India Inc foreign acquisitions can't be taxed locally, rules tribunal

Ruling comes as big boost to corporates

A recent ruling by the Hyderabad income tax tribunal regarding taxation norms of Indian companies investing in their foreign counterparts has come as a big boost to India Inc's arguements. The corporate world has been trying to prove a point, debating, that transfer pricing rules are not applicable to transactions that don't lead to a rise in income.

A host of Indian companies led by the Tatas and Birla-owned Hindalco are facing transfer pricing-based tax demand for giving loan guarantees to their foreign subsidiaries for acquisitions abroad and investments in foreign arms. Besides, many international companies like Shell are also fighting the department’s argument that shares issued by local subsidiaries at a lower valuation should be tax in India.

The ITAT order dated May 31st this year was in the case of Vijay Electricals which was slapped with a tax demand notice by the tax authorities for investing Rs 21 crore in its three subsidiaries overseas. The tax department called the investments as an “international transaction.”

Tax lawyers say this ruling assumes significance in view of the recent controversy following tax department’s action in applying transfer pricing in several cases to issue of fresh shares by Indian subsidiaries to their overseas parents and seeking to tax the differential amount and/or notional interest thereon in the hands of the company issuing the shares.  

“The tribunal has reaffirmed an important principle that only transactions which give rise to some income are subject to transfer pricing provisions.  If this principle is followed, transfer pricing should not apply to a fresh issue of shares to an associated enterprises, as no income arises from such an issue of shares,” according to tax advisory firm, BMR Advisor’s communication to its clients.

During the hearing before the tribunal, the company argued that as the investment made in a foreign subsidiary is not an international transaction as per section 92B of the Act and, thus, there was no requirement of filing a separate report to the department.  Besides, the company said, the transaction was not one of sale involving computation of income and giving rise to an international transaction contemplated under the Income Tax Act.

It further argued the transfer pricing provisions are applicable only when there is income chargeable to tax arising from the transaction, which was not the case for the taxpayer. The Tribunal agreed with the company and asked the tax authorities to withdraw the tax demand.

But lawyers say the Indian companies need not rejoice now as the tax department is expected to file a petition against the ITAT order in the high court.