High Court Ruling: Amounts Received on Share Issue Not Taxable

Case Name:** Equinox Business Parks (P) Ltd. vs. Union of India **Key Takeaways:** 1. The issue of shares and convertible debentures by an Indian company to its non-resident associated enterprises is a capital account transaction, not income. 2. The provisions of the Income Tax Act's Chapter X on transfer pricing do not apply to capital account transactions that do not result in taxable income. 3. The High Court's decision follows the precedent set in the Vodafone case, which held that the issue of shares does not give rise to taxable income. **Issue:** Whether the amounts received by the company on the issue of equity shares and convertible debentures to its non-resident associated enterprises can be taxed under the provisions of the Income Tax Act. **Facts:** - The company, Equinox Business Parks (P) Ltd., had issued 8,89,997 equity shares at a premium of ₹1,990 per share and 8,56,462 convertible debentures at a premium of ₹1,990 per debenture to its non-resident associated enterprises. - The tax authorities sought to tax the company on the basis that the issue price of the shares and debentures was lower than the arm's length price, resulting in deemed income. - The company challenged the tax authorities' orders before the High Court. **Arguments:** - The company argued that the issue of shares and debentures is a capital account transaction, not income, and therefore not taxable under the Income Tax Act. - The tax authorities argued that the shortfall in the issue price compared to the arm's length price should be treated as deemed income and taxed accordingly. **Key Legal Precedents:** - The High Court relied on the decision in the Vodafone case (Vodafone India Services Pvt. Ltd. vs. Union of India, 368 ITR 1), which held that the issue of shares does not give rise to taxable income. - The court also cited sections 2(24), 4, and 5 of the Income Tax Act, which define "income" and the charging provisions for taxation. **Judgment:** - The High Court ruled in favor of the company, holding that the amounts received on the issue of shares and debentures are capital account transactions not taxable under the Income Tax Act. - The court set aside the orders of the tax authorities that sought to tax the company on the basis of the issue price being lower than the arm's length price. **FAQs:** Q: Why did the High Court rule in favor of the company? A: The High Court ruled in favor of the company because it held that the amounts received on the issue of shares and debentures are capital account transactions, not income, and therefore not taxable under the Income Tax Act. The court relied on the precedent set in the Vodafone case and the provisions of the Income Tax Act that define "income" and the charging provisions for taxation. Q: What is the significance of this ruling? A: This ruling is significant because it establishes that the issue of shares and debentures by an Indian company to its non-resident associated enterprises is a capital account transaction, not income, and therefore not subject to taxation under the Income Tax Act. This provides clarity and certainty for companies engaged in such transactions. Q: Can the tax authorities appeal this decision? A: The tax authorities have the option to appeal the High Court's decision to a higher court, such as the Supreme Court, if they believe the High Court's interpretation of the law is incorrect. However, the High Court's decision is binding on the tax authorities unless overturned by a higher court.

The challenge in this Petition is to order dated 30 January 2013 passed by the Transfer Pricing Officer (for short “TPO”) under Section 92CA(3) of the Income Tax Act, 1961 ( for short “the Act”), Draft Assessment Order dated 26 March 2013 passed by the Assessing Officer under Section 143(3) of the Act and directions dated 31 December 2013 given by the Dispute Resolution Panel ( for short “DRP”) under Section 144C(5) of the Act. The impugned orders have held that the issue of equity shares and the issue of Compulsory Convertible Debentures (CCD) convertible into four equity shares each to its non-resident Associated Enterprises (AE) gives rise to income from International Transactions and is chargeable to tax under the Act.

2. This Petition deals with the A.Y. 2009-10.

3. The Petitioner on 24 September 2009 had filed return of his income for the A.Y. 2009-10 declaring a loss of Rs.8.49 crores. Along with its return of income the Petitioner had also filed Form No.3CEB under Section 92E of the Act declaring that during the A.Y. 2009-10, 8,89,997 equity shares of Rs.10/- each at a premium of Rs.1,990 per share and 8,56,462 CCDs of Rs.10/- each were issued at premium of Rs.1990 per debenture. The Assessing Officer in terms of Section 144C(1) of the Act, referred the International transaction mentioned in Form 3CED to the TPO for determining its ALP.

4. On 18 January 2013 the TPO issued a show cause notice to the Petitioner inter alia recording the following:

“(j) The Company has issued the following equity shares:-

(I) 8,89,997 equity shares at Rs.2000 per share

(ii) 8,56,462 CCD of Rs.2000/- each, convertible into 4 equity shares – therefore resulting in issuance of 34,25,848 equity shares at Rs.500/- per share” and called upon the Petitioner to show cause why the Arm's Length Price (for short “ALP”) of the equity shares and CCDs should not be revised upwards.

Further on 24 January 2013, another show cause notice was issued by TPO calling upon the Petitioner to show cause as to why the shortfall in receipt of ALP on issue of shares and CCDs should not be treated as deemed loan on the alleged shortfall on which the deemed interest be charged to tax.

