Transfer Pricing – Issue of Shares at a Premium to Non-resident AEs – Whether alleged shortfall in Share premium can be taxed u/s. 92 of the Act

Tele-Services (India) Holdings Limited, wherein total TP adjustment of Rs. 1,397.26 crore was made for the Assessment Year [AY] 2009-10. The assessment order of the AO was challenged in a Writ Petition before the Bombay HC and the Court, after comprehensively dealing with various contentions, vide its order dated 10th October, 2014 decided the issue in favour of the petitioner.

Similarly, a writ petition in the case of Shell India relating to issue of shares by it to its non-resident AE Shell Gas BV, wherein a total TP adjustment of Rs. 15,220 crore has been made for the Assessment Year [AY ] 2009-10, is being heard by the Bombay High Court [HC].

There are about 24 other assessees facing tax demands on similar grounds.

In this Article, we discuss the salient features of the HC’s decision in the case of Vodafone.

Vodafone India Services Pvt. Ltd. vs. UOI (WP No. 871 of 2014, Bombay HC)

Brief Facts
1. The brief facts are as follows:

1. The Vodafone India Services Private Ltd. [Petitioner] issued certain equity shares to its holding company of face value of Rs. 10 each at a premium of Rs. 8,509 per share.

2. The petitioner contended that Fair Market Value [FMV] of the equity shares was Rs. 8,519 as determined in accordance with the prescribed methodology.

3. However, according to the AO and the TPO, the equity shares ought to be valued at NAV of Rs. 53,775 per share. Thus, the consequence of issue of shares by the Petitioner to its holding company at a lower premium resulted in the Petitioner subsidising the price payable by the holding company. This deficit was treated as a deemed loan extended by the petitioner to its holding company and periodical interest thereon is to be charged to tax as its interest income.

Issues involved

2. The main issues raised in the Writ Petition are as follows:

(a) Whether Chapter X of the Income-tax Act, 1961 [the Act] is a separate code by itself and the difference in valuation between ALP and the contract/ transaction price would give rise to income?

(b) Whether “Income” as defined in section 2(24) of the Act is an inclusive definition and it does not prohibit taxing capital receipts as income?

(c) Whether the forgoing of premium on the part of the Petitioner amounts to extinguishment/relinquishment of a right to receive fair market value and therefore, the issue of shares is a transfer within the meaning of section 2(47) of the Act?, and

(d) Whether the meaning of International Transaction as given in clauses (c) and (e) of the Explanation (i) to section 92B of the Act would include within its scope even a capital account transaction?

Petitioner’s Contentions
3. The petitioner contended that:
(a) Chapter X of the Act is a special provisions relating to avoidance of tax. Section 92 of the Act provides for computation of income arising from International Transaction, having regard to ALP. Section 92(1) of the Act which applies to the present facts, directs that any income arising from an International Transaction should be computed, having regard to the ALP. Thus, the sine-qua-non, for application of section 92(1) of the Act is that income should arise from an International Transaction. In this case, it is submitted that no income arises from issue of equity shares by the Petitioner to its holding company;
(b) T he impugned order dated 11th February, 2014 after correctly holding that the word ‘Income’ has not been separately defined for the purpose of Chapter X of the Act, yet proceeds to give its own meaning to the word ‘Income.’ This is clearly not permissible. The word ‘Income’ would have to be understood as defined by other provisions of the Act such as section 2(24) of the Act. A fiscal statute has to be strictly interpreted upon its own terms and the meaning of ordinary words cannot be expanded to give purposeful interpretation;
(c) Chapter X of the Act is not designed to bring 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 the contracted/book value of said transaction but to reach the fair price/consideration. Therefore, before any transaction could be brought to tax, a taxable income must arise. The interpretation in the impugned order to tax any amounts involved in International Transaction tantamount to imposing a penalty for entering into a transaction (no way giving rise to taxable income) at a value which the revenue determines on application of ALP;
(d) T he impugned order itself demonstrates the fact that the share premium on issue of shares is per se not taxable. This is so as the amounts received by the Petitioner on account of share premium has not been taxed and only the amount of share premium which is deemed not to have been received on application of ALP, alone has been brought to tax;
(e) I n case of issue of shares, it comes into existence for the first time only when shares are allotted. It is the creation of the property for first time. This is different from the transfer of an existing property. An issue of shares is a process of creation of shares and not a transfer of shares. Therefore, there is no transfer of shares so as to make Section 45 of the Act applicable. It was submitted that if the contention of the Revenue is correct, then every issue of shares by any Company would be subjected to tax;
(f) The issue of shares by the Petitioner to its holding company and receipt of consideration of the same is a capital receipt under the Act. Capital receipts cannot be brought to tax unless specifically/expressly brought to tax by the Act. It is well settled that capital receipts do not come within the ambit of the word ‘Income’ under the Act, save when so expressly provided as in the case of section 2(24) (vi) of the Act. This brings capital gains chargeable u/s. 45 of the Act, to tax within the meaning of the word ‘Income’;
(g) Attention was drawn to the definition of `Income’ in section 2(24) (xvi) of the Act which includes in its scope amounts received arising or accruing within the provisions of section 56(2)(viib) of the Act. 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 and not the alleged short-fall in the issue price of equity shares. Thus, this also indicates absence of any intent to tax the issue of shares below the alleged fair market value as in this case;
(h) T he impugned order proceeds on an assumption, surmise or conjecture that in case the notional income, i.e., the amount of share premium forgone was received, the Petitioner would have invested the same, giving rise to income. It is submitted that no tax can be charged on guess work or assumption or conjecture in the absence of any such income arising; and
The impugned order itself demonstrates the fact that the share premium on issue of shares is per se not taxable. This is so as the amounts received by the Petitioner on account of share premium has not been taxed and only the amount of share premium which is deemed not to have been received on application of ALP, alone has been brought to tax;

