EY Tax Alert. Executive summary
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1 16 December 2014 EY Tax Alert Ruling of the Mumbai Tribunal on scope of international transaction and deemed international transaction for applicability of transfer pricing provisions Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This tax alert summarizes a recent ruling of the Mumbai Income Tax Appellate Tribunal (ITAT) in the case of Vodafone India Services Pvt. Ltd. (Vodafone Services or Taxpayer) [1] on the scope of the definition of international transaction and deemed international transaction for applicability of transfer pricing (TP) provisions of the Indian Tax Laws (ITL). The ITAT, based on the facts of the case, ruled that the revision of Framework Agreements (FWA) considered in conjunction with relevant shareholders agreement, amounted to assignment/ transfer of call options rights held by the Taxpayer in favor of its nonresident (NR) Associated Enterprise (AE) and therefore qualifies as an international transaction under the TP provisions of the ITL. The ITAT reached this conclusion even though there was no formal or written agreement between the Taxpayer and its AE for the transfer/assignment. The ITAT accordingly upheld the TP adjustment for determining the Arm s Length Price (ALP) which the Taxpayer should have received for assignment/transfer of the option rights. Further, in respect of the sale of call centre business by the Taxpayer to another domestic entity, Hutchison Whampoa (India) Pvt. Ltd. (HWP India), a subsidiary of Hutchinson Whampoa Ltd. (HWL), the ITAT ruled that the transaction was in substance entered into between the Taxpayer and HWL, an NR AE of the Taxpayer, even in the absence of a formal or written agreement between the Taxpayer and its AE for the business sale. The ITAT therefore held that the same constituted an international transaction under the ITL. The ITAT upheld that Discounted Cash Flow (DCF) was to be considered for determining the ALP for the sale of call centre business; but remanded the manner of computation of the ALP back to the Tax Authority. [1] Vodafone India Services Pvt. Ltd. V. Assistant Commissioner of Income Tax [TS-422-ITAT-2014(mum)-TP].This alert discusses only the issues relating to the scope of transfer provisions under appeal before the ITAT.
2 Detailed discussion Background The Taxpayer is a wholly owned and indirect subsidiary of CGP Investments (Holdings) Ltd. (CGP Investments), a company incorporated in the Cayman Islands. The shares of CGP Investments were held by HTI (BVI) Holdings Ltd., a company incorporated in British Virgin Islands which, in turn, was ultimately controlled by Hutchison Telecommunications International Ltd. (HTIL), a company incorporated in the Cayman Islands. The Taxpayer was engaged in provision of call centre services to Hutchison Group of companies. The holding structure and the transactions detail have been pictorially depicted below. HTIL had provided credit support to Mr. Asim Ghosh and his group of companies (AG) as well as to Mr. Analjit Singh and his group of companies (AS) wherein AG and AS acquired indirect control to the extent of 12.5% shares in Hutchison Essar Ltd. (HEL) (now known as Vodafone India Ltd. [2] ). In consideration [2] The acquisition of HEL was made through another Indian company called Telecom Investments India Pvt. Ltd. (TII). for the credit support, the Taxpayer entered into FWA on 1 March 2006 with AG and AS under which call options were provided to the Taxpayer to buy from AG and AS their entire share holdings in TII and consequently the indirect shareholding in HEL. In August 2006, with the financial assistance of HTIL and the Taxpayer, an FWA with IDFC was executed, in consideration for which the
3 Taxpayer was given a call option to buy additional control in HEL to the extent of 2.5% (through a different company). In February 2007, pursuant to the agreement for Sale and Purchase of Share and Loans (SPA) entered into between HTIL and Vodafone International Holdings BV (VIH BV), HTIL agreed to transfer the entire issued share capital of CGP Investments, free from all encumbrances together with all rights attaching or accruing, and together with assignment of loan interests to VIH BV. Further, as per the SPA, VIH BV wanted to purchase the entire share capital in CGP Investments except the call centre business housed in the Taxpayer entity. In order to hive off the call centre business, the Taxpayer entered into a business transfer agreement (BTA) with HWP India. Further, in light of the SPA with VIH BV, the Taxpayer entered into a revised FWA in 2007 in respect of AG and AS Companies with certain changes, largely to capture change in parties and revised names of the parties to the FWA. Some of the changes in the terms and conditions of 2007 FWA led the Tax Authority to believe that it resulted in assignment/transfer of call option rights held by the Taxpayer as per the 2006 FWA in favour of its AE and thereby qualified as an international transaction to which TP provisions applied. Further, having regard to the global purchase agreements between HTIL and VIH BV, the Memorandum of Understanding between Taxpayer and HWP India, the BTA as well as the SPA, the Tax Authority observed that there exists a prior agreement among the affiliates and the sale of call