of the Revenue (Respondent) in support of DRP’s Order – Other than New Grounds a) The Taxpayer does not challenge the constitutional validity of Chapter X. The Taxpayer raises only an issue of interpretation. Moreover, the Taxpayer and its holding company are Associated Enterprises. Therefore, provisions of Chapter X are fully satisfied, and that Chapter is applicable to the facts of the Taxpayer’s case. Vodafone – Second Writ Petition (No. 871 of 2014) 87
  88. 88. Submission of the Revenue (Respondent) in support of DRP’s Order – Other than New Grounds b) The Taxpayer itself had submitted to the jurisdiction of Chapter X by fling Form 3 CEB, declaring the ALP. So, the AO and the TPO were mandated to apply Chapter X, and compute ALP. Therefore, the Taxpayer should be relegated to the alternate remedy of approaching the Authorities under the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 88
  89. 89. c) Identical provision as found in Sec. 92 of the Act was existing in Sec. 42(2) of the I.T. Act, 1922. The Supreme Court in Mazagaon Dock Ltd vs CIT (1958) 34 ITR 368 observed that notional profits can be taxed under the erstwhile Sec. 42 (2). Thus, the legislative history supports the stand of the Revenue that even in the absence of actual income, a notional income can be brought to tax. Vodafone – Second Writ Petition (No. 871 of 2014) 89
  90. 90. d) For the purposes of Chapter X the real income concept has no application. Otherwise the words used would have been ‘actual income’. The difference between ALP and the contracted price would be added to the total income. e) Under the Act what is taxable is income when it accrues or arises or deemed to accrue or arise, and not only when it is received. The difference between ALP and contract price is an income which has arisen but not received. Thus, income forgone is also subject to tax Vodafone – Second Writ Petition (No. 871 of 2014) 90
  91. 91. f) Chapter X of the Act is a complete code by itself and not merely a machinery provision to compute the ALP. Chapter X of the Act applies wherever the ALP is to be determined by the A.O. It is the hidden benefit in the transaction which is being charged to tax - the charging section is, therefore, inherent in Chapter X of the Act. g) Even if there is no separate head of income under Section 14 of the Act in respect of International Transaction, such passing on of benefit by the Petitioner to its holding company would fall under the head 'Income' from other sources under Section 56(1) of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 91
  92. 92. h) Sec. 4 of the Act is the charging Section which provides that the charge will be in respect of the total Income for the Assessment Year. The scope of total Income is defined in Sec. 5 of the Act to include all Income from whatever source which is received or accrues or arises or deemed to be received, accrued or arisen would be a part of the total Income. Therefore, the word 'Income' for purposes of Chapter X of the Act is to be given a widest meaning to be deemed to be income arising, for the purposes of total income in Sec. 5 of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 92
  93. 93. Rejoinder of the Taxpayer (Petitioner) Sec. 92(2) of the Act will have no application in the present facts as it deals with costs or expenditure allocated or apportioned between two or more AE. The objective of Sec. 92(2) of the Act is only to ensure that profits are not understated, nor losses over-stated, by disclosing higher cost or expenditure, than the benefit received. Therefore, Sec. 92(2) of the Act has no application to the present facts. Vodafone – Second Writ Petition (No. 871 of 2014) 93
  94. 94. 94 Writ Petition (No. 871 of 2014) to Bombay High Court Order dated 10th October 2014 of High Court
  95. 95. Order of the High Court The High Court began by setting out the following relevant Statutory Provisions: Sec. 2 (24) – Definition of “Income” Sec. 56 (1) – Income from Other Sources Sec. 56 (1) (viib) – Taxation of excess consideration - consideration in excess of fair market value of shares - received by a Company on issue of shares to residents Vodafone – Second Writ Petition (No. 871 of 2014) 95
  96. 96. Order of the High Court The High Court began by setting out the following relevant Statutory Provisions: Sec. 92 (1) – Any income arising from an International Transaction shall be computed having regard to the Arm’s Length Price. Sec. 92 (2) – The cost or expense allocated or apportioned or contributed by an enterprise under a Cost Sharing Arrangement (CSA) or a Cost Contribution Arrangement (CCA) shall be determined having regard to the Arm’s Length Price of the benefit, service or facility received under the CSA or CCA. Vodafone – Second Writ Petition (No. 871 of 2014) 96
  97. 97. Order of the High Court The High Court began by setting out the following relevant Statutory Provisions: Sec. 92B – Definition of “International Transaction”. Sec. 92 (f)(i) – Definition of “ Arm’s Length Price” Vodafone – Second Writ Petition (No. 871 of 2014) 97
