Ozg Transfer Pricing Consultant
Back Office Phone # 0091-9811415861-72-84-92-94
Fresh tax uncertainties emerged for foreign investors in India at the end of January — just when they had begun to breathe easy after the government postponed implementation of the controversial General Anti-Avoidance Rules to April 1, 2016. The cause for worry now is transfer pricing orders in which the income-tax department has alleged that Indian subsidiaries of multinational companies such as Royal Dutch Shell and Vodafone underpriced shares issued to group companies. This, according to the tax authorities, was done with the ultimate objective of lowering tax liability.
The tax department estimates the extent of underpricing by Shell India Markets at Rs. 15,220 crore (US$2.7 billion) and by Vodafone India Services at Rs. 1,300 crore (US$244 million). Notices went out late last month to several others, including Indian companies with foreign subsidiaries, for similar “underpricing” of shares in fiscal year 2008-2009. The tax authorities completed transfer pricing assessment for fiscal 2008-2009 in January.
Both Shell and Vodafone have said they will challenge the orders.
The orders disputed the valuation methods adopted by the companies for pricing shares issued to their group companies. Shell said in a statement on February 4 that “the share issuances were in accordance with the terms of the foreign investment policy, the prevailing exchange control regulation, applicable corporate and related laws.” The valuers used the net asset value method to work out the valuation, and it came to less than Rs. 10 (approximately 20 U.S. cents) per share. The new shares were, however, issued at Rs. 10 apiece.
India’s income-tax authorities want companies to use a more subjective discounted cash flow (DCF) method. “The exchange control guidelines for issue of shares to non-residents do not stipulate that valuations have to be calculated using the DCF method. Nor [do they] prohibit it, either,” says Mukesh Butani, chairman, BMR Advisors, adding that these guidelines require valuation be based on net asset value. Shell India is a BMR client.
The transfer pricing order to Shell India said that the 867 million shares issued to its holding company Shell Gas BV in March 2009 should have been valued at Rs. 183 (US$3.37) apiece and not at Rs. 10. Shell Gas paid around US$160 million (Rs. 867 crore) for these shares. The income-tax department is treating the difference between Rs. 183 and Rs. 10 as a loan from Shell India to Shell Gas, on which Shell India would have earned taxable interest income.
“To service the downstream business, which is not making money, we needed an equity injection in 2008 of US$160 million. We have (now) received a tax request of US$1 billion on this equity injection of US$160 million. Somebody needs to explain [this] because I do not understand,” chairman of Shell Group of Companies in India Yasmine Hilton stated following the statement from her company.
Effectively, the tax authorities have recharacterized what should be share premium as a loan, points out Vijay Iyer, partner and leader, transfer pricing at Ernst and Young. “How can the tax authorities presuppose a share capital transaction as a loan?” asks Iyer. According to Butani, there was a Bombay High Court order that prohibited recharaterization of equity as loan and vice versa in the absence of thin capitalization rules.
The order to Vodafone stated that the shares issued by Vodafone India to Vodafone Teleservices Mauritius in 2007-2008 were underpriced to the extent of Rs. 1,300 crore (US$244 million). The telecommunications giant has not shared details of shares issued or its valuation in its statement but said that the order is linked to the 2007-2008 transfer pricing dispute, which the company is already challenging before the Dispute Resolution Panel.
Transfer pricing norms are usually applied to transactions involving transfers of assets, goods and services between related parties or intra-group. Applying these rules to capital infusions or issues of shares to group companies is unheard of — a point both companies have stressed.
“Share subscriptions are not covered by transfer pricing rules either in India or internationally. We will be challenging the order as it has no basis in law,” Vodafone said in a statement from London.
“Taxing the money received by Shell India is in effect a tax on foreign direct investment (FDI), which is contrary not only to law but also to the spirit of the recent global trip by the finance minister to attract further FDI into India,” Hilton said in the February 4 statement.
Predictably, these orders have caused panic among investors, with some even reviewing their future investment plans, tax consultants say. “There is a lot of apprehension among our clients. We get questions [about whether] such orders could be served on them,” says Samsuddha Majumder, counsel at law firm Trilegal. However, there is little tax consultants can do at this stage to calm their clients, given that they, too, have to make sense of the tax authorities’ latest decisions. For the moment, these orders are being seen as desperate measures by tax authorities to collect more taxes. However, the current set of orders will not result in a revenue windfall for the government in the current fiscal year, since companies are set to challenge them.
Transfer pricing is the value at which companies trade products, services or assets between units across borders, a regular part of doing business for a multinational.
Revenue authorities in many countries including Britain, France, Germany and the United States are increasingly challenging efforts of companies to minimise tax liabilities by moving taxable income from higher-taxing jurisdictions to lower-tax ones.
