Transfer-pricing case: Bombay high court rules in favour of Shell India4 min read . Updated: 19 Nov 2014, 12:00 AM IST
Order relates to the issuance of 870 mn shares by Shell India to an overseas group entity, Shell Gas, in March 2009
Mumbai: The Bombay high court has ruled in favour of the Indian arm of Royal Dutch Shell Plc in a tax case that made waves internationally and was cited as one example of why it is difficult to do business in India.
The case arose from two transfer-pricing adjustments made by the income-tax (I-T) department of ₹ 15,000 crore and ₹ 3,000 crore for 2007-08 and 2008-09, respectively, to the taxable income of Shell India Markets Pvt. Ltd.
Last month, the court had ruled in favour of the Indian subsidiary of Vodafone Group Plc in two similar cases of transfer-pricing adjustments of over ₹ 4,500 crore made by the I-T department.
The transfer-pricing tax orders passed against Shell and Vodafone stem from the alleged undervaluation of the shares issued by the Indian firms to their parent companies. Both subsidiaries were private and either wholly or majority owned by the parent.
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.
The I-T order against Shell India relates to the issuance of 870 million shares by the firm to an overseas group entity, Shell Gas BV, in March 2009. The shares were issued at ₹ 10 each, which was contested by the tax authorities in Mumbai.
The I-T department challenged the valuation methodology of Shell India and pegged the value of the shares at ₹ 180 apiece. It then added the difference to the taxable income of Shell India, claiming that this amount should have by rights accrued to it had it sold shares at a fair value.
In the second instance, earlier this year, the tax department issued a show-cause notice and subsequently an order to Shell India, adding over ₹ 3,100 crore to its taxable income for 2008-09.
The company challenged the decisions of the tax department in the high court through a writ petition.
Funding a subsidiary through the share purchase route is a common practice among multinational corporations (MNCs). The MNCs typically view this as a capital transaction and out of the transfer-pricing net. The I-T department, however, disputes this claim.
“We welcome the high court decision. Shell has always maintained that equity infusion by a foreign parent company into an Indian subsidiary cannot be taxed as income. This is a positive outcome, which should provide a further boost to the Indian government’s initiatives to improve the country’s investment climate," said a spokesperson for Shell in India.
According to legal experts, the ruling in the Shell case follows from the Bombay high court’s decision in the Vodafone case, which had said that the transfer-pricing regulations would not be applicable if there is no income component involved in the transaction.
“For transfer-pricing regulations to kick in, the court has said that first they should find out if there is any income component. So that is the basic concept which has been followed in the decision and it is a very well-reasoned decision," said S.P. Singh, senior director at Deloitte Haskins and Sells Llp.
According to Singh, the tax department should come out with detailed guidelines after studying the decisions pronounced by the tribunal and the Bombay high court to ensure frivolous adjustments are avoided.
“Until these problems get a systematic solution, foreign investors will be discouraged from coming to the country. Transfer pricing is not fully serving its purpose and should be selectively used," he said.
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 transfer-pricing tax orders similar to Vodafone and Shell, experts said.
“The Bombay high court has followed its own order in the Vodafone case, which fortifies that the Indian judiciary is independent of the executive," added Mukesh Butani, managing partner of BMR Legal and non-executive chairman of BMR Advisors.
The Vodafone transfer-pricing case is different from the more famous tax case involving Vodafone, where it was asked to pay up a withholding tax arising from the acquisition of what is now Vodafone India Ltd from Hutchison Telecom. The tax department lost that case in the Supreme Court, but then finance minister Pranab Mukherjee brought about a retrospective amendment in tax laws that made it possible for the tax department to raise the demand. The issue is under arbitration. The retrospective change in law has been criticized by analysts and foreign investors, and Jaitley assured investors during his budget speech that this government would do no such thing. However, he stopped short of scrapping the retrospective amendment.