Right call

The Vodafone transfer pricing case should prompt revenue authorities to exercise prudence in tax claims

The Bombay High Court’s ruling setting aside a tax demand of around Rs 3,200 crore on Vodafone India in a case involving alleged under-pricing of shares issued to its Mauritius-based holding company should be welcomed. The issue of shares here, no doubt, was a cross-border transaction between two associated enterprises. It is also not disputable that all such deals need to be valued at arm’s length – as if undertaken between unrelated parties. Vodafone India did, in fact, report having issued equity shares of face value of Rs 10 each at a premium of Rs 8,509 to the Mauritius entity in 2009-10 while filing its returns; it even detailed how the arm’s length pricing had been done in order to determine the premium that was charged. But the Revenue Department not only challenged the methodology, while claiming that that the shares should have been valued much higher (at Rs 53,775 each). It went on to hold that the difference in the two valuations represented ‘income’ liable to be taxed.

This, clearly, was ill-thought-out. How could any transaction have been taxed when no incomes had been generated in the first place? This was a pure capital account transaction where a company had only made a primary issuance of shares. There was no transfer of shares in this case, leading to capital gains that could be subjected to tax. Even the issue of arm’s length pricing from a taxation standpoint would have arisen only if the Mauritius parent had made a killing from the sale of shares it had allegedly received at a discount to the actual net asset value. The Revenue Department, however, contended that Vodafone India by ‘relinquishing’ its right to receive a fair market price had foregone the opportunity to earn income accruing from investing the extra consideration that was due from the holding company. Such incomes – not actually received, but deemed to have arisen – could hence be brought to tax. Thankfully, the High Court did not buy this logic of taxing ‘notional’ incomes or incomes foregone.

What this episode – and also an earlier one involving a retrospective tax demand involving the same company on its acquisition of Hutchison Essar’s telecom business in India – highlights the excessive zeal of our revenue authorities that can prove counterproductive. Currently, not only Vodafone, but even the likes of Shell and IBM are engaged in transfer-pricing disputes here. Taxing cross-border deals is a complex matter, more so when it concerns capital flows as opposed to trade in goods and services. Ultimately, India has to choose between attracting foreign investments (which it requires desperately) and making ambitious tax claims on multinationals having no dearth of countries when it comes to setting up manufacturing or operating bases. The previous UPA regime gravely erred by choosing wrongly and damaging India’s reputation as an investment destination. The present one should not repeat the mistake.

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