SUBSCRIPTION OF SHARES VIS--VIS TRANSFER PRICING AND RELATED ISSUES: A

CRITICAL ANALYSIS OF THE LAW

I.

BACKGROUND

During 2013-14, additions to the income of the companies conducting international transactions
amounted to Rs 60,000 crore.1 There is a growing perception that such adjustments are often
hostile in nature. Recently a new measure of adjustment has come to fore which has received
much attention from the press as well as tax practitioners. There have been cases where the tax
department has sought to tax undervaluation of shares issued by treating subscription of shares as
an international transaction. As reported in the press, Shell India Private Ltd. (Shell India) had
issued shares at Rs 10 per share (based on valuation by an independent company) to its parent
company Shell Gas BV. The tax authorities contended that Shell India had under-priced its shares
and determined a value of Rs 183 per share, thereby treating the short fall of approximately Rs
15,000 crore as a loan extended by the Indian subsidiary to its overseas parent. The Transfer
Pricing Officer (TPO) held that this shortfall along with interest accruable thereon should be
brought within the ambit of taxation. Shell India has preferred a writ petition before the Honble
Bombay High Court in this regard.2
There are some variants of the abovementioned adjustment as well. In the case of Vodafone India
Services Pvt. Ltd. (VIPL), a wholly- owned subsidiary of a Mauritian entity Vodafone TeleServices (India) Holdings Ltd. (VHL) issued 2,89,224 equity shares of face value of Rs 10 each
at premium of Rs 8,591 per share. On reference, the TPO held that the shares should have been
valued on Net Asset Value basis after considering preceding years Transfer Pricing (TP)
adjustments and accordingly enhanced the value of each share to INR 53,775. Accordingly, the
difference was considered to be deemed loan by VIPL to VHL, on which notional interest at the
rate of 13.5% per annum was also levied.3

Santosh Tiwari, Transfer pricing income adjustments decline 14% in 2013-14, Financial Express, March 10, 2014,
http://www.financialexpress.com/news/transfer-pricing-income-adjustments-decline-14-in-201314/1232330
2

http://www.leapridge.com/wp-content/uploads/2014/02/Issue-of-Share-by-Indian-Subsidiary-to-Parent-CompanyIs-there-any-Transfer-Pricing-implication.pdf
3

supra Note 1

The issue has become so contentious that the Chairman of Shell group of companies has
reportedly said that such an adjustment is ...a tax on foreign direct investment... 4 The matter is
currently pending at different stages of litigation all over the country without any conclusive
solution at hand. In this light, it is imperative that an exhaustive analysis about the merits of the
case is undertaken to understand the law better. Part II of the article explains the statutory
provisions in relation to TP. Furthermore, the positions taken by both the tax department as well
as assessee have been analyzed in light of these provisions and judicial precedents. Part III
discusses the related issue of secondary adjustments. An attempt has been made to understand
the concept and trace its existence in the Income Tax Act, 1961 (the Act). Part IV briefly
discusses the international jurisprudence around the issue. It has been concluded in Part V that
the stand taken by the tax department is very aggressive which may not stand the test of time in
court.
II.

DOES SUBSCRIPTION OF SHARES COME UNDER THE PURVIEW OF

TRANSFER PRICING REGULATIONS?

A. BASIC TENANTS OF TRANSFER PRICING
A separate code on transfer pricing under Sections 92 to 92F of the Act covers intra-group crossborder transactions which is applicable from 1 April 2001. Section 92(1) of the Act provides that
any income from an international transaction shall be computed having regard to the
arms-length price. Thus, the pre-requisite for invoking TP provisions is that there must be an
income arising from international transaction and if there is an income, the determination of the
same shall be done having regard to the arms length price. The term income is not defined
under sections 92 to 92F of the Act. Income is defined by way of an inclusive definition in
section 2(24) of the Act. An inclusive definition is normally a definition of expansion and not of
restriction. Income, according to Concise Oxford English Dictionary, means money received,

especially on a regular basis, for work or through investments. A receipt can be brought to tax
under the inclusive definition of term income as defined in section 2(24) of the Act, only if it is
expressly covered within the scope of the said definition. A capital receipt, it is reiterated is fairly

Ashwin Mohan, Shell India says tax order contrary to FMs FDI drive; to challenge strongly, The Economic Times,
February 4, 2013, http://articles.economictimes.indiatimes.com/2013-02-04/news/36743166_1_income-tax-shellindia-tax-authorities

well settled, not being income per se, does not attract the levy of tax under the provisions of the
Act.
What is an international transaction has been defined under the Act5 as a transaction between two
or more associated enterprises, either or both of whom are non-residents, in the nature of:
(a)
(b)
(c)
(d)

Purchase or sale or lease of tangible and intangible property

Provision of services
Lending or borrowing of money
Mutual agreement or arrangement on allocation or apportionment or the any contribution

of cost or expenses
(e) Any other transaction having a bearing on the profits, income, losses or assets.
One may notice that the definition of international transaction is very wide and attempts to
cover every likely transaction that may take place between associated enterprises.
It is the relationship in the nature of associated enterprise that governs the TP regulations all
around the world. In India, section 92A of the Act defines the term associated enterprise in a
very broad manner. It refers to two situations. In the first situation 6, one enterprise directly or
indirectly participates in the management or control or capital of the other enterprise. The second
situation7 refers to a situation when the same person directly or indirectly participates in the
management or control or capital of the two enterprises. It is interesting to note that the
definition is similar to the definition as contained in Article 9 of the OECD Model Convention.
Furthermore, the Act has supplemented the above definition by enlisting several situations under
which two enterprises shall be deemed to be associated enterprises.8
The Arms length price is to be determined by any one of the prescribed methods. The tax payer
can select the most appropriate methods to be applied to any given transaction, but such selection
has to be made by taking into account the factors prescribed in the transfer pricing regulations

