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The Tax Publishers Topsgrup Electronic Systems Ltd. v. ITO [ITA No. 2115 (Mum.) of 2015, dt. 19-2-2016] : 2016 TaxPub(DT) 2151 (Mum-Trib) Re-characterization of income and potential future income in share capital transaction under TP *Facts:* Assessee was in the business of security services. The parent was a UK holding company which had many subsidiaries. One such subsidiary was Tops BV in Netherlands. Assessee was held by two investors India Advantage Fund & Indivision (two PE investors) along with its UK holding company. Arising out of a global acquisition by the group parent of another company Shields UK, the two Private equity investors and the parent company decided to invest in Sheilds UK. The transaction passed through with a share valuation of Sheids as per FEMA/RBI requirements with a discounted cash flow value of Shields UK share value. Since the parent felt that the investment in Shields UK will be routed though its subsidiary Tops BV of Netherlands, the parent divested portion of its holding in Tops BV Netherlands to the assessee subsidiary Topsgroup Electronic systems in India. The pricing of the Dutch subsidiarys shares was fixed at a price of Rs. 10 per share at a premium of Rs. 990 which was also mustered through a DCF valuation as per RBI/FEMA guidelines. Thus INR 124 crores moved as consideration from the assessee to Tops BV for the underlying shares of the holding company in Tops BV. The money was used by Tops BV to invest in Shields UK. The TPO gave a reading that the transaction was colourable and re-characterized the transaction of equity investment of the assessee as though a loan was granted by assessee to the Dutch entity and thus also subjected imputed interest on the same. This was also on the ground had the assessee not had funds with them, they would have resorted to borrowing and then investing in the group entity. The TPO applied schedule III of wealth tax provisions to arrive at the share valuation and thus recharacterized the equity as loan and made additions of interest as TP. This was also upheld by the Commissioner (Appeals). The assessee went in appeal: Held the transaction cannot be recharacterized as loan and no notional interest could be taxed under TP provisions. Following points are worth noting in this ruling :-- In the absence of income arising from international transaction no TP provisions can be applied. This was not accepted by ITAT that the income may be current or prospective. In the share there is a possibility of prospective income but the TPO has not demonstrated the impact of the prospective income but has only read an impact of a hypothetical transaction which may or may not happen. TP provisions are wide enough to circumscribe prospective gains as well but they should be transactions done/not hypothetical conjectures or surmises. Vodafone India Services Pvt. Ltd. in 368 ITR 001 (Bom) applied. Section 56(2)(viia) or (viib) cannot be used as a ploy to do add back on a capital transaction. To fall in its scope there has to be income and unless prescribed capital receipts are not income. There is no scope under TP to recharacterize the investment into loan. This plea was accepted by the ITAT based on the following judgments. (i) Besix Kier Dahbol SA [TS-661-HC-2012 (Bom)] (ii) Aegis Limited [TS-342-ITAT-2015 (Mum) -TP] (iii) Parle Biscuits Pvt. Ltd. [TS-127-ITAT-2014 (Mum) - TP] (iv) Mylan Laboratories Ltd. [TS-399-ITAT-2014 (Hyd) - TP] (v) Allcargo Global Logistics Ltd. [150 ITD 651 (Mum)] (vi) Prithvi Information Solutions Ltd. [34 ITR (T) 429 (Hyd)] (vii) Tooltech Global Engineering Pvt. Ltd. [51 taxmann.com 336 (Pune)] Departments plea that subsequently the assessee might sell the shares of Tops BV Netherlands at a lower value than the cost and show a capital loss in its books. Also the said shareholding of Tops BV might be sold to a non-AE thus falling out of TP transactions. This was not accepted by the ITAT on the ground that fresh grounds cannot be now brought into the case by the DR. Wealth tax provisions cannot be used to read into a bona fide transaction. The transaction of investment falls outside TP provisions. The notional addition cannot be sustained. OCED guidelines give power under TP to recharacterize on the following scenario which is missing in this case :-- 1.37 ............................. The first circumstance arises where the economic substance of a transaction differs from its form. .......... The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price.............. The departments view that inbound investment and outbound investment are to have differential treatment was also not accepted by the ITAT. This was on the premise that Vodafone case was on the basis of inbound investment and that of the assessee is outbound investment. In Vodafone India Services P. Ltd. in 368 ITR 001 (Bom) :-- 31. Similarly, the reliance by the Revenue upon the definition of International Taxation in the sub clause (c) and (e) of Explanation (i) to Section 92B of the Act to conclude that Income has to be given a broader meaning to include notional income, as otherwise Chapter X of the Act would be rendered otiose is farfetched. The issue of shares at a premium does not exhaust the universe of applicability of Chapter X of the Act. There are transactions which would otherwise qualify to be covered by the definition of International Transaction. The transaction on capital account or on account of restructuring would become taxable to the extent it impacts income i.e. under reporting of interest or over reporting of interest paid or claiming of depreciation etc. It is that income which is to be adjusted to the ALP price. It is only a tax on capital receipts. This aspect appears to have been completed lost sight of the impugned order. 42. It was contended by the Revenue that in any event the charge would be found in Section 56(1) of the Act. Section 56 of the Act does provide that income of every kind which is not excluded from the total income is chargeable under the head income from other sources. However, before Section 56 of the Act can be applied, there must be income which arises. As pointed out above, the issue of shares at a premium is on Capital Account and gives rise to no income. The submission on behalf of the revenue that the shortfall in the ALP as computed for the purposes of Chapter X of the Act give rise to income is misplaced. The ALP is meant to determine the real value of the transaction entered into between AEs. It is a re-computation exercise to be carried out only when income arises in case of an International transaction between AEs. It does not warrant re-computation of a consideration received/given on capital account. It permits recomputation of Income arising out of a Capital Account Transaction, such as interest paid/received on loans taken/given, depreciation taken on machinery, etc. All the above would be cases of income being affected due to a transaction on capital account. This is not the Revenues case here. Therefore, although Section 56(1) of the Act would permit including within its head, all income not otherwise excluded, it does not provide for a charge to tax on Capital Account Transaction of issue of shares as is specifically provided for in Section 45 or Section 56(2)(viib) of the Act and included within the definition of income in Section 2(24) of the Act.

