Transfer pricing provisions apply to international transactions which result in income or expenditure (capital or revenue) to one of the parties to the transaction. Without any income or expenditure, can it be argued that the transfer pricing provisions are applicable?
This was the crucial question before Bombay High Court in a recent case involving Vodafone India.
In this case, Vodafone, a wholly owned subsidiary of a Mauritian holding company, issued equity shares of a face value of ₹10, at a premium of ₹8,591, which was in compliance with the pricing guidelines of the exchange control regulations. When Vodafone filed the required form along with the return of income, it declared that the share issuance was an international transaction, with a note that the transaction did not affect Vodafone’s income and was reported only as a matter of abundant caution.
On reference by the assessing officer (AO) to the transfer pricing officer (TPO), the TPO held that the share issuance was an international transaction and the issue of whether any income had arisen would be determined by the AO. The issuance of shares at a lower premium results in subsidizing the price payable by the holding company, which is treated as a loan and such a loan would have bearing on the profits in terms of interest.
The shortfall in the premium was thus treated as a transfer pricing adjustment by treating it as a loan by Vodafone to its holding company. Also, interest on the loan at 13.5% a year was treated as a transfer pricing adjustment. The AO’s order did not deal with the principal contention that transfer pricing provisions would not be applicable to the issuance of equity shares as this did not give rise to any income.
A Vodafone writ petition to the high court questioned the applicability of transfer pricing provisions to the transaction.
The high court’s decision did not determine whether the issuance of shares resulted in income and only discussed when the jurisdiction issue should be decided and whether the dispute resolution panel (DRP) can deal with this issue. The court also dealt with the issue of whether, when an alternative remedy is available to a taxpayer, a writ petition should be entertained.
The court held that it is open to the DRP to consider all issues, including the jurisdictional issue of no income arising and/or affected by the international transaction and thus Vodafone had an alternative remedy available.
For the transfer pricing provisions to apply to an international transaction, there should be income or potential income and if this is challenged, it must be decided at the outset before determining the arm’s length price (ALP), since if there is no income, the determination of the ALP becomes academic. The AO must determine whether any income arises in any international transaction before referring the transaction to the TPO.
The AO must give the assessee a hearing before making a reference to the TPO if the assessee raises a jurisdictional issue. Such a hearing would be sufficient compliance with the principles of natural justice. A failure by the AO to examine whether income arises from the international transaction is an illegality.
After making the above observations, the court held that the DRP would consider the preliminary issue of whether transfer pricing provisions are applicable to the issuance of shares within two months and if Vodafone is aggrieved by the DRP’s decision, Vodafone could directly approach the high court.
When writ petitions have been filed in the past, high courts have usually held that since an alternative remedy is available to the taxpayer, the writ petition is not maintainable. This decision comes as a relief to taxpayers who intend to file writ petitions in relation to tax disputes, since the court held that Vodafone could approach the high court to oppose the DRP order. The decision allows fast-tracking to resolve such disputes, which is one of the key reasons for setting up the DRP for international taxpayers. Thus, Bombay High Court has deviated from the traditional approach adopted by the high courts in relation to writ petitions where an alternative remedy is available, which is a welcome development.
Core issue unresolved
This being said, the core issue remains undetermined, i.e. whether the transfer pricing provisions are applicable to the issuance of shares where there is no resultant income and the transaction is of a capital nature. As the timelines provided are relatively short, early resolution of this issue is expected.
Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune, Ahmedabad, Bengaluru and Chennai. Pranay Bhatia is a partner at the firm and Vidushi Maheshwari is an associate.
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