  98. 98. Order of the High Court – purpose of Chapter X (Transfer Pricing Regulations) The High Court noted the following purpose for which Chapter X (Transfer Pricing Regulations) was introduced in the Act: The aim of Transfer Pricing Regulations enshrined in Chapter X is to have well defined rules to tax transactions between Associated Enterprises, and not leave it to the discretion of the AO, and bring out uniformity in treatment to tax of International Transaction between AEs. Vodafone – Second Writ Petition (No. 871 of 2014) 98
  99. 99. Order of the High Court – purpose of Chapter X (Transfer Pricing Regulations) The Explanatory Notes to the Finance Act, 2001 brings out the objectives as indicated in Circular No.14 of 2001. Those objectives are mentioned below: Chapter X of the Act now existing was to ensure that qua International Transaction between AEs, the profits are not understated nor losses overstated by abuse of either showing lesser consideration or higher expenses between AEs than would be the consideration between two independent entities, uninfluenced by relationship. Vodafone – Second Writ Petition (No. 871 of 2014) 99
  100. 100. Order of the High Court – purpose of Chapter X (Transfer Pricing Regulations) The Explanatory Notes to the Finance Act, 2001 brings out the objectives as indicated in Circular No.14 of 2001. Those objectives are mentioned below: Chapter X did not replace the concept of Income or Expenditure as normally understood in the Act for the purposes of Chapter X of the Act. The objective of Chapter X of the Act is certainly not to punish Multinational Enterprises and/or AEs from doing business inter se. Vodafone – Second Writ Petition (No. 871 of 2014) 100
  101. 101. Order of the High Court – statute has to be construed strictly on basis of what is stated in the Act Having noted the purpose and objective of Transfer Pricing Regulations enshrined in Chapter X of the Act, the High Court then observed that in fiscal statutes, whatever may be the intent of the Parliament, the Courts have to construe the statute strictly on the basis of what is stated in the Act. [Oft quoted Passage of Rowlatt J. and Sales Tax Commissioner vs Modi Sugar Mills, AIR 1961 Page 1047] Vodafone – Second Writ Petition (No. 871 of 2014) 101
  102. 102. Findings of the High Court Vodafone – Second Writ Petition (No. 871 of 2014) 102
  103. 103. Order of the High Court – findings of the High Court I. On Statutory Provisions II. On Revenue’s Contentions - A III. On submissions of Solicitor General – New Grounds raised for the first time during hearing before the High Court IV. On Taxpayer’s Contentions V. On Revenue’s Contentions - B Vodafone – Second Writ Petition (No. 871 of 2014) 103
  104. 104. I. Findings of the High Court On Statutory Provisions Vodafone – Second Writ Petition (No. 871 of 2014) 104
  105. 105. Findings of the High Court – on Statutory Provisions A plain reading of Sec. 92 (1) of the Act very clearly brings out that income arising from a International Transaction is a condition precedent for application of Chapter X of the Act. The word income for the purpose of the Act has a well understood meaning as defined in Sec. 2 (24) of the Act. This is true even when the definition of “Income” in Sec. 2 (24) is an inclusive definition. Vodafone – Second Writ Petition (No. 871 of 2014) 105
  106. 106. Findings of the High Court – on Statutory Provisions It cannot be disputed that income will not, in its normal meaning, include capital receipts, unless it is so specified, as in clause (vi) of Sec. 2 (24). In such a case – where clause (vi) of Sec. 2 (24) applies - Capital Gains chargeable to tax under Section 45 of the Act, are defined to be income. The amounts received on issue of share capital including the premium is undoubtedly on capital account. Vodafone – Second Writ Petition (No. 871 of 2014) 106
  107. 107. Findings of the High Court – on Statutory Provisions Share premium has been made taxable by a legal fiction under Section 56(2)(viib) of the Act and the same is enumerated as Income in Section 2(24)(xvi) of the Act. However, what is bought into the ambit of income is the premium received from a resident in excess of the fair market value of the shares. In this case what is being sought to be taxed is capital not received from a non-resident i.e. premium allegedly not received on application of ALP. Vodafone – Second Writ Petition (No. 871 of 2014) 107
  108. 108. Findings of the High Court – on Statutory Provisions Absent express legislation, no amount received, accrued or arising on capital account transaction can be subjected to tax as Income. This is settled by the decision of this Court in Cadell Weaving Mill Co. vs. CIT 249 ITR 265, which was upheld by the Apex Court in CIT vs. D.P. Sandu Bros. Chember (P) Ltd. 273 ITR 1. Vodafone – Second Writ Petition (No. 871 of 2014) 108
  109. 109. Findings of the High Court – on Statutory Provisions We find considerable substance in the Petitioner's case that neither the capital receipts received by the Petitioner on issue of equity shares to its holding company (a non-resident entity), 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, within the meaning of the expression as defined under the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 109
  110. 110. II. Findings of the High Court on Revenue’s Contentions - A Vodafone – Second Writ Petition (No. 871 of 2014) 110