Section 92B, Income Tax Act, 1961

Section 92A(1)(i), Income Tax Act, 1961

Section 92A(1)(ii), Income Tax Act, 1961

Section 92A(2), Income Tax Act, 1961

with a view to allow a degree of flexibility in adopting the arms length price, a variance
allowance of 5% have been provided under the transfer pricing regulation.
The prescribed method for determining it is as follows:(a) Comparable uncontrolled price method (CUPM)
(b) Resale price method (RPM)
(c) Cost plus method (CPM)
(d) Profit split method (PSM)
(e) Transactional net margin method (TNMM)
(f) Any other method as may be prescribed by the CBDT
B. RETROSPECTIVE AMENDMENT BY FINANCE ACT 2012
Prior to Finance Act 2012, section 92B of the Act defined international transaction in very wide
terms. However, Finance Act 20129 has clarified this definition by way of an explanation with
retrospective effect from April 1, 2002 i.e. the date on which comprehensive TP provisions were
introduced under the Act. Explanation (i) has clarified that the expression international
transaction shall include
(a)
(b)
(c) Capital financing, including purchase or sale of marketable securities
(d)
(e) a transaction of business restructuring or reorganizationirrespective of the fact that it has a
bearing on the profit, income, losses or assetsat the time of the transaction or at any future
date
The memorandum explaining the amendment stated the following rationale:10

Explanation to Section 92B, Income Tax Act, 1961

10

http://indiabudget.nic.in/budget2012-2013/ub2012-13/mem/mem1.pdf

Certain judicial authorities have taken a view that in cases of transactions of business
restructuring etc. where even if there is an international transaction Transfer Pricing provisions
would not be applicable if it does not have bearing on profits or loss of current year or impact
on profit and loss account is not determinable under normal computation provisions other than
transfer pricing regulations. The present scheme of Transfer pricing provisions does not require
that international transaction should have bearing on profits or income of current year.

It is, therefore, proposed to amend section 92B of the Act, to provide for the explanation to
clarify meaning of international transaction and to clarify the term intangible property used in
the definition of international transaction and to clarify that the international transaction shall
include a transaction of business restructuring or reorganisation, entered into by an enterprise
with an associated enterprise, irrespective of the fact that it has bearing on the profit, income,
losses or assets or such enterprises at the time of the transaction or at any future date.
This amendment is seen as a shot in the arm of the tax department as it has strengthened its stand
for making additions. For the purpose of this article, the constitutional validity of the
aforementioned retrospective amendment is not being discussed.
C. REVENUES STAND
Let us understand how the income tax departments claim can be substantiated.
C.1. ISSUE OF SHARES HAS AN IMPACT ON ASSETS
Before moving ahead, it is necessary to have a look at the accounting treatment done at the time
of issue of shares:
Bank A/c Dr
To Share Capital A/c
To Share Premium A/c (if any)

One part of the journal entry affects the reserves and share capital in the balance sheet while the
other part affects the current assets of the company. It is thus undisputable that assets of the
company are affected by the amount of shares issued. On a bare perusal of Section 92B(1), in the
above light, it is clear that the transaction of subscription of shares is an international transaction
as defined under the provision which includes: any other transaction having a bearing on the
profits, income, losses or assets.
C.2. CAPITAL FINANCING INCLUDES ISSUE OF SHARES
By way of Explanation to 92B the term international transaction has been clarified to mean, inter
alia, capital financing, including The Honble Supreme Court in the case of Shree
Gollaleshwar Dev v. Gangawwa11 held that when by an amending Act, the word includes was
substituted for the word 'means' in a definition section, the intention was to make it more
extensive. Thus it can be argued that the definition of capital financing is inclusive in nature. The
term capital can be said to be including equity contribution and the term finance as per Oxford
dictionary connotes management of money. The term finance is also defined in Websters Ninth
New Collegiate Dictionary as the science of the management of funds that includes circulation of
money, the granting of credit, the making of investments, and the provision of banking facilities.
The term financing has been defined in Blacks Law Dictionary as the act or process of
raising or providing funds. The other dictionaries carry similar meaning of the term finance.
The Black law dictionary also has a definition of equity financing as the raising of funds by
issuing capital securities (shares in the business) rather than making loans or selling bonds.
Accordingly, the term capital financing would include issuance of shares. Therefore, a wider
interpretation should be given to the term Capital Financing as defined in the Explanation to
92B which has been introduced with retrospective effect from 1-4-2002
It is pertinent to note that the purpose of the Explanation to 92B has been explained in the
explanatory memorandum to the Finance Bill, 2012, which clarifies that the present scheme of
Transfer Pricing provisions does not require that international transaction should have bearing on
profits or income of current year. Therefore, it is not necessary for international transaction to
have a bearing on the profits of the assessee in India.
11

Shree Gollaleshwar Dev v. Gangawwa AIR 1986 SC 231

C.3. SHARE SUBSCRIPTION AND SHARE PREMIUM AMOUNT IMPACTS INCOME

Furthermore, Section 78 of the Companies Act, 1956 mandates creation of Share Premium
Account and restricts the use of this account for specific purposes only. It is pertinent to note
that what is regulated is the account itself and not the amount received. Hence, amount received
can be utilized without restriction. In a case where a freshly set up company issues shares at a
premium, the bank funds are increased by the amount of share premium and share capital. Now
that enterprise purchases fixed assets out of the funds kept in the bank. Thus what is actually
affected is bank balance and assets but not the Share Premium Account. The income or profits
will be impacted in this case due to depreciation on fixed assets. The only condition precedent
for invoking provisions of Chapter X is that there should be income arising from international
transaction, this view was affirmed by the Honble Punjab & Haryana High Court in Coca Cola
Inc v. Asstt. CIT.12
Furthermore, the concept of opportunity cost also comes into play. The company could have
earned some income by deploying the funds in income generating assets. However, such funds
were foregone which resulted in foregoing of income!
D. CONTENTIONS OF THE ASSESSEE
The assessee in such cases has gone all out to defend its position. It is worthwhile to analyze the
claims of the assessee in the following manner:
D.1. PRINCIPAL OF EJUSDEM GENERIS TO BE APPLIED
It would be apposite to consider the definition of international transaction given under section
92B(1) wherein it is clear that a transaction is an international transaction if, inter alia, it is in
nature of: a) purchase, sale or lease of tangible or intangible property; b) provision of services; c)
lending or borrowing money; or d) any other transaction having a bearing on the profits, income,
losses or assets
It is a well settled rule of interpretation that when general words follow specific words of the
same nature, the rule of ejusdem generis shall apply. The Honble Calcutta High Court in the
12

