Are all cross border share issues immune from TP & tax scrutiny?
Bombay High Court in case of Vodafone concluded that issue of shares is on capital account and does not give rise to any "income" including u/s 56(1), unless specifically provided under the law. HC also observed that “Parliament has consciously not brought to tax amounts received from a non-resident for issue of shares (unlike Sec 56 applicable to residents), as it would discourage capital inflow from abroad”. HC also observed that there is no charge express or implied, in letter or in spirit, to tax issue of shares at a premium as income. Thus, ruling in Vodafone’s favour, HC held that Chapter X - Transfer Pricing, is not a complete code, but a machinery provision to arrive at arm's length price (ALP) and hence one can't read a charging provision into Chapter X, absent specific charging section. The decision also goes to the fundamentals of transfer pricing as it deals with whether tradition “income” principles can be re-looked at by invoking transfer pricing law.
However, my humble take on Vodafone and other decisions is that one cannot hold a blanket proposition that a cross border share issue does not give rise to an income & hence immune from tax scrutiny.
Let’s take a situation where a ‘right share issue’ is made to one of the JV partners in such a way that other partner is diluted. Or a situation where shares are issued to an overseas entity situated in a Tax Favourable Jurisdiction at less than fair values so as to take the benefit of tax exemption available under a particular tax treaty on future capital appreciation. Such cases would certainly give rise to ‘income’ & hence, share valuation should be subject to tax & transfer pricing scrutiny.