Vodafone, Shell May Face New Tax Demands In India
January 30th, 2014. Fresh orders against Indian units of Vodafone, Shell can potentially lead to tax demands for a combined Rs.24,960 crore.
Mumbai: The transfer pricing wing of the income-tax (I-T) department has passed fresh orders against the Indian units of Europe’s largest oil producer Royal Dutch Shell Plc and largest phone firm Vodafone Group Plc that can potentially lead to tax demands for a combined Rs.24,960 crore, adding to the tax troubles of the two companies. In the case of Shell India Markets Pvt. Ltd, the tax authority has added Rs.72,000 crore to its taxable income for the financial year 2010-11. It has added Rs.3,200 crore to the taxable income of Vodafone India Services Pvt Ltd for 2009-10. The orders do not specify the tax demand, but back-of-the-envelope calculations show that Shell India and Vodafone India can face demands to pay Rs.24,000 crore and Rs.960 crore, respectively. Foreign investors have been concerned about a raft of tax demands raised by the I-T department, alleging underpayment of tax, despite reassurances by finance minister P. Chidambaram that India was committed to a stable and non-adversarial tax regime.
“This approach of the revenue department would only add to the huge number of litigations already pending on account of transfer pricing adjustments and will negatively impact the FDI (foreign direct investment) flows into the country,” said Amit Maheshwari, partner, Ashok Maheshwary and Associates, a law firm. An email sent to the spokesperson of the Central Board of Direct Taxes remained unanswered. The transfer pricing orders passed against Shell and Vodafone stem from the alleged undervaluation of the shares issued by the Indian firms to their parent companies. Transfer pricing is 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 tax authority issued a show-cause notice to Shell India on 22 January and Vodafone India on 17 January before passing the orders, making the additions to their taxable income. Both Vodafone India and Shell India moved the Bombay high court seeking relief from the I-T show-cause notice on 27 January, fearing a tax demand order.
Funding a subsidiary by issuing shares is a common practice among multinational companies, which they typically view as a capital transaction and out of the transfer pricing net. The I-T department, however, disputes this claim. Analysts point out that there is still a long way to go before a final legal solution is reached on the contentious interpretation by the tax department. “In the last year of transfer pricing audits, share valuation has become one of the biggest issues,” said Karishma Phatarphekar, partner and practice leader, transfer pricing services, Grant Thornton India LLP, a tax consultancy. “The ruling of the dispute resolution panel in the Vodafone case has gone in favour of the income-tax department. DRP (dispute resolution panel) has ruled that if any adjustment takes place, even if on notional income, under Section 92 of the Income Tax Act (which deals with transfer pricing), it doesn’t matter if it’s a capital or a revenue transaction,” she said.
“But I don’t think it is the correct technical interpretation since the section very specifically mentions that there has to be an income arising out of the transaction,” Phatarphekar said. The share sale of Shell India to its parent company in 2010 was valued by the firm at Rs.8,000 crore; the tax department valued it at Rs.80,000 crore, according to a lawyer familiar with the case. “Now the fresh transfer pricing show-cause notice has sought to tax the differential amount of Rs.72,000 crore,” the lawyer said, requesting anonymity. On Thursday, a division bench of the high court headed by chief justice Mohit Shah heard the cases for the first time. The court stayed the tax department from taking any action against the two firms as the DRP of the tax authority is hearing a case filed by Vodafone India challenging the jurisdiction of the tax department over such offshore transactions.
The DRP is expected to pass its order by 24 February. The high court will hear both the cases next on 7 March. “We confirm that we have challenged the show-cause notice received for FY09-10 (fiscal year 2009-10) in the Bombay high court and the court has stayed further proceedings,” said a Shell India spokesperson in an emailed response. “The issue is similar to that of FY08-09, which is pending in the Bombay high court. Shell holds to its view that an equity injection is a capital receipt on which income tax cannot be levied.”
Vodafone declined to comment
The transfer pricing office of the I-T department had passed the orders against the two companies on 29 January, said Beni Chatterjee, a lawyer representing the tax authority. “The companies will soon receive the orders,” he said. Tax disputes have hurt India’s image as a destination for foreign investment, some analysts say. In 2007, Vodafone International Holdings BV, a Dutch unit of the British telecom firm, bought the Indian business operations of Hutchison Telecommunications International Ltd through the sale of a Cayman Islands-based firm called CGP Investments Ltd, a unit of Hutchison, in a $11 billion deal. The Indian tax department estimated the company’s liability at around Rs.11,000 crores 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.
Presently, Vodafone and the government are holding talks for an informal reconciliation of the case, according to Harish Salve, a lawyer representing Vodafone. He said a final decision on the case is likely by July. Tax disputes like the ones with Vodafone and Shell risk damaging India’s reputation in the international investor community, according to Mark Runacres, secretary at the British Business Group, a platform for India-UK business relations. “These problems also distract corporates from their primary interest, namely growing in this market, and that can only be a bad thing,” said Runacres. According to a World Bank report published in October, India has slipped three positions to the 134th spot in the latest Ease of Doing Business list, which is topped by Singapore.
Besides Vodafone and Shell, other multinational companies recently involved in tax disputes in India include International Business Machines Corp. (IBM), Nokia Oyj, Sanofi SA and WNS (Holdings) Ltd.
All these cases are a fallout of the retrospective amendments introduced in the national budget of 2012. This is not the first time that Vodafone has challenged a transfer pricing tax order. The firm has taken the tax authority to high court over two other transfer pricing tax orders that raised a demand of Rs.3,700 crore and Rs.400 crore on Vodafone India. Both cases are pending in the Bombay high court. The high court on Thursday also heard an appeal filed by the tax authority challenging the interim order of its tribunal that stayed the Rs.3,700 crore tax demand raised on Vodafone India. The case has been adjourned to 6 February. This tax dispute, the first of the three transfer pricing cases, relates to a Rs.8,500 crore transfer pricing adjustment made by the I-T department on Vodafone India.