Coca Cola Inc v. Asstt. CIT [2009] ITR 194 (P&H)

case of CIT v The Statesman13 has held that the maxim serves to restrict the meaning of a
general word to things or matters of the same genus as the preceding particular words.
Thus the meaning of the words any other transaction having a bearing on the profits, income,
losses or assets has to be imported to mean the same as what the earlier mentioned words
signify. A careful reading of the definition gives rise to a generic unity in nature of having an
impact on income or loss. Hence, a transaction shall mean to be an international transaction if it
has an impact on the profit or loss of that enterprise and not otherwise.
Furthermore, the clause in the explanation reads as follows: Capital financing, including any
type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable
securities or any type of advance, payments or deferred payment or receivable or any other debt
arising during the course of business;
In clause (c), the words coming after capital financing indicate that the transactions have to
have an impact on the income or loss. An interpretation that Explanation (i) would fall within the
scope of the expression international transaction even if the ingredients of section 92B(1) are not
satisfied would render redundant. Hence, issue of shares and receipt of share premium though
forms part of capital financing but it impacts neither income nor loss. Issue of shares being a
balance sheet transaction impacts only the assets of the company. The word assets should be
read in light of the words preceding it. Thus, if a capital transaction does not impact the income
or loss then it should not form part of capital financing for the purposes of applicability of
transfer pricing provisions.
In relation to capital financing, the Guidance Note on transfer pricing issued by the Institute of
Chartered Accountants of India (ICAI) states under paragraph 4.10 that the pricing of these
arrangements will have a bearing on the profits or losses of the associated enterprises.
D.2. SECTION 92(1) AND SECTION 92B TO BE HARMONIUOSLY INTERPRETED

13

CIT v The Statesman [1992] 198 ITR 582 (Cal)

The provisions of a code should be read together and not independent of each other. The Honble
Kerala High Court in the case of CIT v Parekh Brothers14 has held that one provision of a statute
should be construed with reference to another provision so as to make a consistent enactment of
the whole statute.
Section 92B defines the term international transaction but it does not anywhere cast a charge
on the income nor does it give rise to computation of income arising from that international
transaction. This charge is enshrined under section 92(1) of the Act. Section 92B and 92(1)
should be given a conjoint reading and should not be read independent of each other. In this
regard, it may be noted that even section 92B of the Act starts with the words: for the purposes
of this section and section 92,92C, 92D and 92E.. which supports the view that the
international transaction as defined under section 92B of the Act has to be read harmoniously
along with other provisions of Chapter X and cannot be read in isolation.
The analysis of both the sections follows that in case no income (or loss) arises from an
international transaction (as defined under section 92B), then the transfer pricing provisions fail
to apply (as required under section 92(1)). Any interpretation contrary to the abovementioned
analysis would be contrary to the intention of the legislature.
D.3. THIS IS A CASE OF ISSUE OF SHARES AND NOT TRANSFER OF SHARES
By no stretch of imagination can we read issue of shares as a part of purchase or sale of
marketable securities. Purchase or sale of marketable securities, refers to transfer of marketable
securities which are already in existence. The Honble Supreme Court in the case of Sri Gopal
Jalan & Company v Calcutta Stock Exchange Association Ltd 15 has held that 'allotment' means
the appropriation out of the previously unappropriated capital of a company, of a certain
number of shares to a person. Till such allotment the shares do not exist as such.
Under the commercial/accounting parlance, subscription of shares is a capital transaction and not
a revenue transaction and it can be concluded that issuance of shares does not have an impact on
income or loss of the enterprise.
14

CIT v Parekh Brothers [2002] 258 ITR 43 (Kerala)

15

Sri Gopal Jalan & Company v Calcutta Stock Exchange Association Ltd 1964 AIR 250

The Honble Supreme Court in the case of Khoday Distilleries Ltd v CIT16 relied on Sri Gopal
Jalan & Company case (supra) and held as follows:
There is a vital difference between creation and transfer of shares. As stated
hereinabove, the words allotment of shares have been used to indicate the creation of shares
by appropriation out of the unappropriated share capital to a particular person. A share is a
chose in action. A chose in action implies existence of some person entitled to the rights in action
in contradistinction from rights in possession. There is a difference between issue of a share to
a subscriber and the purchase of a share from an existing shareholder. The first case is that of
creation whereas the second case is that of transfer of chose in action.For the aforestated
reasons, we hold that the word allotment indicates creation of shares by appropriation out
of the unappropriated share capital to a particular person and that such creation did not
amount to transfer.
Further, the view of the learned authors in the book The Law and Practice of Income Tax 17
which is: The issue of shares by a limited company is not a trading transaction at all. Upon
an issue of shares, the assets of the company are increased by the amounts obtained from the
subscribers. These amounts are obviously not profits or gains of the trade, and they are not
liable to be brought into the accounts for income tax. This is so whether the shares are allotted
at par or at a premium. The amount of the premium, or the fee charged on the issue of fresh
capital, is not a trading profit.
The learned authors in their book The law and practice of Income Tax 18 have the made the
following observation on the question of treating capital receipt as income under section 2(24) of
the Act: Though the definition of income is inclusive, capital receipts do not come within the
ambit of the charging section except to the extent of any capital receipt expressly covered by
this sub-clause. A capital receipt is not income under section 2(24) unless it is chargeable to
tax as capital gain under section 45.