  111. 111. Findings of the High Court – on Revenue’s Contentions The first contention on behalf of the revenue is that no question of even examining the issue of jurisdiction to apply Chapter X of the Act arises in this case, as the Petitioner itself had filed Form 3CEB for purposes of Chapter X of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 111
  112. 112. Findings of the High Court – on Revenue’s Contentions The contention is rejected. The Taxpayer had submitted Form 3CEB by way of abundant caution and had informed the Respondent-Revenue about the International Transaction of issue of share capital, while denying that any income arises from the International Transaction. After accepting the above defence of the Taxpayer, this Court in Writ Petition No. 1877 of 2013, by its order dated 29 November 2013, concluded that the issue, of jurisdiction of income arising, is a condition precedent for applicability of Section 92(1) of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 112
  113. 113. Findings of the High Court – on Revenue’s Contentions Sec. 92 of the Act provides for computation of income from International Taxation having regard to ALP. Sec. 92 (1) of the Act states that while determining /computing/assessing income from an International Taxation regard shall be had to ALP. Vodafone – Second Writ Petition (No. 871 of 2014) 113
  114. 114. Findings of the High Court – on Revenue’s Contentions The DRP’s Order seeks to widen the meaning of the word “Income” to include all incomings. This is sought to be supported by the intent/object of Chapter X of the Act, particularly the definition of International Transaction given in Sec. 92B of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 114
  115. 115. Findings of the High Court – on Revenue’s Contentions The DRP’s Order in support of interpretation on the basis of purpose/intent of the legislation relies upon the decision of the Supreme Court in Maulai Hussain Haji Abrahim Vs. State of Gujarat and ors. 2004 AIR (SC) 3946 rendered in the context of Prevention of Terrorist Activities Act 2002 (POTA). Vodafone – Second Writ Petition (No. 871 of 2014) 115
  116. 116. Findings of the High Court – on Revenue’s Contentions The transaction of issue of shares by the Petitioner company to its holding company has nothing to do even remotely with terrorism. In fact, while interpreting a fiscal/taxing statute, the intent or purpose is irrelevant and the words of the taxing statute have to be interpreted strictly. Vodafone – Second Writ Petition (No. 871 of 2014) 116
  117. 117. Findings of the High Court – on Revenue’s Contentions In case of taxing statutes, in the absence of the provision by itself being susceptible to two or more meanings, it is not permissible to forgo the strict rules of interpretation while construing it. Vodafone – Second Writ Petition (No. 871 of 2014) 117
  118. 118. Findings of the High Court – on Revenue’s Contentions The intention of the legislature in a taxation statute is to be gathered from the language of the provisions particularly where the language is plain and unambiguous. In a taxing Act it is not possible to assume any intention or governing purpose of the statute more that what is stated in the plain language. Words cannot be added to or substituted so as to give a meaning to the statute which will serve the spirit and intention of the legislature. [Mathuram Agarwal Vs. State of M.P. 1999(8) SCC 667] Vodafone – Second Writ Petition (No. 871 of 2014) 118
  119. 119. Findings of the High Court – on Revenue’s Contentions In view of the above, it is clear that it was not open to DRP to seek aid of the supposed intent of the Legislature to give a wider meaning to the word “Income”. Vodafone – Second Writ Petition (No. 871 of 2014) 119
  120. 120. Findings of the High Court – on Revenue’s Contentions The reliance by the revenue upon the definition of International Taxation in the sub clause (c) and (e) of Explanation (i) to Sec. 92B of the Act, to conclude that Income has to be given a broader meaning to include notional income, as otherwise Chapter X of the Act would be rendered otiose, is far fetched. Vodafone – Second Writ Petition (No. 871 of 2014) 120
  121. 121. Findings of the High Court – on Revenue’s Contentions The issue of shares at a premium does not exhaust the universe of applicability of Chapter X of the Act. There are transactions which would otherwise qualify to be covered by the definition of International Transaction. The transaction on capital account or on account of restructuring would become taxable to the extent it impacts income i.e. under reporting of interest or over reporting of interest paid or claiming of depreciation etc. Vodafone – Second Writ Petition (No. 871 of 2014) 121
  122. 122. Findings of the High Court – on Revenue’s Contentions It is that income (as mentioned in the previous Slide) which is to be adjusted to the ALP price. It is not a tax on the capital receipts. This aspect appears to have been completely lost sight of in the impugned order of DRP. Vodafone – Second Writ Petition (No. 871 of 2014) 122
  123. 123. Findings of the High Court – on Revenue’s Contentions The other basis in the impugned order is that as a consequence of under valuation of shares, there is an impact on potential income. The reasoning is that if the ALP were received, the Petitioner would be able to invest the same and earn income, proceeds on a mere surmise/assumption. This cannot be the basis of taxation. Vodafone – Second Writ Petition (No. 871 of 2014) 123
