In 2013, ‘share valuation’ was one of the more unique and controversial issues emerging from the eighth cycle of transfer pricing (TP) audits in India. Revenue authorities have alleged instances of grossly undervalued share investments made by multinational enterprises in their Indian associated enterprises (AEs) and have sought to make adjustments on such alleged under-valuations and have also imputed notional interest in the hands of the Indian AEs by re-characterising the deficit as loans purportedly advanced by the Indian AEs to their overseas parent companies.
There have been relatively high profile cases on the above where writ petitions have been filed before the Bombay High Court challenging the jurisdiction of the transfer pricing officer (TPO) to make TP adjustment on issue of shares. In addition, some aggrieved taxpayers have simultaneously filed their objections against the draft order with the dispute resolution panel (DRP) with regard to valuation/quantification issue. We have highlighted below the following points of contentions put forth by both parties.
l Whether TP provisions are applicable to capital transactions. Taxpayer had contended that the issue of shares as well as premium on shares, if any, are capital transactions and in the nature of capital receipts as per the provisions of Indian Income-tax Act, 1961, and TP provisions should not be applied to capital receipts, which are not taxable under the Act. The revenue authorities rejected this argument stating that the transaction of issue of shares to an AE would amount to an ‘international transaction’, relying on retrospective amendment to Section 92B of the Act, which includes, inter alia, capital financing transactions. Further, the revenue authorities, while quoting the meaning of the term ‘international transaction’ under Section 92B which states that “transactions having a bearing on the profits, income, losses or assets”, argued that transaction of issue of shares has a bearing on the assets and, hence, is within TPO’s jurisdiction to examine the arm’s length price (ALP).
l Basis of valuation. Taxpayer had contended that the valuation was in accordance with the exchange control norms (as they existed in 2009), which mandate that the issue price of shares should not be below the price determined under CCI guidelines. The revenue authorities had rejected this premise of valuation and stated that as per TP provisions, ALP must be determined using the ‘most appropriate method’ under Section 92C(1).
l Re-characterisation of transactions. The revenue authorities have treated such undervaluation of the shares as ‘loan’