16

Khoday Distilleries Ltd v CIT [2009] 176 Taxmann 142 (SC)

17

The law and practice of Income Tax by Kanga, Palkhivala and Vyas, 9th Edition

18

The law and practice of Income Tax by Kanga, Palkhivala and Vyas, 9th Edition

D.4. BEING A CAPITAL TRANSACTION, NO INCOME ARISES

A catena of decisions has held that section 92(1) is not an independent charging provision but
only a computation provision. Section 92(1) does not propose to bring to tax international
transactions not taxable as per substantive charging provisions of the Act. In the case of Dana
Corporation, In re19 it was held that the expression income arising postulates that the income
has arisen under the substantive charging provisions of the Act. In other words, the income
referred to in Section 92 is nothing but the income captured by one or the other charging
provisions of the Act. Section 92 obviously is not intended to bring in a new head of income or to
charge the tax on income which is not otherwise chargeable under the Act.
It is pertinent to discuss the decision of Honble Calcutta High Court in case of CIT v Kusum
products Ltd.20 It is in the context of old S.92 of the Act and the court held that the transaction on
capital account can have no impact on profit calculation of the taxpayer. The question of profit
and/or loss may not arise when one is contributing towards capital. The contribution of capital, in
no circumstances, will result in profit.
In light of the above, it is contended that section 92(1) neither enlarges nor reduces the scope of
the definition of income under section 2(24) but only acts as a tool to compute the same.
In the case of Ranbaxy Laboratories Ltd v ACIT21, the Honble Tribunal held that by issuing
shares at a price less than the market price, the assessee cannot be said to have incurred any
expenditure; rather, it amounts to short receipt of share premium. The receipt of share premium
is not taxable and hence, any short receipt of such premium will only be a notional loss and not
actual loss for which no liability was incurred. Therefore, such notional losses were held not
allowable under the Act. This observation has been affirmed by the Honble Mumbai Tribunal in
its recent judgment in the Green Infra Ltd. v. ITO.22

19

Dana Corporation, In re [2010] 321 ITR 178 (AAR)

20

CIT v Kusum products Ltd. [1993] 203 ITR 672 (Cal)

21

Ranbaxy Laboratories Ltd v ACIT (2009) 124 TTJ (Delhi)771

22

Green Infra Ltd. v. ITO TS-420-ITAT-2013(MUM)

Even if share premium would have been collected by the assessee it would have been a capital
receipt. After referring to Section 78 of the Companies Act, which restricts the use of share
premium account and after analysing the provisions of the Company Law, it was held by the
Court that share premium cannot be brought to tax as revenue receipt or trading receipt but was
exempt as capital receipt in the hands of the company -Addl. CIT v. Om Oils & Oil Seeds
Exchange Ltd.23 Thus the uncollected share premium cannot be regarded as an income foregone.
Clause 21 & 22 of the Finance Bill, 2012 which seeks to amend Sections 56 & 68 of the Act
respectively, do contemplate taxing share premium, only when the assessee offers no explanation
about the nature and source thereof or when the consideration for issue of shares exceeds face
value. However, these amendments will take effect from 1st April, 2013 and will, accordingly,
apply in relation to the assessment year 2013-2014 and subsequent assessment years. Therefore,
is not to be considered for the case at hand.
Furthermore, the heading of Chapter X reads SPECIAL PROVISIONS RELATING TO
AVOIDANCE OF TAX. The heading of the chapter that contains transfer pricing provisions
contemplates avoidance of tax. Where no income arises under any of the substantive charging
provisions of the Act, there can be no avoidance of tax also. Thus the Act intends to capture those
transactions which impact income or loss and leave out the capital receipts. Reliance is placed on
the decision of the Honble Supreme Court in case of CIT v Vadilal24 wherein it was held that
marginal notes and headings may throw light on the intention of the legislature.
It is pertinent to refer to the Circular 12/2001, dated 23-8-2001 wherein it has been stated that:
The aforesaid provisions have been enacted with a view to provide a statutory framework
which can lead to computation of reasonable, fair and equitable profit and tax in India so that
the profits chargeable to tax in India do not get diverted elsewhere by altering the prices
charged and paid in intra-group transactions leading to erosion of tax revenues.
E. APPROACH TAKEN BY THE COURTS SO FAR ON THIS ISSUE

23

Addl. CIT v. Om Oils & Oil Seeds Exchange Ltd. [1985] 152 ITR 552 (Delhi).

24

CIT v Vadilal [1972] 86 ITR 2,11 (SC)

The Honble Bombay High Court had the opportunity to look into the matter, though not at the
merits of the case. A writ petition was filed on the same issue by VIPL. The court in the case of
Vodafone India Services Pvt. Ltd. v Union of India 25 observes in Para 32 that It is clear that in
view of Section 92(1), there must be income arising and/or affected or potentially arising and/or
affected by an International Transaction for the purpose of application of Chapter X . This
would appear to be in the nature of jurisdictional requirement and the Assessing officer must be
satisfied that there is an income or a potential of an income arising and/or being affected on
determination of an ALP before he proceeds further in determining the ALP or referring the
issue to the TPO to determine the ALP.
The Hyderabad Bench of the Honble Tribunal has in a recent case of Vijai Electricals Ltd v
ACIT26 held that investment in share capital is not an international transaction as per section 92B
as there is no income. The operative part of the judgment is reproduced below:
10.In our opinion, the amount representing 2118.84 is towards investment in share capital of
the subsidiaries outside India as the transactions are not in the nature of transactions referred to
section 92-B of the IT Act and the transfer pricing provisions are not applicable as there is no
income.
It is pertinent to note that the aforesaid decision has been pronounced after the enactment of
Finance Act 2012. However the transaction involved pertained to an outbound investment.
Very recently, the Hyderabad bench of the ITAT in the case of Prithvi Information Solutions Ltd.
v ACIT27 while following the Vijai Electricals decision (supra) has held that
Unless there are evidences and material to show that assessee has made investment of Rs.
30,60,50,000/- in shares in addition to the amount mentioned as loan in form No. 3CEB, it
cannot be presumed that loans stated in auditors report in Form No. 3CEB and shares allotted
are different. Unless this fact is verified properly by examining the books of account and final
accounts of the assessee, no inference can be drawn merely on presumption and surmises. If the
25

