Mumbai: The Bombay high court on Friday ruled in favour of the Indian unit of Vodafone Group Plc in a 3,200 crore tax dispute, delivering a boost to overseas entities enmeshed in similar litigation with the tax department and assuaging the concerns of foreign investors.

The order stems from a case in which the tax department accused Vodafone India Services Pvt. Ltd of under-pricing shares in a rights issue to the parent firm for fiscal year 2009-10.

“There is no taxable income arising out of the issue of shares. Share premium received on the issue of shares is not taxable," a division bench comprising chief justice Mohit Shah and justice M.S. Sanklecha ruled on Friday.

The tax authority issued a show-cause notice to Vodafone India on 17 January before passing the order and adding 3,200 crore to its taxable income for the period in question.

Vodafone welcomed the ruling. “Vodafone has maintained consistently throughout the legal proceedings that this transaction was not taxable," said a spokesperson for the British telecom firm.

The case has been watched closely by overseas investors, who have been concerned about a raft of tax demands raised by the income-tax (I-T) department, alleging underpayment of tax.

Apart from Vodafone India, Shell India Markets Pvt. Ltd and Leighton India Contractors Pvt. Ltd have also moved the court against similar show-cause notices and so-called transfer pricing orders by the I-T department. An order in the case of Shell India, which is contesting an addition of over 3,000 crore to its taxable income for fiscal year 2009-10, will be delivered on Monday.

Transfer pricing refers to the practice of arm’s length pricing for transactions between group companies based in different countries to ensure that a fair price—one that would have been charged to an unrelated party—is levied.

“Today’s judgement vindicates the taxpayer’s stands and lends clarity to the vexed question of applicability of the transfer pricing law to share issuance," said Mukesh Butani, managing partner at BMR Legal, adviser to Vodafone on tax litigation and transfer pricing matters.

“Undoubtedly this will improve investors’ sentiments and I hope that the government gracefully accepts the court’s verdict and puts an end to the controversy, which in the first place should not have arisen," Butani added.

Mint could not immediately ascertain if the I-T department plans to move the apex court against Friday’s ruling.

Since it took office in May, the new government led by the Bharatiya Janata Party has assured foreign investors of fair tax treatment. Finance minister Arun Jaitley has promised to end the “tax terrorism" that critics have accused the previous Congress-led government of practising.

More than 20 companies such as Bharti Airtel Ltd, two Essar Group firms, HSBC Securities, Patel Engineering Ltd and Havells India Ltd are contesting similar transfer pricing tax orders, experts said.

“The decision of the high court endorses an almost unanimous view that the tax authorities have absolutely no case to defend the transfer pricing adjustment on account of undervaluation of issue price of shares," said Arun Chhabra, director of Grant Thornton Advisory Pvt. Ltd, a consulting company.

Vodafone India had on 22 January written to the tax office seeking a decision on “the preliminary issue about jurisdiction—whether or not any income arises or any potential income arises or is effected by issue of shares". The firm had also asked for an extension of the deadline for filing a reply to the show-cause notice.

On 27 January, Vodafone India moved the Bombay high court seeking relief from the I-T show-cause notice.

“Share premium received on issue of shares is never taxable," Harish Salve, senior counsel representing Vodafone, had argued. He described the tax authority’s action as a “blatant attempt to tax hypothetical or non-existent income".

The judgement reconfirms that income must be generated in the first place to trigger transfer pricing provisions, said Amit Maheshwari, managing partner at tax consulting firm Ashok Maheshwary and Associates.

“The ruling also ensures that secondary adjustment proposed by the tax authorities by re-characterization of premium as loan will not hold good. This judgement would further boost sentiment of foreign investors and will result in higher FDI (foreign direct investment) in India," said Maheshwari.

This is not the first time that Vodafone has challenged a transfer pricing order. The firm has taken the tax authority to court over two other transfer pricing tax orders that raised a demand of 3,700 crore and 400 crore on Vodafone India. Both cases are pending in the Bombay high court.

The telecom firm and the government are also locked in arbitration over a 11,000 crore dispute related to the 2007 transaction in which Vodafone International Holdings BV, a Dutch unit of Vodafone, bought the Indian operations of Hutchison Telecommunications International Ltd.

The acquisition was made through the sale of a Cayman Islands-based firm called CGP Investments (Holdings) Ltd, a unit of Hutchison, in an $11 billion deal. The Indian tax department estimated Vodafone’s liability at around 11,000 crore for not withholding a part of the amount as tax while paying Hutchison.

In 2012, the Supreme Court ruled in favour of Vodafone and held that the deal was not taxable in India. To counter this, the government introduced a retrospective amendment to laws to bring such indirect transfers of shares under the tax net. It also introduced a validation clause that effectively made Vodafone liable to pay tax in India, sparking large-scale protests from the investor community.

Besides Vodafone and Shell, other multinational companies recently involved in tax disputes in India include International Business Machines Corp., Nokia Oyj, Sanofi SA and WNS (Holdings) Ltd.

All these cases are a fallout of the retrospective amendment introduced in the Union budget of 2012.

Tax consultants say the government should carefully weigh the issues at stake before deciding whether or not to move the Supreme Court.

“Legally as well as economically, there appears no justification to impute income in infusion of shares. The government must consider all aspects before going in appeal and ensure certainty to taxpayers," said S.P. Singh, a senior director at consulting firm Deloitte Haskins and Sells.

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