In the same week that Nokia announced the shutdown of its manufacturing facility in Chennai, a decision that is widely seen to be a fallout of its troubles with an overzealous taxman, the Bombay High Court on Friday delivered a welcome judgment that brings clarity on transfer-pricing issues which could go a long way in improving the investment climate in the country. While the Nokia disputes are unrelated to transfer pricing, Friday’s judgment, which scotched the tax department’s 2014 demand, adding Rs 3,200 crore to Vodafone India’s income for 2009-10, could influence the outcome in 26 similar cases. At a time when the government has been exerting itself to attract foreign investment, and potential investors have been concerned about hostile tax authorities, the high court verdict is reassuring. Indeed, it was another, yet-to-be-resolved, Rs 10,000 crore retrospective Vodafone case that was widely seen to be the ominous tipping point vis a vis investors.
In 2009-10, Vodafone India had issued shares to a subsidiary of its UK-based parent in return for an infusion of money for its local operations. In fact, most of the 26 pending transfer-pricing cases involve a foreign company injecting capital into its Indian subsidiary in return for shares. But by contending that the shares had been sold at a discount to a related party, and accordingly adjusting Vodafone India’s taxable income by Rs 3,200 crore, the tax department, in effect, unreasonably sought to levy income tax amounting to approximately Rs 1,050 crore for bringing capital into India. Now, the court has cleared the decks for this kind of investment. Funds infused by a foreign entity into an Indian company will now continue to be classed as capital, as opposed to income, which would be taxable under the Income Tax Act.
There is a larger trend that frames these cases and adds to the impression that the tax authorities are unnecessarily belligerent and litigious. The number of income tax disputes doubled between 2010 and 2011. But for all the bad blood, it’s not as though the tax-GDP ratio is much improved — it was 10.3 per cent in 2012-13, compared to 10.32 per cent in 1989-90. The taxman’s strike rate in courts of law is abysmal. According to the Tax Administration Reforms Commission, in 2012-13, the tax department lost approximately 88 per cent of all CBDT cases that went up to the Supreme Court and about 80 per cent in high courts and income tax tribunals. Given this record, the tax authorities would be well advised to accept the HC verdict, and not take this case to the Supreme Court.