  124. 124. Findings of the High Court – on Revenue’s Contentions In any case, the entire exercise of charging to tax the amounts allegedly not received as share premium fails, as no tax is being charged on the amount received as share premium. Chapter X is invoked to ensure that the transaction is charged to tax only on working out the income after arriving at the ALP of the transaction. This is only to ensure that there is no manipulation of prices/consideration between AEs. The entire consideration received would not be a subject-matter of taxation. Vodafone – Second Writ Petition (No. 871 of 2014) 124
  125. 125. Findings of the High Court – on Revenue’s Contentions It appears for the above reason that the learned Solicitor General did not seek to defend the conclusion in the impugned order on the basis of the reasons found therein, but sought to support the conclusion with new reasons/grounds. Vodafone – Second Writ Petition (No. 871 of 2014) 125
  126. 126. III. Findings of the High Court on submissions of Solicitor General (New Grounds raised) Vodafone – Second Writ Petition (No. 871 of 2014) 126
  127. 127. Findings of the High Court – on submissions of Solicitor General The learned Solicitor General submitted that Sec. 92 (1) has to be read with Sec. 92 (2) of the Act - a conjoint reading would indicate that what is taxed is the cost incurred in passing on the benefit to the holding company. The share premium, not received, is not subjected to tax by the Revenue. The difference between the ALP and the price charged for issue of shares is the benefit conferred upon the holding company. Thus passing of benefit to holding company, is the cost to the Petitioner, which is being brought to tax. Vodafone – Second Writ Petition (No. 871 of 2014) 127
  128. 128. Findings of the High Court – on submissions of Solicitor General In support the learned Solicitor General wanted the High Court to read Sec. 92(2) of the Act by omitting certain words in the Section. According to the High Court, this indeed is a unique way of reading a provision i.e. to omit words in the Section. This manner of reading a provision by ignoring/rejecting certain words without any finding that in the absence of so rejecting, the provision would become unworkable, is certainly not a permitted mode of interpretation. Vodafone – Second Writ Petition (No. 871 of 2014) 128
  129. 129. Findings of the High Court – on submissions of Solicitor General It would lead to burial of the settled legal position that a provision should be read as a whole, without rejecting and/or adding words thereto. This rejecting of words in a statute to achieve a predetermined objective is not permissible. This would amount to redrafting the legislation which is beyond/outside the jurisdiction of Courts. Vodafone – Second Writ Petition (No. 871 of 2014) 129
  130. 130. Findings of the High Court – on submissions of Solicitor General Be that as it may, Section 92(2) of the Act deals with a situation where two or more AE's enter into an arrangement whereby they are to receive any benefit, service or facility then the allocation, apportionment or contribution towards the cost or expenditure is to be determined in respect of each AE having regard to ALP. Vodafone – Second Writ Petition (No. 871 of 2014) 130
  131. 131. Findings of the High Court – on submissions of Solicitor General Thus, to illustrate, the cost of research carried on by an AE for the benefit of three AE's, then the cost will be distributed i.e. allocated, apportioned or contributed depending upon the ALP of such benefit to be received by the assessed AE. It would have no application in the cases like the present one, where there is no occasion to allocate, apportion or contribute any cost and/or expenses between the Petitioner and the holding company. Vodafone – Second Writ Petition (No. 871 of 2014) 131
  132. 132. Findings of the High Court – on submissions of Solicitor General The learned Solicitor General next contended that the issue is no long res intergra as the issue stands covered by the decision of the Apex Court in Mazgaon Dock Ltd. (supra) while interpreting Sec. 42 (2) of 1922 Act. It is submitted that the above Sec. 42 (2) of the 1922 Act dealt with transfer pricing. Vodafone – Second Writ Petition (No. 871 of 2014) 132
  133. 133. Findings of the High Court – on submissions of Solicitor General In the above case, the Apex Court held that under Section 42(2) of the 1922 Act, the tax is charged on the resident in respect of profits which he would have normally made but not made, because of a business association with a non resident. The resident was subjected to tax on notional profits in respect of its business dealing with a non resident with whom he had close connection. Vodafone – Second Writ Petition (No. 871 of 2014) 133
  134. 134. Findings of the High Court – on submissions of Solicitor General If the provision of Sec. 42 (2) of the 1922 Act is contrasted with the provisions of Chapter X of the Act, and in particular Section 92 thereof, it would be noticed that the crucial words “shall be chargeable to income tax” which are found in Section 42(2) of the 1922 Act are absent in Chapter X of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 134