5. On 30 January 2013, the Petitioner responded to the show cause notices and inter alia submitted that no occasion to apply Chapter X of the Act could arise as issue of equity shares & CCDs does not give rise to any income. Besides, the Petitioner also submitted that the transaction is not an international transaction as defined under Section 92B of the Act. Besides, objections were also raised as regards the computation of ALP of the issue price of equity shares and CCDs. On 30 January 2013, TPO passed an order without dealing with the Petitioner's objections that no income arises on issue of equity shares and CCDs so as to attract Chapter X of the Act. The impugned order merely dealt with the computation of ALP on issue of equity shares and CCDs and determined an adjustment on issue of equity shares of Rs.946.50 crores and Rs.1039.31 crores on issue of CCDs holding the aforesaid amounts as being short received from the AE and consequently treating the same as deemed loan and charging the same to interest aggregating to Rs.239 crores.

6. Consequent to the above, on 26 March 2014, a draft assessment order was passed by the Assessing Officer inter alia in terms of the order dated 30 January 2013 passed by the TPO. The Petitioner filed its objections to the draft assessment order with DRP under Section 144C(2) of the Act. The DRP considered the issue of equity shares as well as the issue of CCDs and held that the shortfall in the issue price of equity shares and CCDs when benchmarked with their ALP resulted in a shortfall of the amounts received by the Petitioner.

7. The Petitioner has challenged the three impugned orders on the ground of the same being without jurisdiction. The contention is that the alleged shortfall on the amounts received on equity shares and CCDs is on capital account and does not give arise to any income. We find that the Revenue has proceeded on the basis that with the issue of equity shares and CCDs which results in four equity shares being available to the holders of CCDs are both in the nature of issue of equity shares and benchmarked the same with the ALP of the issue price of equity shares. In the above facts the issue stands concluded by the decision of this Court in Vodafone India Services Pvt. Ltd. Vs. Union of India 368 ITR 1 (Vodafone IV) and the subsequent decision in Writ Petition No.589 of 2014 in Vodafone India Services Pvt. Ltd. Vs. Union of India dated 13 October 2014, wherein the finding in Vodafone IV has been broadly summarized as under:

(I) The sine-qua-non to apply Chapter X of the Act would be arising of Income under the Act out of an International Transaction. This income should be chargeable under the Act, before Chapter X can be applied;

(II) The definition of income does not include within its scope capital receipts arising out of capital account transaction unless so specified in Section 2(24) of the Act as income;

(III) There is no charge in the Act to tax amounts received and/or arising on account of issue of shares by an Indian entity to a non-resident entity in Sections 4,5,15,22,28,45 and 56 of the Act. This is as it arises out of Capital Accounts transaction and, therefore, is not income;

(IV) Chapter X of the Act does not contain any charging provision but is a machinery provision to arrive at ALP of a transaction between Associated Enterprises; and

(V) Chapter X of the Act does not change the character of the receipts but only permits re-quantification of income uninfluenced by the relationship between the Associated Enterprises.” Thus the issue arising in this Petition stands covered by the decision of Vodafone IV.

8. This has been accepted by the Revenue and is evident from the order of DRP dated 30 October 2014 in Petitioner's case for A.Y. 2010-11. In the A.Y.2010-11 also the Petitioner had issued CCDs and equity shares and the basis was identical to the present Petition. The Revenue sought to tax the Petitioner in terms of Chapter X of the Act. However, the Petitioner objected to the Draft Assessment order before DRP. On 30 October 2014, DRP issued directions under Section 144C(5) of the Act to the Assessing Officer for the A.Y. 2010-11 and on identical facts qua equity shares and CCDs holding as under:

“3.4 We find that the issue under consideration of applying Transfer Pricing Provisions on 'issue of shares' has been decided in favour of the assessee by the Hon'ble Bombay High Court in the case of M/s Vodafone India Services Private Limited in Writ Petition number 871 of 2014 dated 10th October 2014. The honourable High Court has held that the amounts received on issue of shares is a capital account transaction not separately brought within the definition of 'income' as per the provisions of section 2(24) as well as sections 4 & 5 of the Act.

Therefore, such capital account transaction not falling within a statutory exception cannot be brought to tax. Even income arising from international Transaction between AE must satisfy the test of income under the Act and must find its home in one of the above heads i.e. charging provisions. There is no charging section in chapter X of the act. Only if there is income which is chargeable to tax under the normal provisions of the act, then alone chapter X of the act could be invoked. Further, since there is no income arising from the transaction of issue of shares, the provisions of chapter X would not apply. The honourable High Court in the said case has quashed and set aside as being without jurisdiction, null and void, the reference made by the TPO, and the order of the TPO making a transfer pricing adjustment on issue of shares. Respectfully following the decision of the jurisdictional Bombay High Court, the adjustment proposed by the TPO on account of issue of shares is deleted. Accordingly, ground of objection number 16 of the assessee is allowed”

9. Mr Tejveer Singh, learned Counsel for the Revenue fairly concedes that the decision of this Court in Vodafone IV would squarely apply even here in favour of the Petitioner. It is further submitted that the DRP has in the Petitioner's case for the A.Y. 2010-11 on identical facts has applied Vodafone IV in favour of Petitioner.

10 Accordingly, we set aside the orders of TPO dated 30 January 2013, the Draft Assessment order dated 26 March 2014 and of DRP dated 1 December 2013 to the extent they seek to make additions on account of issue of equity shares and debentures to its AE and the shortfall in receipt thereof being considered as deemed loan and deemed interest thereon being sought to be brought to tax.

11. Accordingly, the Petition is allowed in the above terms. There shall be no order as to costs.

( S.C.GUPTE J. ) ( M.S.SANKLECHA J. )