In India’s case, critics worry overly aggressive tax authorities could undermine foreign investment although tax officials say they have been working overtime as Finance Minister P. Chidambaram looks to make up a revenue shortfall and head off the threat of a credit rating downgrade.
“On some days we had to work through the night to meet the deadline,” said one official. “There are so many cases that are coming to us but we don’t have an adequate number of people.”
At least 1,500 transfer pricing disputes were in litigation in India as of February 2011, compared with fewer than six in the United States and none in Taiwan or Singapore, an Ernst & Young survey showed in August 2012. Still, Western campaigners say BRIC countries – Brazil, Russia, India and China – are tougher on corporate tax avoidance than developed countries.
One company in the cross hairs, Anglo-Dutch oil major Royal Dutch Shell said earlier this month it would challenge a claim its local unit underpriced shares transferred to the parent by $2.8 billion. Shell said the claim is based on an “incorrect interpretation” of tax rules and “bad in law”.
Shell said its India unit issued 870 million shares to parent Shell Gas BV at 10 rupees apiece in 2009 but that tax authorities valued them at 183 rupees each.
Effectively, India is demanding the tax on the interest Shell would have earned on the $2.8 billion, in the largest ever claim in an Indian transfer pricing case, tax officials said.
South Korea’s LG Electronics Inc , Singapore property group Ascendas, French IT services firm Capgemini and chocolate maker Cadbury, are among numerous global companies involved in transfer pricing disputes in India, documents at the tax department’s appellate tribunal show. These companies have challenged the tax department’s orders.
In information technology and business process outsourcing (BPO), the tax department believes many firms are taking advantage of low costs in India to develop high-end, patented services or products that are sent to overseas parent firms as low-value routine work, the tax officials said.
These sectors are expected to account for more than half the total claims in transfer pricing deals in the fiscal year 2008/09, one of the officials said, up from about one-third earlier.
Outsourcing makes up more than $100 billion of India’s economy with companies such as Accenture , Bank of America Merrill Lynch, and Microsoft Corp mploying thousands in functions such as customer service, risk and fraud management and finance and accounting.
A spokeswoman for the National Association of Software and Services Companies said the Indian outsourcing lobby group was concerned tax authorities have been making “inconsistent and very aggressive adjustments.”
HOT TAX ISSUE
Because valuing an internal transaction is often a matter of opinion and assumption of future growth, companies and tax authorities can arrive at widely divergent views on their value.
“Some of their decisions on valuations are very arbitrary and obviously may not be sustainable at higher appellate levels,” said Sanjay Tolia, partner for transfer pricing at Price Waterhouse & Co in Mumbai.
In LG Electronics’ case, tribunal documents show the company’s Indian unit was deemed to be promoting the LG brand owned by its parent, which should have compensated the local unit, thereby generating taxable income. Authorities claim the excess expenditure amounted to a transfer pricing adjustment of 1.61 billion rupees.
Earlier this month, British-based mobile phone giant Vodafone Group Plc said it had received a fresh transfer pricing order in India over the issue of shares by a unit, adding to its tax woes in the country. India’s tax office says the Vodafone unit under-priced shares issued to a Mauritius-based group company by nearly 13 billion rupees, ET NOW TV station reported recently. Vodafone said it would challenge the order.
Vodafone is already fighting a transfer pricing case in the Bombay High Court that involves a $1.6 billion disagreement, a person with direct knowledge of the matter said. The company declined to comment.
India is also trying to claim more than $2 billion in tax stemming from Vodafone’s 2007 acquisition of an Indian mobile company from Hong Kong’s Hutchison Whampoa.
Vodafone says share subscriptions are not covered by either Indian or international rules on transfer pricing so the latest order had “no basis in law”.
Tax officials say that while shares are not taxable, the department is increasingly clamping down on under-priced share deals on the premise that it is losing out on taxing the interest that the adjusted amount would have earned.
Still, consultants say the department’s argument would not stand the test of law.
Cadbury said it has challenged a ruling made against it for 2007-08 and that India’s income tax tribunal had granted a stay on the demand upon payment of less than 10 percent of the amount.
The income tax department argues the local unit overpaid its parent for brand royalty and service fees, thereby lowering its profit in India and resulting in a lower tax obligation.
“It is not uncommon that the income tax department and a tax payer have a difference of opinion on the interpretation of tax laws,” Cadbury said in a statement to Reuters.
Ascendas and Capgemini also declined to comment.
The average corporate tax rate in Asia in 2013 is 22.89 percent while in Europe it is 20.49 percent, compared with 32.45 percent in India, KPMG says
March 7, 2013 / knowledgetoday
Ozg Transfer Pricing Consultant
Back Office Phone # 0091-9811415861-72-84-92-94