  135. 135. Findings of the High Court – on submissions of Solicitor General The High Court pointed out this difference in the two provisions to the learned Solicitor General and he agreed that the above difference exists. However, according to him this was in view of the fact that Sections 4, 5, 14 and 56 of the Act does create a charge to income tax on deemed income earned from International taxation. Therefore, it is clear that the deemed income which was charged to tax under Section 42(2) of the 1922 Act was done away with under the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 135
  136. 136. Findings of the High Court – on submissions of Solicitor General The charge of Income now has to be found in Section 4 of the Act. If it is income which is chargeable to tax, under the normal provision of the Act, then alone Chapter X of the Act could be invoked. Sections 4 and 5 of the Act brings /charges to tax total income of the previous year. Vodafone – Second Writ Petition (No. 871 of 2014) 136
  137. 137. Findings of the High Court – on submissions of Solicitor General This would take us to the meaning of the word income under the Act as defined in Section 2(24) of the Act. The amounts received on issue of shares is admittedly a capital account transaction, not separately brought within the definition of Income, except in cases covered by Section 56(2) (viib) of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 137
  138. 138. Findings of the High Court – on submissions of Solicitor General Thus such capital account transaction, not falling within a statutory exception, cannot be brought to tax, as already discussed herein above, while considering the challenge to the grounds as mentioned in the impugned order. Vodafone – Second Writ Petition (No. 871 of 2014) 138
  139. 139. Findings of the High Court – on submissions of Solicitor General In tax jurisprudence, it is well settled that following four factors are essential ingredients to a taxing statute:- (a) subject of tax; (b) person liable to pay the tax; (c) rate at which tax is to be paid, and (d) measure or value on which the rate is to be applied. Vodafone – Second Writ Petition (No. 871 of 2014) 139
  140. 140. Findings of the High Court – on submissions of Solicitor General There is difference between a charge to tax and the measure of tax (a) & (d) above. This distinction is brought out by the Supreme Court in Bombay Tyres India Ltd. Vs. Union of India reported in 1984 (1) SCC 467 wherein it was held that the charge of excise duty is on manufacture while the measure of the tax is the selling price of the manufactured goods. Vodafone – Second Writ Petition (No. 871 of 2014) 140
  141. 141. Findings of the High Court – on submissions of Solicitor General In this case also the charge is on income as understood in the Act, and where income arises from an International Transaction, then the measure is to be found on application of ALP so far Chapter X of the Act is concerned. The arriving at the transactional value/ consideration on the basis of ALP does not convert non-income into income. Vodafone – Second Writ Petition (No. 871 of 2014) 141
  142. 142. Findings of the High Court – on submissions of Solicitor General The tax can be charged only on income; in the absence of any income arising, the issue of applying the measure of ALP to transactional value/consideration itself does not arise. The ingredient (a) above is not satisfied i.e. subject of tax is ‘income which is chargeable to tax’. The issue of shares at a premium is a capital account transaction and not income. Vodafone – Second Writ Petition (No. 871 of 2014) 142
  143. 143. Findings of the High Court – on submissions of Solicitor General It was contended by the Revenue that in view of Chapter X of the Act, the notional income is to be brought to tax and real income will have no place. The entire exercise of determining the ALP is only to arrive at the real income earned i.e. the correct price of the transaction, shorn of the price arrived at between the parties on account of their relationship viz. AEs. Vodafone – Second Writ Petition (No. 871 of 2014) 143
  144. 144. Findings of the High Court – on submissions of Solicitor General In this case, the revenue seems to be confusing the measure to a charge and calling the measure a notional income. We find that there is absence of any charge in the Act, to subject issue of shares at a premium to tax. Vodafone – Second Writ Petition (No. 871 of 2014) 144
  145. 145. IV. Findings of the High Court on Taxpayer’s Contentions Vodafone – Second Writ Petition (No. 871 of 2014) 145
  146. 146. Findings of the High Court – on Taxpayer’s Contentions The High Court also found merit in the submission on behalf of the petitioners that w.e.f. 1 April 2013, the definition of income under Section 2(24)(xvi) of the Act includes within its scope the provisions of Section 56(2) (vii-b) of the Act. This indicates the intent of the Parliament to tax issue of shares to a resident, when the issue price is above its fair market value. Vodafone – Second Writ Petition (No. 871 of 2014) 146