Vodafone India Services Pvt. Ltd. v Union of India [2013] 39 taxmann.com 201 [Bombay]

26

Vijai Electricals Ltd v ACIT TS-142-ITAT-2013(HYD)-TP

27

Prithvi Information Solutions Ltd. v ACIT TS-237-ITAT-2014(HYD)-TP

assessees claim that the investment was towards equity is correct, then, it cannot be brought
within the purview of international transactions as defined u/s 92B of the Act.
Similar issue arose again before the Hyderabad Bench of the ITAT in the case of M/s Hill County
Properties Ltd v Addl. CIT28 wherein the tribunal followed its own decision in case of Vijai
Electricals Ltd. (supra).
While examining clause (c) of the explanation to section 92B the Delhi bench of the ITAT29
observed that
the scope of these transactions, as could be covered under Explanation to Section 92 B read
with Section 92B(1), is restricted to such capital financing transactions, including inter alia
any guarantee, deferred payment or receivable or any other debt during the course of business,
as will have a bearing on the profits, income , losses or assets or such enterprise. This precondition about impact on profits, income, losses or assets of such enterprises is a precondition embedded in Section 92B(1) and the only relaxation from this condition precedent is
set out in clause (e) of the Explanation which provides that the bearing on profits, income, losses
or assets could be immediate or on a future date. The contents of the Explanation fortifies,
rather than mitigates, the significance of expression having a bearing on profits, income, losses
or assets appearing in Section 92 B(1).
32. There can be number of situations in which an item may fall within the description set out
in clause (c) of Explanation to Section 92 B, and yet it may not constitute an international
transaction as the condition precedent with regard to the bearing on profit, income, losses or
assets set out in Section 92B(1) may not be fulfilled.
In the case of M/s Allcargo Global Logistics Ltd v ACIT 30, the facts before the Mumbai bench of
the ITAT were slightly different. The appellant in that case had invested in shares of its AEs but
the shares were allotted after a delay of approximately 11 months. The department had alleged
that this transaction is akin to a loan. However the Tribunal rejected this argument and deleted
28

M/s Hill County Properties Ltd v Addl. CIT TS-214-ITAT-2014(HYD)-TP

29

Bharti Airtel Limited v ACIT TS-76-ITAT-2014(DEL)-TP

30

M/s Allcargo Global Logistics Ltd v ACIT TS-176-ITAT-2014(Mum)-TP

the TP adjustment on account of interest chargeable on the amount of share application money
paid by the assessee and lying unutilized with its AE treating the same as the transaction of loan.
It is interesting to note that in case of Aminatit International Holding, In re31, the AAR held that
TP provisions are not applicable where income is not chargeable to tax. It was held that shares
transferred to AE without consideration during restructuring process is not subject to capital
gains tax and hence TP provisions will not apply. However, this decision was pronounced before
the enactment of Finance Act 2012.
III.

SECONDARY ADJUSTMENTS

A. CONCEPT
The Transfer Pricing adjustments are of two types viz. primary adjustment and secondary adjustment. The
primary adjustment is an adjustment which is attributable to a transaction which has been entered into
by the parties during the accounting year. Once the adjustment is made, the income as assessed would
represent the sum of revenue as would have been reported had the transaction been always concluded at
the right value. The secondary adjustment, if and to the extent, specifically authorized by the statute,
may seek to make unilateral adjustment which accommodates a derivative consequence of the primary
adjustment. In the impugned case, adjustment made by the AO is a secondary adjustment. For example,
the derivative loan transaction has been deemed to exist or has been deemed to have resulted on the basis
of a presumption that had the Indian company recovered correct value towards shares, the Indian
company would have had the liquidity which is presently enjoyed by the parent company.

The secondary adjustment, if and to the extent, specifically authorized by the statute, may seek to
make unilateral adjustment which accommodates a derivative consequence of the primary
adjustment. Para 4.66 of the OECD TP Guidelines states that:
The exact form that a secondary transaction takes and of the consequent secondary adjustment
will depend on the facts of the case and on the tax laws of the country that asserts the secondary
adjustment
Further Para 4.69 of the OECD TP Guidelines states the following:

31

Aminatit International Holding, In re TS-42-AAR-2010

The commentary on paragraph 2 of Article 9 of the OECD Model Tax Convention notes that
the Article does not deal with secondary adjustments, thus it neither forbids nor requires tax
administrations to make secondary adjustments. . Many countries do not make secondary
adjustments either as a matter of practice or because their respective domestic provisions do not
permit them to do so.
B. SECONDARY ADJUSTMENT VIS--VIS INCOME TAX ACT, 1961
The Indian statute supports solely primary adjustments through section 92(1) of the Act, which
states the following: Any income arising from an international transaction shall be computed
having regard to the arm's length price. Hence, the adjustment is a result of the international
transaction which has in fact been undertaken between the two associated enterprises.
In the present case, the derivative loan transaction has been deemed to exist on the basis of a
presumption that had the assessee recovered correct value towards shares, the Indian company
would have had the liquidity which is presently enjoyed by the parent company. Adjustment
made by the AO is a secondary adjustment. Present Indian tax regime does not permit or
authorize such secondary adjustment.
The statute merely recognizes the transaction which has been entered into by associate
enterprises. It does not authorize revenue authority to multiply or rewrite the transaction. In the
impugned case, the only transaction which can, therefore, be recognized by the Indian statute is
the transaction of share subscription.
Since a transaction of the nature of loan or receivable has not been entered into, it cannot at all be
presumed to be an international transaction warranting any adjustment. Reliance is placed on the
observation given by the Honble Mumbai Bench of the ITAT in the case of Besix Kier Dabhol, SA
Vs. DDIT(IT).32