The Tax Publishers

Topsgrup Electronic Systems Ltd. v. ITO [ITA No. 2115 (Mum.) of 2015, dt. 19-2-2016] : 2016 TaxPub(DT) 2151 (Mum-Trib)

Re-characterization of income and potential future income in share capital transaction under TP

Facts:

Assessee was in the business of security services. The parent was a UK holding company which had many subsidiaries. One such subsidiary was Tops BV in Netherlands. Assessee was held by two investors India Advantage Fund & Indivision (two PE investors) along with its UK holding company. Arising out of a global acquisition by the group parent of another company Shields UK, the two Private equity investors and the parent company decided to invest in Sheilds UK. The transaction passed through with a share valuation of Sheids as per FEMA/RBI requirements with a discounted cash flow value of Shields UK share value. Since the parent felt that the investment in Shields UK will be routed though its subsidiary Tops BV of Netherlands, the parent divested portion of its holding in Tops BV Netherlands to the assessee subsidiary Topsgroup Electronic systems in India. The pricing of the Dutch subsidiarys shares was fixed at a price of Rs. 10 per share at a premium of Rs. 990 which was also mustered through a DCF valuation as per RBI/FEMA guidelines. Thus INR 124 crores moved as consideration from the assessee to Tops BV for the underlying shares of the holding company in Tops BV. The money was used by Tops BV to invest in Shields UK. The TPO gave a reading that the transaction was colourable and re-characterized the transaction of equity investment of the assessee as though a loan was granted by assessee to the Dutch entity and thus also subjected imputed interest on the same. This was also on the ground had the assessee not had funds with them, they would have resorted to borrowing and then investing in the group entity. The TPO applied schedule III of wealth tax provisions to arrive at the share valuation and thus recharacterized the equity as loan and made additions of interest as TP. This was also upheld by the Commissioner (Appeals). The assessee went in appeal:

Held the transaction cannot be recharacterized as loan and no notional interest could be taxed under TP provisions.