  147. 147. Findings of the High Court – on Taxpayer’s Contentions In the instant case, the Revenue's case is that the issue price of equity share is below the fair market value of the shares issued to a non-resident. Thus Parliament has consciously not brought to tax amounts received from a non-resident for issue of shares, as it would discourage capital inflow from abroad. The revenue has not been able to meet the above submission but have in their written submission only submitted that the above provisions would have no application to the present facts. Vodafone – Second Writ Petition (No. 871 of 2014) 147
  148. 148. V. Findings of the High Court on Revenue’s Contentions - B Vodafone – Second Writ Petition (No. 871 of 2014) 148
  149. 149. Findings of the High Court – on Revenue’s Contentions It was contended by the Revenue that in any event the charge would be found in Section 56(1) of the Act. Section 56 of the Act does provide that income of every kind which is not excluded from the total income is chargeable under the head income from other sources. However, before Section 56 of the Act can be applied, there must be income which arises. Vodafone – Second Writ Petition (No. 871 of 2014) 149
  150. 150. Findings of the High Court – on Revenue’s Contentions As pointed out above, the issue of shares at a premium is on Capital Account and it gives rise to no income. The submission on behalf of the revenue that the shortfall in the ALP as computed for the purposes of Chapter X of the Act gives rise to income is misplaced. The ALP is meant to determine the real value of the transaction entered into between AEs. Vodafone – Second Writ Petition (No. 871 of 2014) 150
  151. 151. Findings of the High Court – on Revenue’s Contentions Determination of ALP is a re-computation exercise to be carried out only when income arises in case of an International transaction between AEs. It does not warrant re-computation of a consideration received /given on capital account. It permits re-computation of Income arising out of a Capital Account Transaction, such as interest paid/received on loans taken/given, depreciation taken on machinery etc. All the above would be cases of income being affected due to a transaction on capital account. Vodafone – Second Writ Petition (No. 871 of 2014) 151
  152. 152. Findings of the High Court – on Revenue’s Contentions This is not the revenue's case here. Therefore, although Section 56(1) of the Act would permit including within its head, all income not otherwise excluded, it does not provide for a charge to tax on Capital Account Transaction of issue of shares as is specifically provided for in Section 45 or Section 56(2)(viib) of the Act and included within the definition of income in Section 2(24) of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 152
  153. 153. Findings of the High Court – on Revenue’s Contentions It was contended by the revenue that income becomes taxable no sooner it accrues or arises or when it is deemed to accrue or arise and not only when it was received. It is submitted that even though the Petitioner did not receive the ALP value/ consideration for the issue of its shares to its holding company, the difference between the ALP and the contract price is an income, as it arises even if not received and the same must be subjected to tax. Vodafone – Second Writ Petition (No. 871 of 2014) 153
  154. 154. Findings of the High Court – on Revenue’s Contentions There can be no dispute with the proposition that income under the Act is taxable when it accrues or arises or is received or when it is deemed to accrue, arise or received. The charge- ability to tax is when right to receive an income becomes vested in the assessee. However, the issue under consideration is different viz: whether the amount said to accrue, arise or receive is at all income. The issue of shares to the holding company is a capital account transaction, therefore, has nothing to do with income. Vodafone – Second Writ Petition (No. 871 of 2014) 154
  155. 155. Findings of the High Court – on Revenue’s Contentions It was also contended that Chapter X of the Act is a complete code by itself and not merely a machinery provision to compute the ALP. It is a hidden benefit of the transaction which is being charged to tax and the charging Section is inherent in Chapter X of the Act. It is well settled position in law that a charge to tax must be found specifically mentioned in the Act. In the absence of there being a charging Section in Chapter X of the Act, it is not possible to read a charging provision into Chapter X of the Act. Vodafone – Second Writ Petition (No. 871 of 2014) 155
  156. 156. Findings of the High Court – on Revenue’s Contentions The High Court noted: We can do no better than refer to the following observations of the five Member Bench of the Apex Court in CIT vs Vatika Township P Ltd 367 ITR 466:- “Tax laws are clearly in derogation of personal rights and property interests and are, therefore, subject to strict construction, and any ambiguity must be resolved against imposition of the tax… in statutes levying taxes, the literal meaning of the words employed is most important, for such statutes are not to be extended by implication beyond the clear import of the language used. If the words are doubtful, the doubt must be resolved against the Government and in favour of the taxpayer…” Vodafone – Second Writ Petition (No. 871 of 2014) 156