The Honble Tribunal in this case was dealing on the question of applicability of thin
capitalization rules to an Indian assessee. Under the thin capitalization rules (as understood
generally), the amount of debt taken by a company is treated as a capital investment in the
32

Besix Kier Dabhol, SA Vs. DDIT(IT) [2011] 134 TTJ (Mum) 513

company and hence any interest expense is disallowed for the purpose of taxability. The Honble
ITAT has ruled against the recharacterisation of debt into equity which was based on the
international practice which was still to find its place in the Indian Income Tax Act, 1951. Taking
the ratio of the judgment and applying the same to the present case we can reach the same
conclusion. Recharacterising a transaction is permissible under the GAAR framework which is
yet not present under the ITA.
It is a well settled law that there can be no presumption about the acting of two parties in concert.
This has been very clearly laid down by the Honble SC in case of Daiichi Sankyo Co. Ltd. Vs.
Jayaram Chigurupati & others.33
It is further arguable that a secondary adjustment which is connected with a fictional transaction
should not be allowed to hold the field if the existence thereof is in conflict with FEMA or other
law. To assume that the Indian company has granted a loan from an overseas company without
permission of FEMA authorities and to assume that the loan is, under Civil Law, of a nature
which is non-enforceable, would be in conflict with FEMA. The legislature cannot be expected
to permit existence of state of affairs which is in conflict with another statute of the legislature.
In a recent decision by the Hyderabad Bench of the Honble Tribunal in case of Northgate
Technologies Ltd v DCIT34, it has been held as follows:
Unless the price paid as premium is justified in an arms length situation, the same will be
treated as NIL under CUP method as no independent party would like to pay such huge amounts
in the form of premium without any basis. Therefore, the monies parked with its subsidiaries in
the form of share premium have to be treated as loan transactions
In the aforementioned case, the assessee had invested funds in its subsidiaries outside India. The
TPO questioned the huge payout of share premium and in absence of any economic rational
given by the assessee, treated that share premium as loan. Hence, he proposed an addition of
notional interest on this deemed loan. The Tribunal has rightly observed that in case no
justification is provided, the share premium amount has to be treated as a loan. This is implied
33

34

Daiichi Sankyo Co. Ltd. Vs. Jayaram Chigurupati & others [(2010)157 Company Cases 380 (SC)]
Northgate Technologies Ltd v DCIT TS-164-ITAT-2013(HYD)-TP

from the decision that in absence of economic or commercial rationale, any short receipt or
excess payment of share premium has to be treated as a loan transaction. The economic rational
says that a company will issue shares at its fair market value and not below that fair market
value. Thus the short receipt of share premium amount actually constitutes a loan given to the
overseas entity.
Even if discount on share capital is regarded as being in capital account and not taxable, there
could be a case to treat on revenue account, the income by way of interest foregone on the funds
not collected due to issuing of shares at a discount, and make transfer pricing adjustment. Thus
the funds received from issue of shares not only affect the assets of the entity but also play a
major role in operations of the business. Thus somehow and somewhere it impacts income,
expense or profits of the entity.
In this regard, the Honble Tribunal in case of Logix Micro Systems Ltd. vs. ACIT 35 has observed
that the ALP of an outstanding amount should not calculated considering the same as loan but it
should be determined considering the factor that if the fund were brought back by assessee
within reasonable time it would have earned income on the said funds (opportunity cost).
In the case of Perot Systems TSI (India) Limited v DCIT 36 it has been held by the Delhi bench of
the Honble Tribunal that if Assessee's contention that whenever interest-free loan was granted
to associated enterprises, there should not be any adjustment, was accepted, it will tantamount
to taking out such transactions from the realm of Section 92(1) and Section 92B. Section 92(1)
mandates that any income arising from an international transaction shall be computed having
regard to the arm's length price. Furthermore, as rightly observed by the CIT(A), RBI's approval
did not put a seal of approval on the true character of the transaction from the perspective of
transfer pricing regulation as the substance of the transaction has to be judged as to whether the
transaction was at arm's length price or not.
Furthermore, the Finance Act 2012 has added a clarification to section 92B by way of an
explanation as per which any type of receivable or debt arising during the course of business is
considered as an international transaction. Thus, such international transaction needs to be
35

Logix Micro Systems Ltd. vs. ACIT TS-49-ITAT-2010(Bang)

