2015 (6) TMI 492 - AT - Income Tax

Transfer pricing adjustment - addition on account of interest on the deemed loan, determined as a result of the issue of shares at value lower than their fair value estimated by the Transfer Pricing Officer (TPO) - whether the transaction of issue of share capital leads to generation of any income chargeable to tax in the hands of a company issuing shares, warranting the substitution of such income with income determined on the basis of its ALP? Held that - Since the transaction of purchase of asset is on capital account, there can be no addition of ₹ 200 (Rs.300 minus ₹ 100), being the difference between the ALP and transacted value. However this international transaction of purchase of asset on capital account having impact on the income of the assessee by means of transaction of claim of depreciation is to be adjusted to the ALP price. Consequently, the TPO will be within his jurisdiction to determine the ALP of the transaction of claim of depreciation by reducing it to ₹ 10 on the basis of the ALP of the international transaction on capital account, for which no addition of ₹ 200 is maintainable. Similar is the position as regards the under reporting of interest on an international transaction on a capital account. The Hon ble High Court in Shell India Markets Pvt. Ltd. Vs. ACIT 2014 (11) TMI 897 - BOMBAY HIGH COURT following the judgment in Vodafone India Services Pvt. Ltd. (2014 (10) TMI 278 - BOMBAY HIGH COURT) held that there can be no addition by applying the provision under Chapter-X on account of less share premium received and also the consequential interest on the resultant deemed loan. The learned DR has not drawn our attention towards any contrary judgment not mandating the determination of ALP of interest on deemed loan consequent upon issue of shares by an Indian company to its non-resident AE at lower price than its fair market value. Respectfully following the precedent, we hold that the addition of ₹ 6.63 crore on account of interest on the deemed loan due to under-receipt of share premium, upheld by the learned CIT(A), cannot be sustained. Accordingly, the addition is deleted - Decided in favour of assessee.

Summary

Issues Involved:
1. Transfer pricing adjustment on account of interest on deemed loan due to the issue of shares at a value lower than their fair value.

Detailed Analysis:

1. Transfer Pricing Adjustment on Account of Interest on Deemed Loan:

The appeal concerns the addition sustained due to a transfer pricing adjustment related to interest on a deemed loan, which arose because shares were issued at a value lower than their fair value as estimated by the Transfer Pricing Officer (TPO). The assessee, a 100% Indian subsidiary of a German company, issued shares at Rs. 10 per share, while the book value was Rs. 13.70 per share. The TPO considered this under-valuation as a deemed loan to the Associated Enterprises (AEs) and calculated interest on this deemed loan.

The TPO determined the arm's length value of the shares at Rs. 13.70 per share, treating the differential amount of Rs. 47.40 crore as a deemed loan and proposed a transfer pricing adjustment of Rs. 6.63 crore based on a 14% interest rate. This addition was upheld by the Assessing Officer (AO) and affirmed in the first appeal.

2. Legal Framework and Interpretation:

Section 92(1) of the Income-tax Act, 1961, mandates that any income arising from an international transaction should be computed with regard to the arm's length price (ALP). The transaction of issuing shares was rightly considered an international transaction. However, for the provisions of Chapter-X to be invoked, the transaction must result in income chargeable to tax.

The definition of 'international transaction' under Section 92B includes transactions affecting the assets of enterprises, such as capital financing. However, the issuance of shares, being a capital transaction, does not inherently generate taxable income. The Finance Act, 2012, introduced Section 56(2)(viib), which taxes excess consideration received over the fair market value of shares from resident shareholders, but this provision does not apply retrospectively or to non-resident shareholders.

3. Judicial Precedents:

The Bombay High Court in Vodafone India Services Pvt. Ltd. held that Chapter-X does not change the character of receipts but allows re-quantification of income based on ALP. The court ruled that the issue of shares at a premium does not generate taxable income, and hence, no addition can be made for transfer pricing adjustments on capital receipts.

Similarly, in Shell India Markets Pvt. Ltd., the court held that no addition could be made for transfer pricing adjustments on less share premium received, nor for consequential interest on deemed loans.

4. Application to the Current Case:

The tribunal concluded that the transaction of issuing shares at a lower price does not generate taxable income, and thus, no addition can be made for transfer pricing adjustments. The TPO's treatment of the differential amount as a deemed loan and the subsequent interest adjustment was found unsustainable.

The tribunal, following the precedents set by the Bombay High Court, deleted the addition of Rs. 6.63 crore on account of interest on the deemed loan due to under-receipt of share premium.

Conclusion:

The appeal was allowed, and the addition of Rs. 6.63 crore was deleted, as the transaction of issuing shares at a lower value did not result in taxable income, and the interest on deemed loan adjustment was not justified.

Decision Pronounced:

The decision was pronounced in the open court on 5th June 2015.