  157. 157. Findings of the High Court – on Revenue’s Contentions In this case, we are not in the zone of uncertainty referred to above. There is no charge express or implied, in letter or in spirit to tax issue of shares at a premium as income. Vodafone – Second Writ Petition (No. 871 of 2014) 157
  158. 158. Findings of the High Court – on Revenue’s Contentions Chapter X of the Act is a machinery provision to arrive at the ALP of a transaction between AEs. The substantive charging provisions are found in Sections 4, 5, 15 (Salaries), 22 (Income from house property), 28 (Profits and gains of business), 45 (Capital gain) and 56 (Income from other Sources). Even Income arising from International Transaction between AEs must satisfy the test of Income under the Act and must find its home in one of the above heads i.e. charging provisions. This the revenue has not been able to show. Vodafone – Second Writ Petition (No. 871 of 2014) 158
  159. 159. Findings of the High Court – on Revenue’s Contentions It was next submitted that the machinery Section of the Act cannot be read de-hors charging Section. The Act has to be read as an integrated whole. On the aforesaid submission also, there can be no dispute. However, as observed by the Supreme Court in CIT vs B. C. Srinivasa Shetty 128 ITR 294, “there is a qualitative difference between the charging provisions and computation provisions and ordinarily the operation of the charging provisions cannot be affected by the construction of computation provisions.” Vodafone – Second Writ Petition (No. 871 of 2014) 159
  160. 160. Findings of the High Court – on Revenue’s Contentions In the present case, there is no charging provision to tax capital account transaction in respect of issue of shares at a premium. Computation provisions cannot replace/ substitute the charging provisions. Vodafone – Second Writ Petition (No. 871 of 2014) 160
  161. 161. Findings of the High Court – on Revenue’s Contentions In fact, in B. C. Srinivasa Shetty (supra), there was charging provision but the computation provision failed and in such a case the Court held that the transaction cannot be brought to tax. The present facts are on a higher pedestal as there is no charging provision to tax issue of shares at premium to a non- resident, then the occasion to invoke the computation provisions does not arise. Vodafone – Second Writ Petition (No. 871 of 2014) 161
  162. 162. Findings of the High Court – on Revenue’s Contentions In course of the hearing the learned Solicitor General also made submissions with regard to taxing income in the hands of the Petitioner even though the income has allegedly been earned by the holding company. None of the notices issued to the Petitioner on the draft order passed by AO on the impugned order passed by DRP even proposes to assess the Petitioner in its representative capacity. Hence, the Petitioner had no occasion to challenge the jurisdiction of the Revenue on the above aspect. Therefore, there is no reason to examine the issue. Vodafone – Second Writ Petition (No. 871 of 2014) 162
  163. 163. Findings of the High Court – on Revenue’s Contentions In its written submissions, the revenue has raised an issue of alternative remedy which was not raised at the hearing and contended that there is no patent illegality in the impugned order warranting interference by this Court. However, the very fact that at the time of oral submissions, the Revenue supported the conclusions in the impugned order on grounds different from those mentioned therein would itself speak volumes of the patent non-sustainability of the impugned order. The preliminary objection, not raised at the hearing, is, completely devoid of any substance. Vodafone – Second Writ Petition (No. 871 of 2014) 163
  164. 164. Final Order of the High Court Vodafone – Second Writ Petition (No. 871 of 2014) 164
  165. 165. Final Order of the High Court In the present facts issue of shares at a premium by the Petitioner to its non-resident holding company does not give rise to any income from an admitted International Transaction. Thus, no occasion to apply Chapter X of the Act can arise in such a case. Vodafone – Second Writ Petition (No. 871 of 2014) 165
  166. 166. Final Order of the High Court Petition is allowed in terms of the above finding and the following orders are quashed and set aside as being without jurisdiction, null and void:- (i) Reference dated 11 July 2011 by the AO to TPO to determine the ALP of issue of shares at a premium by the petitioner to its holding company which is a non-resident entity; (ii) Order dated 28 January 2013 of the TPO; Vodafone – Second Writ Petition (No. 871 of 2014) 166
  167. 167. Final Order of the High Court (iii) Draft Assessment Order dated 22 March 2013 passed by AO under section 143 read with section 144C(1) of the Act; and (iv) Order dated 11 February 2014 of DRP on the preliminary issue of jurisdiction to tax issues of shares at a premium to its holding company. Vodafone – Second Writ Petition (No. 871 of 2014) 167
  168. 168. 168 Way Forward – Implication of the High Court’s Verdict How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders?
