By Jayesh Gupta
Edited by Madhavi Roy, Senior Editor, The Indian Economist
It is due to the veil of economic jargon that the masses today are unaware of the significant loss of government revenue and abrogation of investment prospects in India. Similar is the case with transfer pricing disputes. Here I intend to simplify this dispute. Further, I also intend to throw some light on a recent judgment by the Bombay HC and it’s after effects.
Transfer price refers to the actual price at which a transaction takes place between two related parties, usually belonging to the same group. In the present case of Vodafone, this dispute arises through an indirect transfer of share and control of Hutchison Essar Limited. In February 2007, Vodafone International Holdings B.V (Vodafone or VIH), a Dutch entity, had acquired 100 percent shares in CGP (Holdings) Ltd. (CGP), a Cayman Island company, for $11.1 billion from Hutchison Telecommunications International Limited (HTIL). CGP, through various intermediate companies/contractual arrangements controlled 67 percent of Hutchison Essar Limited (HEL), an Indian company. Thus, this acquisition resulted in Vodafone acquiring control over CGP and its downstream subsidiaries, including HEL.
The bone of contention revolved around section 9 (1) (I) of the income tax Act. As per the section, inter alia, income accruing/arising directly or indirectly through transfer of a capital asset situated in India is deemed to accrue/arise in India in the hands of a nonresident, hence can be taxed. Thus began the litigation by filing of a ₹ 20,000 crore claim by the Income Tax Department at the Bombay HC. The HC holds that prima facie, the transaction was one of transfer of a capital asset situated in India, hence the Indian Income Tax Department had jurisdiction over the matter. However, in an SLP (Special Leave Petition) filed by Vodafone, the SC held a contrary viewpoint. It emphasized the existence of three elements in charge of capital gains under Section 9 (1) (I). These three elements are transfer, existence of a capital asset and situation of such asset in India. It further stated that the legislature has not used the words “indirect transfer” in section 9 (1) (I) and even if it was used, it would then render the phrase “capital asset situated in India” nugatory. Further, it iterated that section 9 (1) (I) does not have a “look through” provision and therefore cannot be extended to cover indirect transfer of capital asset/property situated in India. The judgment was emboldened by a DTC bill, 2010, which indicates that indirect transfers are not covered by section 9 (1) (I), hence the transfer of shares in CGP did not result in the transfer of a capital asset situated in India.
The judgment and argument seemed plausible since it also suggested that “substance over form” and the principle of “piercing the corporate veil” test should be applied after it is established on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidance. Further the judgment indicates a view that the transfer of share holdings in CGP, on the facts, didn’t fall out of artificial tax avoidance scheme, but was a genuine commercial decision to exit from the Indian telecom sector.
The whole transfer pricing dispute seems to center around two contradictory opinions. One opinion which suggests that transactions of a similar nature are a sham or tax avoidant, hence a need for litigation by the Income Tax Department. The other opinion seems to suggest an unwillingness of private telecommunication firms to establish themselves, given the complex tax regime of our country. The government, in 2012, held a view that it is a loss to the public exchequer and hence a need of legislative measures. Thus the Union Budget, in 2012, proposed to bring a retrospective amendment in the Income Tax Act (which had been in effect since 1962). This amendment made tax deduction at source mandatory for all overseas transactions executed by a resident or non-resident having a business connection in India. Thus began the long talked about international arbitration between GOI and Vodafone.
The recent judgment of the Bombay HC, dated 10th October, 2014, suggests a deviation from the “tax avoidant opinion”. This judgment is for one among many cases fought between Vodafone and the tax authority. The present case is related to rights issued by Vodafone India. The tax authority claims that the share was underpriced, hence giving Vodafone PLC a larger stake in Vodafone India with lesser price and this amounts to a violation of the transfer pricing regulation. The tax authority suggests a higher price per share by using a methodology called “discounted tax flow”, to curb tax avoidance by Vodafone. However the HC held a view that the share premium is not taxable and hence a shortfall in the same cannot be taxed either. This judgment seems to alter the definition of “transfer of share”. The Income Tax Department holds a view that the transfer of shares is transfer of income and hence taxable according to section 9 (1) (I) of the Income Tax act. This definition is altered by the HC judgment to suggest that the transfer of shares is transfer of capital and not income, and thus cannot be taxed. It is this interpretation that can have larger implications for similar cases of the other 26 companies including Nokia, Shell India Markets etc. This could lead to a plausible solution of many transfer pricing disputes. But only given that the judgment, if challenged in SC, sustains its essence.
It seems that the new government is determined to reduce the complexity of the tax regime and particularly transfer pricing. This is further supported by the budget speech given by Mr. Arun Jaitley. It suggests aligning the transfer pricing regulations in India with the best available practices. And the steps suggested include the use of multiple year data and additional use of the range concept to determine the arm’s length price (a transaction where the buyers & sellers of a product act independently and have no relationship with each other, it ensures that both the parties act independently and in their own self-interest, rejecting any duress from another party). Thus the recent HC judgment is an opportunity for the government to reach an amicable solution to past transfer pricing disputes, which would be acceptable to both the parties. A simplified tax regime in the near future will help in avoiding similar litigations and will enhance the investors’ confidence. After all, the positive effect of globalization can only be felt with multiple service providers and minimum cost to the customers. If the precedents set by this government is true, then it seems that a future with investor confidence and minimum tax avoidance is plausible.
Jayesh Gupta is a recent graduate from IIT Mandi (H.P) .He believes in gaining a mélange of experience and has worked at various organizations like CSIR, teri & Maruti Suzuki, only to realize that his real interest lies in foreign affairs. An aspiring diplomat and a budding writer, he enjoys writing on international affairs and India’s position in the world. Due to his prior engagement as President of student’s technical affairs at his college he has a nick for politics and enjoys writing on political and social issues. Contact him at [email protected]