    In case of issue of shares, it comes into existence for the first time only when shares are allotted. It is the creation of the property for first time. This is dif-ferent from the transfer of an existing property. An issue of shares is a process of creation of shares and not a transfer of shares. Therefore, there is no transfer of shares so as to make Section 45 of the Act applicable. It was submitted that if the contention of the Revenue is correct, then every issue of shares by any Company would be subjected to tax;

    The issue of shares by the Petitioner to its holding company and receipt of consideration of the same is a capital receipt under the Act. Capital receipts cannot be brought to tax unless specifically/expressly brought to tax by the Act. It is well settled that capital receipts do not come within the ambit of the word ‘Income’ under the Act, save when so expressly provided as in the case of section 2(24) (vi) of the Act. This brings capital gains chargeable u/s. 45 of the Act, to tax within the meaning of the word ‘Income’;

    Attention was drawn to the definition of `Income’ in section 2(24) (xvi) of the Act which includes in its scope amounts received arising or accruing with-in the provisions of section 56(2)(viib) of the Act. 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 and not the alleged short-fall in the issue price of equity shares. Thus, this also indicates absence of any intent to tax the issue of shares below the alleged fair market value as in this case;

    The impugned order proceeds on an assumption, surmise or conjecture that in case the notional income, i.e., the amount of share premium forgone was received, the Petitioner would have invested the same, giving rise to income. It is submitted that no tax can be charged on guess work or assumption or conjecture in the absence of any such income arising; and

    The impugned order places reliance upon the meaning of International Transaction as provided in subsection (c) and (e) of Explanation (i) to section 92B of the Act to conclude that the income arises. It is submitted that Explanation (i)(c) to section 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 etc. Similarly, Explanation (i)(e) to section 92B of the Act, which covers business restructuring would only have application if said restructuring/reorganising impacts income. If there is any impact of income on account of business restructuring/reorganising, then such income would be subjected to tax as and when it arises whether in present or in future. In this case, such a contingency does not arise as there is no impact on income which would be chargeable to tax due to issue of shares.

    Revenue’s Contentions

    Revenue contended that:

    Section 92(1) of the Act is to be read with section 92(2) of the Act. It is stated that 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. Issue of shares by the Petitioner to its holding company, resulted in the following benefits to its holding company:

    Cost incurred by the Indian Co. for a correspond-ing 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.

    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.

Besides the above, at the hearing, following further sub-missions in support of the conclusion arrived by the impugned order were also advanced:

    The Petitioner does not challenge the constitutional validity of Chapter X of the Act or any of the Sec-tions therein. The Petitioner raises only an issue of interpretation. Moreover, the fact that the Petitioner-Company and its holding company are AEs within the meaning of Chapter X of the Act is also not disputed. Therefore, the provisions of Chapter X of the Act are fully satisfied and applicable to the facts of the present case;

    The Petitioner itself had submitted to the jurisdiction of Chapter X of the Act by filing/sub-mitting Form 3-CEB, declaring the ALP. Thus, the respondent-revenue were under an obligation to scrutinise the same and when found that the ALP determined by the Petitioner-Company is not cor-rect, the AO and the TPO were mandated to apply Chapter X of the Act and compute the correct ALP. Therefore, the Petitioner should be relegated to the alternate remedy of approaching the Authorities under the Act;

