12 October 2014

Issue of shares at premium not an international transaction

To apply provisions of Chapter X of the Income Tax Act, 1961 (the Act), there must be some income chargeable to tax arising from an international transaction. The High Court of Bombay in Vodafone India Services v. UOI, Writ Petition 871/2014 [10th October,2014] held that issue of shares at a premium did not give rise to any income and transfer pricing provisions were therefore not attracted. 


At issue

The Indian subsidiary –Associated Enterprise (AE) had issued shares at a premium to the holding company – a non-resident. The revenue authorities contended that the shortfall in premium charged from the holding company was a deemed loan and interest was chargeable on the same. The revenue authorities reading of the transaction was as follows:


    • Transaction was an international transaction in as much as cost was involved in passing on a benefit to the AE.        
    • The charging section is inherent in Chapter X which is not merely a machinery provision. Chapter X is a complete code by itself and difference in valuation between the Arm’s Length Price (ALP) and transaction price gave rise to income.   


  • All incomings would fall within the concept of income. 
  • Share premium foregone could have been invested in business giving rise to income and this notional income was liable to be taxed.


The High Court, however, did not concur with the views of the department and after examining assessee’s contentions, allowed the petition. Some of the leading points emerging from this landmark decision are briefly mentioned in this report.  


Income– meaning

Income is not defined in Chapter X. It has to be understood as defined in Section 2 (24) of the Act. A capital receipt cannot be brought to tax except as capital gains as per the provisions of the Act. In the instant case, premium would not have been chargeable to tax and hence shortfall in the same cannot be subject to tax.


Requirements for taxation

The four essentials of taxation are subject of tax, person liable to tax, rate and value on which the rate is to be applied. Emphasising the distinction between as brought out in Bombay Tyres India Ltd. v. Union of India reported in 1984 (1) SCC 467, the High Court observed that the entire exercise of determining the ALP was to arrive at the real income. The revenue authorities had confused the measure to a charge and called the measure a notional income. The issue of shares at a premium is a capital account transaction and not income. The arriving at the transactional value/ consideration on the basis of ALP does not convert non-income into income. There can be no tax on capital inflow. No income arises from a transaction on capital account. 


Whether the transaction is one of cost of passing on a benefit

The High Court opined that Section 92(2) of the Act applies where two or more AEs enter into an arrangement whereby they are to receive any benefit, service or facility then the allocation, apportionment or contribution towards the cost or expenditure is to be determined in respect of each AE having regard to ALP. This was not applicable in the impugned transaction. 


Chapter X is not a code in itself

Arising of income on account of international transaction is a condition precedent for application of Chapter X of the Act. The charge to tax must be found specifically mentioned and there was no such specific provision in Chapter X.    

The High Court noted that the aim of inserting new Sections 92 to 92 F was to do away with discretion of Assessing Officer and have well defined rules to tax transactions between AEs. It did not replace the concept of income or expenditure as normally understood in the Act for the purposes of Chapter X of the Act.


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