Transfer Pricing .. from Economic point of view.!

The latest Transfer Pricing Adventure, a new angle ….                                                              

There has been much of a controversy lately about the tax demands raised against the Multinational Shell, Vodafone, etc. in the matter relating to under-pricing of shares issued by these companies to its Associated Enterprises sitting in foreign countries. The Income tax department has been struggling hard to uncover the impugned transactions claiming them as deceptive, under the transfer pricing regulations and provisions. There are some respected economists who are on one hand constantly jabbering and babbling about how these actions on the part of the I.T Dept. will discourage the future economic conditions FDI, etc. and on the other hand forgetting completely that such approach is completely antithetical as far as their bother about country’s economic interest is concerned.

The manipulative nature of the transaction can be scrutinized by simple logic. For e.g., Shell India which is engaged in business of exploitation / exploration of natural resources of India has availed various kinds of licenses, permissions etc. from the Indian Government for its such functioning. Now on one hand where it has all the authority to extract this valuable crude given by India, can it just be allowed to value it at such a petty price of Rs. 10/- per share being the price at which ownership in the company is invited to its own Associated Enterprise sitting in foreign Country. If yes, why not such shares unbiasedly issued to Indian investors as well, at such price? Furthermore when MNCs of this level of business like Vodafone, Nokia, etc. are using the services, resources, facilities and infrastructure provided by the Indian Government, it cannot be just freely permitted to indirectly transfer its ownership just by using a manipulative legal mask and thereby abusing legal provisions for personal benefit. This will then result in undermining of the Indian infrastructure and so its wealth and be a catastrophe for the Indian economy !

The whole ‘Transfer-Pricing’ regulations have been enacted to check on the improper transfer of benefits arising in the country, to stake owners sitting in Foreign Countries, thereby causing a loss to Indian Economy. Economists can’t take a narrow minded approach about country’s economy harping about probable discouragement for FDIs, simultaneously ignoring the current losses caused to the economy due to such manipulative practices on part of MNCs. The income tax department, by using the machinery provided to it, has been trying to apply a correct value to the stake in such companies so that the benefit arising from Indian Resources’ utilization doesn’t get transferred to the foreign stake owners at a miserably petty price. Such companies are not only sabotaging the intent for which the whole transfer pricing regulations were enacted but by such deceptive forms are also disturbing the country’s need and idea for FDI. The percentage FDI which would have been otherwise induced at a particular value consequently came to be brought about in the same proportion but for a lesser value due to such current form. The concise nature of the definition of the term ‘International transaction’ in the Transfer pricing provisions, doesn’t mention all the nature and details of the transactions entered, taking benefit of which large no. of taxpayers have omitted to report the International transactions. Therefore for clarification purpose, section 92B of the Income tax was amended by the Legislature in the last Finance Bill 2012 whereby transaction of Business re-organization and Restructuring were also made to be included. This insertion undisputedly applies to such Re-organizing and restructuring transactions irrespective of the fact that it has a bearing on Profits, income, losses or Assets of the Enterprise. This amendment being a clarification of the intended Legislative purpose was inserted by way of Explanation to the section 92B with retrospective effect from 1.4.2002.

            Some Critics have also alleged that the instant scenario, if compared to a Bonus Issue, clearly illustrates that the taxing action of the Dept. is rubbish! But hello, the same logic cannot, by any stretch of imagination apply to the current scenario !!   Comparing two totally diverse things as such is absolutely non-sensical.  Although in a bonus issue, the benefit of owning a stake in a company is passed for free, such issue is always made to all the shareholders in an unbiased manner. Also there is no issue of new capital but the existing ownership is further diluted into a larger no. of shares, and no specific Associated Enterprise of the company has right to subscribe to a bonus issue.

The reasonability of determinations of price /value of assets transferred on the part of the I.T. Officials in such transfer pricing cases depends on how they substantiate it and how satisfactory and plausible it is found by the adjudicating forums. The Judicial authorities are undoubtedly competent to decide the issue in a way that will finally meet the ends of Justice from all perspectives.

Sahil Garud
Chartered Accountant

Res Integra – section 45(2) r.w.s 54

Res Integra – section                         Sahil Garud

45(2) r.w.s 54                                       [B.com, A.C.A.]

It is true that the glitches and blotches in the literal language of the law, with various sections linked together, are noticed only when a sui generis practical scenario pops up which challenges its position in such well-constructed law. This is another such situation which needs clarifications and opinions so that the tax professionals can be impeccable in the advice they provide on tax mitigation through planning.