    The issue of Chapter X of the Act being applicable is no longer res integra as identical provision as found in Section 92 of the Act was available in sec-tion 42(2) of the Income-tax Act, 1922 (1922 Act). The SC in Mazagon Dock Ltd. vs. CIT [1958] 34 ITR 368 – upheld the action of revenue in seeking to tax a resident in respect of profit which he would have normally made but did not make because of his close association with a non-resident. Further, the Court observed that it is open to tax notional prof-its and also impose a charge on the resident. The aforesaid provision of section 42(2) of the 1922 Act were incorporated in its new avtar as section 92 of the said Act. It was thus emphasised that the legis-lative history supports the stand of the respondent-revenue that even in the absence of actual income, a notional income can be brought to tax;

    Section 92(1) of the Act uses the word ‘Any in-come arising from an International Transaction’. This indicates that the income of either party to the transaction could be subject matter of tax and not the income of resident only. Further, it is submitted that for the purpose of Chapter X of the Act, real income concept has no application, otherwise the words would have been ‘actual income’. Therefore, the difference between ALP and the contracted price would be added to the total Income;

    It was further submitted that under the Act what is taxable is income when it accrues or arises or when it is deemed to accrue or arise and not only when it is received. Therefore, even if an amount is not actually received, yet, in case income has aris-en or deemed to arise, then the same is charge-able to tax. Thus, the difference between ALP and contract price is an income which has arisen but not received. Thus, income forgone is also subject to tax;     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. Therefore, the charging section is inherent in Chapter X of the Act; Even if there is no separate head of income u/s.

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  u/s.  56(1)  of  the Act; and Section 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 section 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 widest meaning to be deemed to be income aris-ing, for the purposes of total income in section 5 of the Act.

In view of the above, it was submitted that the Petition should not be entertained.

    Findings/Decision of the HC

    Wider meaning of ‘Income’ is not permissible in absence of specific provision in the Statute

On the contention of the revenue that the definition of In-ternational Transaction in the sub-Clause (c) and (e) of Explanation (i) to section 92B of the Act should be given a broader meaning to include notional income, the HC held as under:

    While interpreting a fiscal/taxing statute, the intent or purpose is irrelevant and the words of the taxing statute have to be interpreted strictly;

    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;

    The SC in Mathuram Agarwal vs. State of M.P. [1999] 8 SCC 667 had laid down the following test for interpreting a taxing statue as under:

 “The intention of the legislature in a taxation statute is to be gathered from the language of the provisions particu-larly 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 than what is stated in the plain language. It is not the economic results sought to be obtained by making the provision which is relevant in interpreting a fiscal statute.

Equally impermissible is an interpretation which does not follow from the plain, unambiguous language of the statute. 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. The statute should clearly and unambiguously convey the three components of the tax law i.e. the subject of the tax, the person who is liable to pay the tax and the rate at which the tax is to be paid. If there is any ambiguity regarding any of these ingredients in a taxation statute then there is no tax in law. Then it is for the legislature to do the needful in the matter.”

    In view of the above, it was 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’.

    Whether the definition of ‘Income’ u/s. 2(24) includes ‘Capital Receipt’

    Following decision of the Bombay HC in the case of Cadell Weaving Mill Company Private Limited vs. CIT [2001] 249 ITR 265 (Bombay) upheld by the Apex Court in CIT vs. D. P. Sandu Brothers Chembur Private Limited. [2005] 273 ITR 1 (SC), it could not be disputed that income would not in its normal meaning under the Act include capital receipts unless specified.

    Section 56(2)(viib) of the Act seeks to tax a Com-pany in which public are not substantially interest-ed, in respect of the consideration received from a resident on sale of shares, which is in excess of the fair market value of the shares, as Income from Other Sources. The amount received on issue of shares was admittedly a capital account transac-tion not separately brought within the definition of income, except in cases covered u/s. 56(2)(viib) of the Act. Therefore, in absence of express legisla-tion, no amount received, accrued, or arising on capital account transaction could be subjected to tax as income. Parliament had consciously not brought to tax amounts received from a non-resident for issue of shares, as it would discourage capital inflow from abroad.

    Neither the capital receipts received by the tax payer on issue of equity shares to its AE, a non-resident entity, nor the alleged shortfall between the so called fair market price of its equity shares and the issue price of the equity shares, could be considered as ‘Income’ within the meaning of the expression as defined under the Act.

    A transaction on capital account or on account of restructuring would become taxable to the extent it impacts income, i.e., under-reporting of interest received or over-reporting of interest paid or claim of depreciation, etc. It was only that income which had to be adjusted to the ALP. The issue of shares at a premium was a capital account transaction and not income.

    In tax jurisprudence, it is well settled that the fol-lowing four factors are essential ingredients to a taxing statute:

    subject of tax;

    person liable to pay the tax;

    rate at which tax is to be paid, and

    measure or value on which the rate is to be applied.

    There is difference between a charge to tax and the measure of tax (i) & (iv) above. This distinction is brought out by the SC 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.

