In the past few years we have seen an exponential increase in tax controversy, especially transfer pricing disputes. Deviating significantly from precedence, in the TP audits concluded in January 2013 the officers recommended adjustments to transactions that have no bearing on the taxable profits of the taxpayer. The applicability of TP provisions on the cross-border equity share capital infusion by a foreign associated enterprise in its Indian subsidiary does not have any element of income or expense, and hence has no impact on the taxable profits.

One such adjustment was faced by Vodafone India Services Pvt Ltd in the issue of additional equity shares to its foreign shareholder. The company had reported it as an “international transaction” on a cautionary basis in Form 3 CEB (TP certificate), with the primary claim that TP provisions didn’t apply as there was no income arising in the hands of the company. However, following proceedings by the assessing officer (AO), including reference to the transfer pricing officer (TPO), the arm’s length nature of the issue price was disputed. The arm’s length price was held to be significantly higher than the issue price and an upward adjustment was made to the extent of Rs 1,397 crore in the hands of the company, resulting in a tax demand exceeding Rs 400 crore.

After receiving the draft assessment order from the AO, the company filed a writ petition before the Bombay High Court, challenging the jurisdiction of the TPO/AO to make the TP adjustment. On the merits of the adjustment, the company filed objections before the Dispute Resolution Panel (DRP).

On November 29, 2013, the Bombay High Court disposed of the writ petition challenging the jurisdictional issue. It asked the company to approach the DRP, which has powers to adjudicate on the matter. The court held that as the AO had not passed any final assessment order and the issues at large were pending before the DRP, the jurisdiction issue too could be agitated before it. The court directed the company to file its objection on the jurisdictional issue before the DRP within two weeks and the DRP had to decide within two months. Further, the court said that if the outcome of the DRP decision is patently illegal, the company could approach the court, without waiting for re-course to the Income Tax Appellate Tribunal (ITAT).

The court observed that there should be an income arising and/or affected or potentially arising and/or affected by an international transaction for the application of TP provisions. It also observed that this is in the nature of jurisdictional requirement and the AO must be satisfied that there is an income or potential for income arising or being affected on determination of the ALP before proceeding with it or referring it to the TPO. The court further held that the AO should deal with the jurisdictional issue where specifically raised by the taxpayer, and the taxpayer should be given a hearing before referring to the TPO.

The court’s views seem to hint that TP provisions should not be applicable on transactions that are in the nature of capital receipt and do not have a bearing on the taxable income of the taxpayer. As the transaction involved capital received by a taxpayer from its shareholder that does not have a bearing on its income, TP provisions should not apply, as the determination of ALP would then be merely an academic exercise.

In the past, the Authority for Advance Rulings held similar views related to non-applicability of TP provisions in a few judicial pronouncements where the AAR held that in the absence of any income chargeable to tax in India, TP provisions don’t apply. Subsequently, there was one stray case (Castleton Investments Ltd) in which the AAR took the view that arm’s length price should be determined even if the transaction had no bearing on taxable profits.

The taxpayer community, in general, has been severely hit by the adjustment made to capital transactions and was hoping that the High Court would settle the issue completely. However, the wait for resolution has got longer. The Government has to intervene to reassure foreign investors. The onus is on the Finance Ministry and the DRP to work out a solution that minimises the damage done by the adjustments on share capital transactions.

Sumit Khadria, Associate Director — Tax and Regulatory Services, contributed to the article.

The author is Partner and National Leader — Transfer Pricing, EY

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