        When any tax payer decides to convert his investment/property, say a residential house on a plot of land being a capital asset covered u/s 2(14), into his stock in trade (SIT) with a view to deal in that property, he suffers a notional capital gain. Such gain is measured as the difference between the Fair Market value as on the date when he converts his asset & the original cost of acquisition (with indexation) of the Property. Such a charge is made under the provision of section 45(2). The Supreme Court Judgment in the case of CIT Vs. Bai Shririnbai Kooka (46 ITR 86 SC) dated 23/02/1962 following its verdict in the Bombay High Court (30 ITR 753) had an great impact on the plans of revenue authorities and it may be considered as a reason for enactment of this section 45(2) originally w.e.f 01.04.64. The Court in that case held in favour of the Assessee saying that a person cannot make profit out of himself and hence charged only that portion of Income which was arrived at as a difference between the market value on the date of conversion and the final sale value of the stock in trade (SIT).

        According to me, the legislature in its wisdom deferred the charge of the capital gain introduced by 45(2) till a date when the stock is actually sold, since such gain is a notional gain and the assessee does not receive any actual consideration on the date of its transfer. In this era of inflation of property prices, charging the Assessee with a heavy amount of tax just on conversion of his property into his stock in trade would result in undue hardship to the Assessee. Therefore such deferment of tax payment till the date of actual sale of the stock in trade and thus till an actual receipt of some consideration thereon was well justified. But according to me, the position w.r.t. timing of investment u/s 54/54F…(series) so as to claim exemption from the capital gain still needs clarification from viewers and experts. The literal reading of the section 45(2) and section 54 doesn’t give a clear picture and leave a scope for argument due to slight ambiguity.

Section 45(with subs.1 to 6) is the charging section, subsection (2) of which deals with the current scenario put forward here. This subsection (2) reads as follows: “Notwithstanding anything contained in subsection (1), the profits and gains arising from transfer by way of conversion by the owner……………………… as a result of transfer of the capital asset”. Thus by using the words “transfer by way of conversion” this section recognizes the conversion as the transfer with regard to timing of the gain.

Now, the plain reading of Section 54 says that “Subject to provisions of subsection (2),………then], instead of capital gain being charged to income tax as income of the previous year in which transfer took place, it shall be dealt with in accordance with…….” Thus it can be / might be construed by the Revenue authorities that since section 54 in the above given portion refers to the year in which transfer took place while simultaneously section 45 using the words ‘transfer’ interchangeably with ‘conversion’, the time limit for an Assessee to invest as per section 54 (2 years/3years) will start ticking from the date of conversion. But such interpretation is contrary to the very scheme of the Act and in a way fails to avoid the Assessee’s hardship.

        As said above, since the legislature has purposely deferred the charge on capital gain till he actually earns some consideration by selling the stock, in a similar way the time limit for enjoying the benefit of exemption should also be deferred. Discrimination can’t be made between subsection (2) and other subsections of section 45, all being part of the same charging section. An Assessee suffering a charge under other subsections of section 45 and the Assessee suffering it u/ss (2) must be given equal opportunity to claim exemptions as per the charging provisions, otherwise it can be argued as a violation of Article 14 of the Constitution of India in so far as it makes such discrimination. Therefore these provisions should be interpreted in such a way that time limit (2/3 years) for investment u/s 54 would incept from the day when he actually receives some consideration, in the same way as the charge is deferred till the stock is sold. Deferring the charge but not deferring the time limit for investment u/s 54 would go against the scheme of the act.

“It should be remembered that ‘language’ is at best an imperfect instrument for the expression of human intention.” 

It is a well settled position in law following the Supreme Court Judgment in case of CIT Vs. J.H Gotla (1985 AIR 1698) that, if a result which is not intended to be subserved by the object of the legislation is found from literal interpretation, and if another construction is possible apart from strict literal construction, then that construction should be preferred to the strict literal construction. In other words, where the plain literal interpretation of a statutory provision produces a manifestly unjust result which could never have been intended by the Legislature, the court can modify the language used by the Legislature. Also in the case of Bajaj Tempo (1992 AIR 1622) the Hon’ble Supreme Court of India resorted to an interpretation which was different from the literal interpretation saying that “it becomes necessary to resort to a construction which is reasonable and purposive to make the provision meaningful, and adopting literal construction in such cases would result in defeating the very purpose of the relevant sections”. The Hon’ble Bombay High Court also in the case of CIT Vs. Manjula Shah (16 Taxmann 42) while dealing with a matter w.r.t. Capital gain taxation, permitted that the meaning of one section can be imported while interpreting the other linked section so that the overall interpretation does not go contrary to the scheme of the Act and the legislative intent.

Therefore, according to me, while interpreting the provisions of section 54 which exempts the Charge of tax in the year of transfer, the meaning and intent of deferring the charge as per section 45(2) should be imported into this section so as to give proper justice to the scheme of the Act and so to the Assessee.

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Sahil Garud

Chartered Accountant.

Bom. High Court