centre business was to give effect to the global arrangement. Applying the Doctrine of lifting of corporate veil and Substance over Form, the Tax Authority concluded that the sale of call centre business was a transaction in effect entered into between the Taxpayer and its NR AE i.e. HWL, even though it was effected between two domestic companies (i.e. Taxpayer and HWP India). The Taxpayer, in the TP study and the accountants report in Form 3CEB for financial year (FY) , did not consider the assignment of call options and sale of call centre business as international transactions. However, during the audit proceedings, the Tax Authority determined these transactions to be international transactions within the ambit of the ITL and proceeded to compute the ALP as follows : In respect of the call option rights, the Tax Authority compared the call option in 2007 FWA to the value of option rights vested to the Tax payer under the IDFC agreement and applying the Comparable Uncontrolled Price (CUP) method, made an adjustment of about INR61.78 billion. In respect of sale of call centre business, while the Tax Authority observed that use of DCF was appropriate, in the absence of information pertaining to future cash flows of the Taxpayer, the Tax Authority computed that share value based on Profit Earning (PE) multiple of comparable listed companies and made an adjustment to the tune of INR23.50 billion (subsequently reduced to INR14.08 billion in the final assessment order). Aggrieved by the TP adjustments proposed by the Tax Authority, the Taxpayer filed its objections before the Dispute Resolution Panel (DRP), an alternate dispute resolution mechanism under the ITL. The Taxpayer also filed a writ petition before the Bombay High Court (HC) to quash and set aside the TP adjustment. The HC held that there are several issues of fact and of law on every material aspect which must be considered by the Tax Authority under the ITL. Hence it is not a fit case for invoking the extraordinary jurisdiction under Article 226 of the Constitution of India [3]. [3] Refer EY Tax Alert dated 18 September 2013 on Ruling of Bombay High Court on maintainability of Writ petition of transfer pricing matter
4 In the interim, the Taxpayer also sought a stay on further proceedings before the DRP on various grounds. However, the HC held that it was not necessary to provide interim relief as the due date to pass DRP directions was to expire within few days. The HC directed that the DRP may continue with the proceedings but no order shall be communicated to the Taxpayer unless as directed by the HC. Thereafter, the DRP passed its order in which it upheld the order of the TPO, with some enhancements and reduction in the quantum of TP adjustments. Aggrieved by the DRP s direction, the Taxpayer filed an appeal before the ITAT against the final assessment order passed as a result of the DRP directions.. Ruling of the ITAT Assignment/transfer of call options Various factual and legal arguments were put forth by both the Taxpayer and the Tax Authority. Having heard both sides, the ITAT held as follows: The decision of the Supreme Court (SC) in the case of VIH BV [4] examined the question in the context of transfer of asset by HTIL to VIH BV and not in the context of the transfer of option rights by the tax payer. Hence, the SC s decision is binding on all subordinate courts only on the principle laid down on the substantial question of law as it is based on either undisputed facts or on assumption of facts and cannot be said that the decision is binding even on the facts that are in dispute in the current case. Section 2(47) of the ITL lays down the definition of transfer. The SC s decision is based on un-amended provisions of section 2(47) and hence it shall not be considered a binding precedent so far as applicability of amended provisions of section 2(47) [5] of the ITL is concerned and that too to the additional facts brought on record in this case. It is undisputed that the call option rights held by the Taxpayer is a valuable right. The re-writing of the 2007 FWA, in itself, did not amount to assignment of call options rights. However, based on a combined reading of 2007 FWA, shareholders agreement dated 5 July 2007 (entered into between the TII, TII s shareholders, CGP Investments and VIH BV) and other relevant facts and circumstances, the call options rights under the 2007 FWA held by the Taxpayer were assigned/transferred in favor of CGP Investments, its AE. The rights of the Taxpayer ceased to exist the moment the shareholders agreement was signed. As contemplated under section 92B read with section 92F(v) of the ITL, there shall be an international transaction if there is an arrangement, understanding and action in concert, whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings or not, provided the said understanding, arrangement and action has a bearing on the profits, income, losses or asset of the enterprises. [4] Refer EY Tax Alert dated 20 January 2012 SC Rules transfer of shares of foreign company that indirectly held underlying Indian assets not taxable. [5] Vide Finance Act 2012, Explanation 2 to section 2(47) was inserted with retrospective effect which read as For the removal of doubts, it is hereby clarified that "transfer" includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India."