Following points are worth noting in this ruling :--

In the absence of income arising from international transaction no TP provisions can be applied. This was not accepted by ITAT that the income may be current or prospective. In the share there is a possibility of prospective income but the TPO has not demonstrated the impact of the prospective income but has only read an impact of a hypothetical transaction which may or may not happen. TP provisions are wide enough to circumscribe prospective gains as well but they should be transactions done/not hypothetical conjectures or surmises. Vodafone India Services Pvt. Ltd. in 368 ITR 001 (Bom) applied.

Section 56(2)(viia) or (viib) cannot be used as a ploy to do add back on a capital transaction. To fall in its scope there has to be income and unless prescribed capital receipts are not income.

There is no scope under TP to recharacterize the investment into loan. This plea was accepted by the ITAT based on the following judgments.

(i) Besix Kier Dahbol SA [TS-661-HC-2012 (Bom)]

(ii) Aegis Limited [TS-342-ITAT-2015 (Mum) -TP]

(iii) Parle Biscuits Pvt. Ltd. [TS-127-ITAT-2014 (Mum) - TP]

(iv) Mylan Laboratories Ltd. [TS-399-ITAT-2014 (Hyd) - TP]

(v) Allcargo Global Logistics Ltd. [150 ITD 651 (Mum)]

(vi) Prithvi Information Solutions Ltd. [34 ITR (T) 429 (Hyd)]

(vii) Tooltech Global Engineering Pvt. Ltd. [51 taxmann.com 336 (Pune)]

Departments plea that subsequently the assessee might sell the shares of Tops BV Netherlands at a lower value than the cost and show a capital loss in its books. Also the said shareholding of Tops BV might be sold to a non-AE thus falling out of TP transactions. This was not accepted by the ITAT on the ground that fresh grounds cannot be now brought into the case by the DR.

Wealth tax provisions cannot be used to read into a bona fide transaction.

The transaction of investment falls outside TP provisions. The notional addition cannot be sustained.

OCED guidelines give power under TP to recharacterize on the following scenario which is missing in this case :--

1.37 ............................. The first circumstance arises where the economic substance of a transaction differs from its form. .......... The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price..............

The departments view that inbound investment and outbound investment are to have differential treatment was also not accepted by the ITAT. This was on the premise that Vodafone case was on the basis of inbound investment and that of the assessee is outbound investment.

In Vodafone India Services P. Ltd. in 368 ITR 001 (Bom) :--

31. Similarly, the reliance by the Revenue upon the definition of International Taxation in the sub clause (c) and (e) of Explanation (i) to Section 92B of the Act to conclude that Income has to be given a broader meaning to include notional income, as otherwise Chapter X of the Act would be rendered otiose is farfetched. The issue of shares at a premium does not exhaust the universe of applicability of Chapter X of the Act. There are transactions which would otherwise qualify to be covered by the definition of International Transaction. The transaction on capital account or on account of restructuring would become taxable to the extent it impacts income i.e. under reporting of interest or over reporting of interest paid or claiming of depreciation etc. It is that income which is to be adjusted to the ALP price. It is only a tax on capital receipts. This aspect appears to have been completed lost sight of the impugned order.

42. It was contended by the Revenue that in any event the charge would be found in Section 56(1) of the Act. Section 56 of the Act does provide that income of every kind which is not excluded from the total income is chargeable under the head income from other sources. However, before Section 56 of the Act can be applied, there must be income which arises. As pointed out above, the issue of shares at a premium is on Capital Account and gives rise to no income. The submission on behalf of the revenue that the shortfall in the ALP as computed for the purposes of Chapter X of the Act give rise to income is misplaced. The ALP is meant to determine the real value of the transaction entered into between AEs. It is a re-computation exercise to be carried out only when income arises in case of an International transaction between AEs. It does not warrant re-computation of a consideration received/given on capital account. It permits recomputation of Income arising out of a Capital Account Transaction, such as interest paid/received on loans taken/given, depreciation taken on machinery, etc. All the above would be cases of income being affected due to a transaction on capital account. This is not the Revenues case here. Therefore, although Section 56(1) of the Act would permit including within its head, all income not otherwise excluded, it does not provide for a charge to tax on Capital Account Transaction of issue of shares as is specifically provided for in Section 45 or Section 56(2)(viib) of the Act and included within the definition of income in Section 2(24) of the Act.