2014 (12) TMI 1204 - AT - Income Tax

Transfer pricing adjustment - transaction of issue of equity shares - Held that - The capital receipts received by the assessee on issue of equity shares to its holding company cannot be considered income. Ajustment made by the AO on account of share premium and interest charged on account of under charged premium amount cannot be endorsed. We also hold that TP provisions are not applicable to such transaction. See Vodafone India Services Private Limited case 2014 (10) TMI 278 - BOMBAY HIGH COURT - Decided in favour of the assessee.

Summary

Issues Involved:

1. Jurisdiction and validity of the assessment order.
2. Transfer pricing adjustment of Rs. 122.62 crore.
3. Applicability of transfer pricing provisions to share premium.
4. Splitting of the transaction of issue of shares.
5. Benchmarking of capital receipts under Chapter X.
6. Application of Section 2(47) and capital gains.
7. Taxability of notional receivables.
8. Addition of notional interest of Rs. 7.69 crore.
9. Valuation of shares and application of methods.
10. Rejection of assessee's valuation method.
11. Incorrect application of the Discounted Cash Flow (DCF) method.
12. Transfer pricing adjustment reduction.

Detailed Analysis:

1. Jurisdiction and Validity of the Assessment Order:
The assessee challenged the jurisdiction and legality of the assessment order passed under Section 143(3) read with Section 144(C) of the Income Tax Act, asserting that it was without jurisdiction and bad in law. The Tribunal held that the assessment order was in pursuance of directions issued by the Dispute Resolution Panel (DRP) and was within jurisdiction.

2. Transfer Pricing Adjustment of Rs. 122.62 Crore:
The assessee contested the transfer pricing adjustment of Rs. 122.62 crore made by the Assessing Officer (AO) based on the Transfer Pricing Officer's (TPO) recommendation. The Tribunal found that the adjustment was not justified, referencing the Bombay High Court's decision in the Vodafone India Services Pvt. Ltd. (VISPL) case, which held that share premium received on the issue of shares is a capital receipt and not income.

3. Applicability of Transfer Pricing Provisions to Share Premium:
The Tribunal noted that the transfer pricing provisions do not apply to capital receipts such as share premium. The decision in the VISPL case was cited, wherein it was held that capital receipts on the issue of equity shares to a holding company cannot be considered income under the Act.

4. Splitting of the Transaction of Issue of Shares:
The AO/TPO/DRP had split the transaction of issuing shares into two separate transactions: the issue of equity shares and the grant of financial assistance. The Tribunal held that there was no provision in the Act that permitted such splitting and that the General Anti-Avoidance Rule (GAAR) provisions, which allow for recharacterization of transactions, were not in force during the assessment year in question.

5. Benchmarking of Capital Receipts under Chapter X:
The AO/TPO/DRP considered the difference between the arm's length price of equity shares and the actual amount received as an international transaction. The Tribunal found that capital receipts do not need to be benchmarked under Chapter X, as they are not considered income.

6. Application of Section 2(47) and Capital Gains:
The AO/TPO/DRP held that the assessee had extinguished a right under Section 2(47)(i) and Section 2(47)(ii) of the Act, considering it a transfer for capital gains determination. The Tribunal disagreed, stating that the issuance of equity shares creates rights rather than transferring them, and thus, does not give rise to capital gains.

7. Taxability of Notional Receivables:
The AO/DRP/TPO confirmed the taxability of alleged notional receivables without specifying the relevant heads of income. The Tribunal held that Chapter X is not a separate code and Section 92 is not a separate charging provision.

8. Addition of Notional Interest of Rs. 7.69 Crore:
The DRP confirmed the addition of notional interest of Rs. 7.69 crore. The Tribunal found this addition to be erroneous, following the VISPL case, which ruled that such interest on deemed loans arising from share premium adjustments is not taxable.

9. Valuation of Shares and Application of Methods:
The AO/TPO/DRP incorrectly valued the arm's length price of the equity shares. The Tribunal held that the prescribed methods were not applied correctly in the present case, and thus, the transfer pricing adjustment should not have been made.

10. Rejection of Assessee's Valuation Method:
The AO/TPO/DRP rejected the assessee's valuation method and held that the Discounted Cash Flow (DCF) method was the proper method for valuation of shares. The Tribunal found that the DCF method was incorrectly applied, leading to an overvaluation of the fair value of the shares.

11. Incorrect Application of the Discounted Cash Flow (DCF) Method:
The Tribunal noted that the DCF method was incorrectly applied, resulting in a significant overvaluation of the shares. The VISPL case was cited, which emphasized that the capital receipts on the issue of shares cannot be considered income.

12. Transfer Pricing Adjustment Reduction:
The assessee prayed for the deletion or appropriate reduction of the entire transfer pricing adjustment of Rs. 122.62 crore. The Tribunal, following the Bombay High Court's decision in the VISPL case, allowed the appeal of the assessee and deleted the entire transfer pricing adjustment.

Conclusion:
The Tribunal allowed the appeal of the assessee, deleting the transfer pricing adjustment of Rs. 122.62 crore and the notional interest addition of Rs. 7.69 crore. The appeal filed by the AO was dismissed. The judgment emphasized that capital receipts on the issue of shares cannot be considered income and that transfer pricing provisions do not apply to such transactions. The Tribunal followed the precedent set by the Bombay High Court in the VISPL case.