5 A consideration was paid by VIH BV for securing the call option rights. Hence, the mutual understanding and arrangement as well as action in concert between the Tax payer and VIH BV for securing the call option rights would be considered as an international transaction as per the provisions of section 92B read with section 92F(v) of the ITL. With respect to valuation of the option rights, the Taxpayer had made various arguments against the approach adopted by the Tax Authority by citing differences in underlying shares, difference in option price, cash vs. cashless consideration etc. The Taxpayer also submitted that the value of the options was determined to be nil based on valuation report prepared by valuation expert. Considering various material brought on record and having regard to the arguments made by Taxpayer and the Tax Authority, the ITAT held as follows: The options under the agreement with IDFC and the options assigned by the Taxpayer to its AE under 2007 FWA were both for acquisition of shares in HEL. The presence of layers of upstream/downstream companies without any other asset except the shares of HEL made both options equivalent/comparable. The ALP determined by the Tax Authority was appropriate and the computation of capital gains must consider the cost of acquisition of options. Sale of call centre business Having heard both sides, the ITAT observed/ held as follows: The chronological sequence of the execution of SPA and BTA are given under: Date Description 11 February 2007 HTIL enters into SPA with VIH BV 8 May 2007 Taxpayer enters into a BTA with HWP India 8 May 2007 Completion of SPA post signing of BTA 4 December 2007 Sale of call centre business post receipt of requisite statutory approvals/ licenses. Up to 8 May 2007, the Taxpayer was a subsidiary of HTIL Group and after 8 May 2007, the Taxpayer was a subsidiary of VIH BV Group. Hence, the Taxpayer was AE of both HTIL and VIH BV during the relevant year. The execution of BTA was observed to be a pre-condition to the SPA entered into between HTIL and VIH BV. HWP India lacked commercial or economic substance prior to acquisition of the call centre business and the payment for acquisition of the call centre business was in effect made by HWL by routing the transfer of funds through the bank account of HWP India. HWP India had no economic interest in the purchase of call centre business and was interposed in the transaction only to avoid chargeability of tax under the provisions of transfer pricing under the ITL. Hence, by lifting corporate veil, it can be said that the transaction was in substance entered into between the Taxpayer and HWL, an NR company and therefore was covered under the provisions of section 92B(1) of the ITL. On the issue of the applicability of section 92B(2) of the ITL regarding the Tax Authority s contention of treating the sale of call centre business as deemed international transaction, the ITAT ruled that while there existed a prior agreement in the form of SPA, the transaction of the Taxpayer was not with a person other than an associated enterprise as required by section 92B(2) of the ITL. Hence, it cannot be considered as deemed international transaction. With regard to determining the ALP for sale of call centre business, the ITAT rejected the approach adopted by the Tax Authority and ruled that DCF method was the most appropriate method to value the call centre business and set aside the matter to the record of the Tax Authority for determination of ALP.
6 Implications TP provisions under the ITL are applicable to international transactions. The term international transaction would generally cover transactions between two or more AEs, where either one or both of them are NRs. The ITL also deems transactions with non-aes to be an international transaction (and therefore subject to TP provisions) if a prior agreement exists in relation to the relevant transaction between the non-ae and the AE, or the terms of the relevant transaction are determined in substance between the non-ae and the AE. Further, the term transaction has been defined to include an arrangement, understanding or action in concert whether or not such an arrangement, understanding or action is formal or in writing or intended to be enforceable by legal proceedings. This ruling highlights the importance of considering the overall facts and circumstances, intent and conduct of the parties and substance of the arrangement to determine existence an international transaction, even in situations where the apparent transaction is between non-aes or between parties resident in India. Taxpayers may need to review impact of the ruling on their business and commercial arrangements to assess if they have properly identified, documented and reported any international transaction or deemed international transaction that may be embedded in these arrangements.
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