Penal consequences force taxpayers to report deals that are not taxable: Vijay Iyer

The Bombay High Court recently in the case of Vodafone India Services Private Limited (Vodafone) held that the foreign direct investment (FDI) received by the Indian company in the form of share capital cannot be taxed in India under the ambit of Indian transfer pricing (TP) regulations, as this transaction does not give rise to any "taxable income" in India. While ruling in favour of the Indian taxpayer, the HC held that Indian TP provisions are on machinery and one cannot tax capital receipts which are otherwise not taxable under the Indian laws.

Apart from the Vodafone case, there are 20-odd companies (Shell, Bharti, Essar, Standard Charted, HSBC, etc.) fighting similar cases. Though the facts vary, since the underlying issue pertains to applicability of TP provisions on subscription of share capital, the principles laid down by the Bombay HC should ordinarily apply to such cases as well. Also, the Bombay HC decision puts to rest the controversy created by the Advance Ruling in the case of Castleton Investment Limited, wherein it was held that the applicability of the Indian TP provisions are not dependent on the chargeability to tax under the Indian laws. Therefore, the decision provides needed respite and certainty to the foreign investors, who had run a risk of erosion to their capital investment in India due to onerous demands raised by Indian tax administrators.

Looking ahead, tax administrators may choose not to litigate the matter before the Supreme Court and bring a curtain on the subject controversy. Also, as a matter of administrative principle, tax officers while adjudicating transfer pricing cases in future may choose not to raise TP issue which do not give rise to income chargeable to tax in India. Such transactions may include capital work in progress, subscription to shares of overseas wholly-owned subsidiaries, tax exempt business restructuring transactions, merger, amalgamations and transfer of shares exempt under the Indian income tax laws or specific tax treaty provisions.

To ensure similar issues do not arise in future, a clarification can be provided under the legislation itself that only those transactions will be subject to rigours of Indian TP regulations which give rise to taxable income in India. Such a clarification would also relieve taxpayers from 0reporting these transactions in Form 3CEB and transfer pricing documentation. Currently, only due to penal consequences, taxpayers are forced to report transactions which otherwise are not taxable in India. It is worthwhile to note that the controversy in the Vodafone case arose due to disclosure of a share issuance transaction by the company. Any such clarification will relieve taxpayers from onerous transfer pricing compliances in India.

The above measures would go a long way in restoring the confidence of foreign investors in tax administrators and would also help attract FDI in India which will supplement our Prime Minister's 'Make in India' initiative.

Vijay Iyer
Partner & National Leader - Transfer Pricing, EY