36

Perot Systems TSI (India) Limited v DCIT [2010] 130 TTJ (Delhi) 685

benchmarked having regard to the arms length principles. In light of above, it can be said that
the short receipt of share premium amount is a furtherance of loan and hence an international
transaction. It is pertinent to note that the Honble Mumbai Tribunal in, the recent case of
Medusind Solutions India Pvt. Ltd. v ACIT 37 has remanded back the matter relating to
outstanding receivable being treated as an international transaction in light of the new
clarification to Section 92B.
In a very recent case of Bharti Airtel Limited v ACIT38, the Delhi ITAT held as follows:
No doubt, if these transactions are treated as in the nature of lending or borrowing, the
transactions can be subjected to ALP adjustments, and the ALP so computed can be the basis of
computing taxable business profits of the assessee, but the core issue before us is whether such
a deeming fiction is envisaged under the scheme of the transfer pricing legislation or on the
facts of this case. We donot find so. We donot find any provision in law enabling such deeming
fiction. What is before us is a transaction of capital subscription, its character as such is not in
dispute and yet it has been treated as partly of the nature of interest free loan on the ground
that there has been a delay in allotment of shares. On facts of this case also, there is no finding
about what is the reasonable and permissible time period for allotment of shares, and even if one
was to assume that there was an unreasonable delay in allotment of shares, the capital
contribution could have, at best, been treated as an interest free loan for such a period of
inordinate delay and not the entire period between the date of making the payment and date of
allotment of shares. Even if ALP determination was to be done in respect of such deemed interest
free loan on allotment of shares under the CUP method, as has been claimed to have been done
in this case, it was to be done on the basis as to what would have been interest payable to an
unrelated share applicant if, despite having made the payment of share application money, the
applicant is not allotted the shares. That aspect of the matter is determined by the relevant
statute. This situation is not in pari materia with an interest free loan on commercial basis
between the share applicant and the company to which capital contribution is being made. On
these facts, it was unreasonable and inappropriate to treat the transaction as partly in the
nature of interest free loan to the AE. Since the TPO has not brought on record anything to
37

Medusind Solutions India Pvt. Ltd. v ACIT [2013] 56 SOT 177 (Mum)

38

Bharti Airtel Limited v ACIT TS-76-ITAT-2014(DEL)-TP

show that an unrelated share applicant was to be paid any interest for the period between
making the share application payment and allotment of shares, the very foundation of impugned
ALP adjustment is devoid of legally sustainable merits.
A similar finding has been given by Honble Mumbai ITAT in the case of Parle Biscuits Pvt Ltd
v DCIT.39
IV.

INTERNATIONAL JURISPRUDENCE

Article 9 of tax treaties does not cover any such secondary adjustment. The OECD has clarified
in its commentary on Article 9 of the model treaty convention that sovereign countries can opt
for

secondary

adjustments,

if

permissible

by

their

domestic

laws.

Some of the countries have adopted the practice to apply secondary adjustments, on the backing
of express provisions in their respective domestic tax laws, namely: 40
Canada
Canadas Income Tax Act, empowers the Revenue to treat an upward TP adjustment as deemed
dividend. However, no deemed dividend would arise if the non-resident is a controlled foreign
affiliate for Canadian tax purposes. The provisions for the same are covered under Section
247(2) of the Income Tax Act. The Canada Revenue Agency generally treats the amount of the
primary adjustment, i.e., the disallowed portion of the price paid to the non-arms length nonresident, as a shareholder benefit under subsection 15(1) of Canadas Income Tax Act which is
deemed to be a dividend subject to withholding tax under paragraph 214(3)(a). Prior to the
Budget 2012 amendments to Canadas Income Tax Act, secondary adjustments were raised using
traditional benefit conferral provisions (i.e. sections 15, 214 etc). The amendments of 2012 added
provisions dealing specifically with secondary adjustments. Under the new provisions, notably
subsection 247(12), the amount of the primary adjustment results in a deemed dividend to the
non-resident party, thereby invoking Part XIII withholding tax. The amendments provide41:

39

Parle Biscuits Pvt Ltd v DCIT TS-127-ITAT-2014(MUM)-TP

40

Rahul Mitra, Undervaluation of shares Do Indian TP provisions support adjustment?, Taxsutra.com, April 1,
2013 http://www.tp.taxsutra.com/experts/column?sid=101#content-bottom
41

http://www.martindale.com/corporate-law/article_Miller-Thomson-LLP_1490240.htm

Amount:

The amount subject to withholding tax is the sum of the Canadian corporations income and
capital transfer pricing adjustments under section 247, but with the capital adjustments
determined on a gross basis. And, this amount is determined as if the Canadian corporation had
undertaken no transactions other than those transactions in which the particular non-arms length
non-resident participated.

Reduction:

The amount subject to withholding tax is reduced by transfer pricing adjustments in the Canadian
taxpayers favour.

Deemed Dividend:

The excess amount is treated as a deemed dividend for withholding tax purposes. Therefore, the
withholding tax rate under any applicable tax treaty will be the rate for dividends. Nothing is said
about when such deemed dividends will qualify for the lower dividend withholding tax rate
available under many treaties where the shareholding meets a specified minimum threshold.

Timing:

The deemed dividend is deemed to be paid at the end of the taxation year in which the relevant
transactions occurred.

CFA Exception:

There is an exception for a transaction with a non-resident that is a controlled foreign affiliate
(CFA) under subsection 17(15) of the Tax Act. A primary transfer pricing adjustment in
relation to a transaction with this type of CFA will not give rise to a deemed dividend subject to
withholding tax. Excess payments by the Canadian corporation to such a CFA are considered to
be equivalent to downstream capital contributions to the foreign affiliate rather than upstream
distributions of surplus to foreign shareholders. Therefore, a withholding tax assessment is not