  169. 169. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? Unless the Bombay High Court’s Order is overruled by the Supreme Court, we may follow its decision to report – for purposes of Transfer Pricing - the issue of shares by an Indian Company to Non- Resident Shareholders. Way Forward – Implication of the High Court’s Verdict 169
  170. 170. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? As the High Court has ruled, the issue of shares and resulting receipt of consideration or premium is beyond the scope of Transfer Pricing Regulations enshrined in Chapter X of the Act. Therefore, the issue of shares to Non-Residents will have to be valued and priced as per rules prescribed under FEMA. Arm’s length pricing of shares under the Transfer Pricing Regulations (Chapter X of the Act) is not required. Way Forward – Implication of the High Court’s Verdict 170
  171. 171. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? Form 3 CEB in Column No. 16 requires the Accountant to report ‘any international transaction(s) entered into by an assessee in respect of purchase or sale of marketable securities or issue of equity shares.’ Way Forward – Implication of the High Court’s Verdict 171
  172. 172. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? Here, it must be noted that the High Court has not given any finding on the issue ‘Whether the issue of shares by an Indian Company to a Non-Resident Holding Company is, or is not, an International Transaction?’ Way Forward – Implication of the High Court’s Verdict 172
  173. 173. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? The High Court has held that no income arises out of issue of shares by an Indian Company to a Non-Resident Holding Company. And, therefore, the Transfer Pricing Regulations are not applicable to the issue of shares. The High Court has clearly held that no occasion to apply Chapter X of the Act can arise in a case of issue of shares by an Indian Company to its Non-Resident Holding Company. Way Forward – Implication of the High Court’s Verdict 173
  174. 174. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? Further, the High Court has quashed and set aside interalia the following orders as being without jurisdiction, null and void:-  Reference by the AO to TPO to determine the ALP of issue of shares  Order passed by the TPO  Draft Assessment Order passed by the AO under section 143 read with section 144C(1) of the Act Way Forward – Implication of the High Court’s Verdict 174
  175. 175. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? So, we may fairly infer that the provisions of Chapter X - including Sec. 92B (International Transaction) and Sec. 92E (Accountant’s Report) - do not apply to the transaction of issue of shares. Way Forward – Implication of the High Court’s Verdict 175
  176. 176. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? Based on such inference we may place a Note as under in Column No. 16 of Form 3 CEB regarding the issue of shares to non- residents: “During the year, the Assessee has issued…number of shares to…SH (name of the shareholder). The Assessee and SH are Associated Enterprises. But, this transaction does not fall within the scope of Chapter X of the Act, as held by the Hon. Bombay High Court in the case of Vodafone India Services Pvt Ltd (citation). Therefore, no specific particulars regarding the issue of shares are reported here.” Way Forward – Implication of the High Court’s Verdict 176
  177. 177. How to, henceforth, report issue of shares by an Indian Company to Non-Resident Shareholders? In future, our stand and reporting will ultimately depend on the Verdict of Supreme Court, because the Revenue will surely challenge the Order of the Bombay High Court before the Supreme Court. Way Forward – Implication of the High Court’s Verdict 177
  178. 178. Website: www.taxwize.in For any queries related to this Analysis you may Contact Nilesh Patel – CPA (USA), IRS (Former) at the Email ID: Nilesh@taxwize.in Contact
  179. 179. Thank You Vodafone India – Order of Bombay High Court on issue of Shares

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