The government has decided not to challenge the Bombay High Court’s verdict on Vodafone India Services Private Limited’s (VISPL) transfer pricing dispute involving the issuance of shares to its parent company in 2008. This decision was taken after the Attorney General of India advised the Income Tax [IT] Department to accept the high court’s judgment. The government has stated that it wants to avoid “fruitless litigation” and improve foreign investors’ perception about investing in India.

The government’s intentions are clear. It wants to send out a positive message to the global investor community and allay their concerns regarding Indian tax issues. It further wants to assure investors that its decisions would be “fair, transparent and within the four corners of the law”. With companies as well as investors demanding clarity on tax regulations, this augurs well for the telecom sector.

Vodafone transfer pricing case

The transfer pricing case pertains to the issue of 289,224 equity shares by VISPL at a premium of Rs 8,509 per share for a total consideration of Rs 2.46 billion to its parent company, Vodafone Tele-Services (India) Holdings, in 2008. However, the IT Department was of the view that the transaction should have been valued at Rs 53,775 per share using the arm’s length pricing mechanism. Given this, the IT Department considered that the remaining amount of Rs 13.08 billion was given as a loan by VISPL to its parent company. Further, it was of the view that VISPL charged a notional interest of 13.5 per cent. Consequently, the IT Department asked Vodafone India to pay a tax of Rs 32 billion under the transfer pricing norms.

However, in a writ petition filed with the Bombay High Court, Vodafone India asserted that the Indian transfer pricing provisions are not applicable to share issues and that the tax authority did not have jurisdiction in the matter. The court transferred the case to the Dispute Resolution Panel and sought its opinion on whether the IT Department had jurisdiction in the matter. Thereafter, the Bombay High Court gave a verdict in favour of VISPL and stated that the issue of shares does not result in any income and, therefore, the Indian transfer pricing provisions are not applicable. As a result, the court held that VISPL is not liable to pay any tax.

Implications for foreign investors

The government’s decision is in line with its pre-election declaration to reduce tax ambiguities and provide a stable and predictable regulatory regime in the country. In the past few years, litigation on tax issues against various companies, especially in the telecom sector, has escalated. While the cancellation of 2G licences by the Supreme Court came as a big blow to Indian telecom companies, particularly the new entrants, regular tax notices issued by the IT Department to service providers have adversely affected sector growth. Therefore, during 2012-13, Indian service providers failed to attract much interest from foreign investors. This was evident from the steep 81.64 per cent decline in foreign direct investment (FDI) in the telecom sector in 2012-13 as compared to 2011-12.

Given that investments in the telecom sector remain crucial for the overall economic growth of the country, the government has promised to expedite the process to reduce tax uncertainty, improve the approval process and provide a stable business environment. If the government fulfils its promises, a positive regulatory environment will go a long way in achieving sector growth and attracting investments. Decisions such as the removal of the FDI cap in telecom have resulted in an increase in foreign investment. In fact, among all the sectors, the telecom sector attracted the maximum FDI in 2014-15, owing to positive regulatory decisions and the improvement in the sector’s outlook.

Conclusion

The decision regarding Vodafone’s transfer pricing case has been well received by the industry and investors alike. It has set a precedent for other cases that involve companies facing similar litigation. With the new government focusing on providing a stable regulatory regime, it is hoped that it will now expedite the various other cases, thus enabling service providers to focus on their core operations and plan investments accordingly.