appropriate. A subsection 17(15) CFA is generally a CFA controlled by the taxpayer and/or
Canadian residents with whom the Canadian corporation does not deal at arms length. The nonresident must qualify as this type of CFA throughout the period during which the subject
transaction or series of transactions occurred.
The Canada Revenue Agencys policy with respect to assessing withholding tax for such
secondary adjustments is set out in paragraph 211 of CRA Information Circular 87 - 2R on
International Transfer Pricing. As per the circular, a relief may be provided if the following
conditions are met42:
1. The Canadian taxpayer agrees in writing to the proposed transfer pricing adjustments
(such an agreement does not restrict the Canadian taxpayer or the non-arm's length party
from seeking relief under the Mutual Agreement Procedure article of Canada's tax
treaties)
2. The adjustments did not arise from a transaction that may be considered abusive; and
3. The foreign corporation repatriates the funds equivalent to the gross amount arising from
the transfer pricing adjustment immediately or agrees in writing to repatriate such amount
within a reasonable time
European Union Joint Transfer Pricing Forum (EUJTPF)
As per a report issued by EUJTPF 43 dated 18th October, 2013 on "secondary adjustments" in TP,
one notes that out of the twenty seven EU Member States, nine countries have legislation on
"secondary adjustments", namely Austria; Bulgaria; Denmark; Germany; France; Luxemburg;
Netherlands; Slovenia; and Spain. EUJTPF has also provided for certain recommendations
around secondary adjustments in the sense that Member States should refrain from inflicting
upon "secondary adjustments", when they lead to double taxation. Where secondary adjustments
are compulsory under the legislation of a Member State, it is recommended that Member States
provide for ways and means to avoid double taxation (e.g. by endeavoring to solve it through a
MAP, or by allowing the repatriation of funds at an early stage, where possible).
42

43

http://www.cra-arc.gc.ca/E/pub/tp/ic87-2r/ic87-2r-e.html#P918_102991

http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transfer_pricing/forum/final_rep
ort_secondary_adjustments_en.pdf

Furthermore, with a view to avoid complications it has been recommended that within the EU
Member States characterise secondary adjustments as constructive dividends or constructive
capital contributions rather than as constructive loans, as long as there is no repatriation. The
EUJTPF is of the view that penalties should only relate to the transfer pricing adjustment itself,
i.e. the primary adjustment and not to the secondary adjustment. Hence it has recommended that
when a secondary adjustment is required, Member States should refrain from imposing a penalty
with respect to the secondary adjustment.
The aforesaid elucidations clearly demonstrate that even globally, sovereign countries resort to
carrying out of "secondary adjustments" in TP, only if there is an express & specific mandate
provided in their respective domestic legislation. Countries do not undertake "secondary
adjustments" in TP as a matter of practice, without the express blessing of their respective
domestic legislation
As far as applicability of TP regulations on subscription of shares is concerned, such a position is
unprecedented globally. In the case of Lowry (Inspector of Taxes) v. Consolidated African
Selection Trust Ltd.44 It was held that amounts related to issue of shares are obviously not profits
or gains of the trade, and they are not liable to be brought into the accounts for income-tax. The
sum which the company might hypothetically have received for premiums was not an item in its
profits and gains. The above observation been relied upon by the Calcutta Bench of the Honble
Tribunal in case of Asiatic Oxygen Ltd. v DCIT.45
Also it is worthwhile to pay attention to the following observations made in context of
applicability of TP regulations in the English case of Ametalco UK v IRC:46
transactions involving money which are not naturally described as the giving of business
facilities are not within the scope of the relevant statutory provisions and that a subscription for
ordinary shares in an associated company is not naturally so described and is not within the
statutory net, but that is not, they say, a reason for excluding transactions which can naturally be
44

Lowry (Inspector of Taxes) v. Consolidated African Selection Trust Ltd. [1940] 8 ITR (Supp.) 88 the House of
Lords in England
45
46

Asiatic Oxygen Ltd. v DCIT [1994] 49 ITD 355 (Cal)

Ametalco UK v IRC [1996] STC (SCD) 399

so described (such as an advance on a loan) although the purely economic purpose of such a
loan may be similar to a subscription for shares.

V.

CONCLUSION

Clarity of law and consistency in approach is the bedrock of a good tax administration and better
tax collection. In the words of former Chief Justice of India, Shri S.H. Kapadia, FDI flows
towards location with a strong governance infrastructure which includes enactment of laws and
how well the legal system works. Certainty is integral to rule of law. Certainty and stability form
the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including
foreign investors) to make rational economic choices in the most efficient manner. . It is for the
Government of the day to have them incorporated in the Treaties and in the laws so as to avoid
conflicting views. Investors should know where they stand. It also helps the tax administration in
enforcing the provisions of the taxing laws.47 In wake of numerous ongoing transfer pricing
related litigation pertaining to share subscription, a proper guidance is required from the tax
department. The well settled principal that emerges from the above discussion is that in
absence of a legislative mandate TP provisions are not applicable on transactions which are
capital in nature. Income has to be present in order to compute the ALP. And such income
should necessarily be real income and not notional in nature. Furthermore, secondary
adjustments also require a legislative backing. In absence of the same, the stand taken by
the department seems to be weak. On the fundamental jurisdictional issue, the Bombay High
Court48 has held that it should be dealt with before determination of ALP, or else the entire
exercise of determining ALP becomes academic, and therefore redundant. When the tax
department is trying to levy income tax even on share capital, this is an extremely reassuring and
positive comment made by the judiciary. The amendment brought in by the Finance Act, 2012
has laid down a new law in this regard. Hence the same is substantive in nature. By this very
nature, it should not have been made retrospective. The stand taken by the tax department in the
present case seems to be very desperate and aggressive in nature. When on one hand excess
security premium is not being charged to tax, then taxing under receipt of the same seems to be a
farfetched idea.

47

Vodafone International Holdings B.V. v Union of India 341 ITR 1(SC)

48

Vodafone India Services Pvt. Ltd. v Union of India [2013] 39 taxmann.com 201 [Bombay]

That being said, going forward, in the interest of the tax administration and to instill confidence
in foreign investors as well as taxpayers that we must remember the following words written by
Nani Palkhivala:
Every government has a right to levy taxes. But no government has the right, in the process of
extracting tax, to cause misery and harassment to the taxpayer and the gnawing feeling that he
is made the victim of palpable injustice.
The ghost of the great Vodafone saga is yet to be buried and enough bridges have been burnt in
the process. It is hoped that in such cases the courts deal with them in a rational manner rather
than by extending the concept of income beyond its natural and sensible bounds. This will help
in solving not only the interpretation issue but also allay the fears that the foreign investors are
experiencing off late.