    In this case also the charge is on income as under-stood in the Act, and where income arises from an International Transaction, than 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. The tax can be charged only on income and 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 (g)(i) mentioned above, relating to subject of tax is income which is chargeable to tax, is not satisfied. The issue of shares at a premium is a capital account transaction and not income.

    TP Provisions – Scope and Objective

    Section 92(1) of the Act has clearly brought out that ‘Income’ arising from an International Transaction is a condition precedent for application of

Chapter X of the Act. Transfer Pricing provisions in Chapter X of the Act are to ensure that in case of International Transaction between AEs, neither the profits are understated, nor losses overstated.

They do not replace the concept of income or expenditure as normally understood in the Act, for the purposes of Chapter X of the Act.

    Section 92(2) of the Act dealt with a situation where two or more AEs entered into an arrangement whereby, if they were to receive any benefit, ser-vice or facility, then the allocation, apportionment or contribution towards the cost or expenditure had to be determined in respect of each AE having regard to the ALP. It would have no application in Petitioner’s case where there was no occasion to allocate, apportion or contribute any cost and/ or expenses between the tax payer and the AE.

    The objective of Chapter X of the Act is not to punish Multinational Enterprises and/ or AEs for doing business inter se. Arm’s Length Price (ALP) is meant to determine the real value of the transaction entered into between AEs. It is a re-computation exercise to be carried out only when income arose in case of an International transac-tion between AEs. It does not warrant re-computation of a consideration received/given on capital account.

    Real income versus Notional income

Reliance by the Revenue upon the definition of Interna-tional Transaction in sub-Clauses (c) and (e) of Explanation (i) to section 92B of the Act to conclude that income had to be given a broader meaning to include notional income, as otherwise Chapter X of the Act would be ren-dered otiose/ meaningless, was held to be far-fetched.

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. In this case, the revenue seems to be confusing the measure to a charge and call-ing the measure a notional income. The HC found that there is absence of any charge in the Act to subject issue of shares at a premium to tax.

    Charging or Machinery Provisions

    Chapter X of the Act is a machinery (computation-al) provision to arrive at the ALP of a transaction between AEs. The substantive charging provisions are 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 Transactions between AEs had to satisfy the test of ‘Income’ under the Act and had to find its home in one of the above heads, i.e., charging provisions. Following the five member bench of the apex court in CIT vs. Vatika Township Private Limited [2014]

49 taxmann.com 249 (SC), in absence of a charg-ing section in Chapter X of the Act, it was not possible to read a charging provision into Chapter X of the Act.

    It was 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. The HC held that on the aforesaid submission also, there can be no dispute. However, as observed by the SC 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 pro-visions cannot be affected by the construction of computation provisions.” In the present case, there is no charging provision to tax capital account transaction in respect of issue of shares at a pre-mium. Computation provisions cannot replace/ substitute the charging provisions. 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. The HC therefore, found no substance in the aforesaid submission made on behalf of the Revenue.
 

    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 pos-sible to read a charging provision into Chapter X of the Act. There is no charge express or implied, in letter or in spirit to tax issue of shares at a premium as income. 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.

    The HC held that the issue of shares at a premium by the Petitioner to its nonresident holding company does not give rise to any income from an admitted International Transaction. Thus, no occa-sion to apply Chapter X of the Act can arise in such a case.

    Whether the Share premium is chargeable to tax as ‘Income from other sources’

    Share premium have been made taxable by a legal fiction u/s. 56(2)(viib) and the same is enumerated as ‘Income’ in section 2(24)(xvi) of the Act. How-ever, 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.

    Whereas 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. Therefore, in absence of express legislation, no amount received, accrued or arising on capital account transaction can be subjected to tax as income.

    Thus, 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. Although section 56(1) of the Act would permit in-cluding within its head all income not otherwise excluded, it did not provide for taxing a capital account transaction of issue of shares as was 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.

    Concluding Remarks

Thus, the HC held that the issue of shares at a premium by Petitioner to its AE did not give rise to any ‘Income’ from an International Transaction and therefore, there was no need to invoke TP provisions. The ruling surely comes as a morale booster for investors’ confidence and will also help improving the overall image of the Indian tax system. It goes without saying that the said principles should squarely apply to similar matters pending before the Bombay HC, namely Shell, Essar, etc., provided the basic facts are the same as those of Petitioner.

It seems that the tax department may take the matter to the SC and pass on the responsibility for taking a decision in this regard to the SC, instead of dropping the issue at this stage, as otherwise the dispute should not have actually traversed beyond the level of the DRP.

One can only hope that wiser counsel will prevail and the department as also the Government will accept the decision, issue a circular clarifying that except for specific charging provisions, capital receipts are not taxable and generally, use this opportunity to win/regain the faith of taxpayers and investors especially foreign investors.