(2014) 368 ITR 1 (Bom)
Computation of income from an international transaction having regard to arm's length price; meaning of international transaction
No. The issue of shares at a premium is a capital account transaction that gives rise to no income. Transfer pricing provisions are machinery for computing income and cannot create income where none arises.
Where shares are issued to a foreign associated enterprise at a premium said to be below fair value, can the shortfall be treated as income and subjected to transfer pricing adjustment?
The Indian company issued equity shares to its non-resident group holding company at a premium, valuing the shares on a stated basis. The Transfer Pricing Officer took the view that the shares had been undervalued, computed what he regarded as the correct arm's length value, and treated the shortfall between that value and the issue price as a transfer of value to the associated enterprise. He then treated the shortfall as a deemed loan advanced by the Indian company to its parent and imputed interest on it, making adjustments on both counts.
The taxpayer challenged the jurisdiction by writ petition before the Bombay High Court, contending that the entire exercise was without authority of law. The Court decided the matter on the fundamental question of chargeability, and the Union subsequently accepted the decision and directed that it not be appealed.
For the assessee
Chapter X is a machinery provision for computing income arising from an international transaction. The issue of shares is a transaction on capital account: the premium received is a capital receipt, and no income arises from it. Where there is no income, there is nothing for the machinery to compute, and a shortfall in premium cannot be converted into taxable income by the transfer pricing provisions.
For the Revenue
The transaction is between associated enterprises and falls within the wide definition of international transaction, which includes capital financing. The failure to charge full value transferred an economic benefit abroad, and the provisions exist precisely to neutralise such transfers.
The Court held the entire exercise to be without jurisdiction. It reasoned that Chapter X does not contain a charging provision; it supplies machinery for computing income that arises from an international transaction, having regard to the arm's length price. The foundational requirement is therefore that income must arise. The issue of shares at a premium is a transaction on capital account between a company and its subscriber: the amount received, including the premium, is capital and is not income. It followed that even if the shares had been issued at less than fair value, the shortfall was not income but at most a lesser receipt of capital. The Court held that neither the residual clause of the definition of international transaction nor the reference to capital financing could convert a capital receipt into income, since the definition operates within Chapter X and is subject to the same requirement of income arising. The consequential treatment of the shortfall as a deemed loan, and the imputation of interest upon it, fell away with the primary adjustment, being founded on a transaction the Court had held did not give rise to income.
The income-first principle carries directly into Sections 161 and 163 of the IT Act 2025, which remain computation provisions rather than charging ones. The decision was accepted by the Government and continues to govern capital-account dealings with associated enterprises, including share issues, conversions and similar capital restructurings.