Tax Disputes in India – a Year in Review

By Andrew Salzman

When elected in May 2014, India’s Prime Minister Narendra Modi and the BJP sought to establish rule of law in disputes with foreign firms and reduce uncertainty amongst foreign investors caused by issues surrounding Vodafone  and Nokia. With the end of the year fast approaching, in this article we take a look at some recent court decisions to see if the climate for foreign investors in the judiciary is matching recent efforts by the government to make the country friendlier for foreign firms.

Shell India

The Shell India case involved transfer pricing principles. Transfer pricing arises when there are transactions between controlled and/or related entities. Governments want to ensure a fair market value price is paid between the companies, partly to guard against tax avoidance.

In 2009, Shell India transferred shares to its parent, Royal Dutch Shell. The company considered this to be a capital transaction, which is outside of transfer pricing rules. However, the Indian tax authorities disagreed and claimed the shares were undervalued by $2.5B USD, and tried to add this figure to Shell India’s taxable income.

The case went through the court system and in November, the Bombay High Court ruled in favor of Shell India. It held that transfer pricing rules do not apply to an issue of shares from an Indian company to a foreign parent because the transaction did not give rise to any taxable income. Therefore, the shares were not undervalued and Shell India is not liable for tax claimed by the Indian government.

Copal Research Limited

The Copal Research case involved an indirect transfer of shares. The facts involve three share transfer agreements where Copal’s subsidiaries were transferred to a third party. As part of the transfer, two of the subsidiaries were Indian.

The tax authorities imposed taxes on the transaction, claiming the motivation behind the transaction was avoiding the capital gains tax. Under their interpretation of the Income Tax Act, when a non-Indian company is transferred by a non-resident (here, Copal), taxes may be levied if the transferred non-Indian company derives “substantial value” from Indian assets.

The Delhi High Court first ruled that there was a legitimate commercial purpose for the transaction, and that it was not tax avoidance. Next, the court put a more restrictive definition upon the term “substantial.” It held that if the gain from this type of a transaction cannot be taxed in India if the value of the Indian assets is less than 50% of the total value of the overseas company.

Understanding India’s Industry-Specific Tax Incentives

Vodafone

There have been two recent decisions involving Vodafone and transfer pricing. Neither of these cases were the more notorious Vodafone case, which sowed a lot of discord between foreign investors in India. Both cases here involved a different dispute between Vodafone and the Indian government. Like Shell India, transfer pricing came into play.

In one dispute, there was a transfer of shares between an Indian subsidiary and the parent company. The taxing authorities alleged that the transferred shares were undervalued, and that this transfer was really a disguised loan. Therefore, they taxed the shares at what they perceived to be the real value.

The court disagreed. It held that transfer pricing regulations were not applicable because there is no income in the transaction. 

The other decision was a pleading from 2012. Vodafone disputed the jurisdiction of the tax department, which issued a transfer pricing order that would raise Vodafone’s taxable income for the 2008 fiscal year. The ITAT denied this plea, meaning that the next step for Vodafone is to challenge the transfer pricing order at the Bombay High Court. The order arose from a 2007 transaction where Vodafone sold a portion of its business to a Hong Kong company.

Conclusion

These three positive decisions for taxpayers, when grouped together, could have significant implications for foreign companies operating in India. They serve as a rebuke to the Indian tax authorities, which have been aggressive in seeking income from foreign companies, particularly in the realm of transfer pricing. While the second Vodafone case is still winding its way through the courts, defeat for Vodafone is not certain. In addition, there are other cases similar to Shell India and the positive Vodafone decision in the pipeline, and these rulings may reassure the companies disputing those tax bills that they can win.

With the interpretation of laws by the court system, there is optimism that uncertainty amongst foreign investors can be reduced. While a top Ministry official recently hinted that the government may appeal these decisions, the Attorney General has advised against this strategy. If decisions like this continue, and any appeals are denied, the firms investing into India will come to know that they will only be taxed on their earnings in the country, and they can be secure that the court system will back them against potential tax overreach by the taxing authorities. There is a real chance that the era of “tax terrorism” is over.

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