Applicability of Transfer Pricing on Capital Investments: Analysis of Pr. CIT vs. PMP Auto Components Pvt. Ltd.

The article is written by Dipendra Jain (Partner) at Jain Doshi & Co.

The case Pr. CIT vs. PMP Auto Components Pvt. Ltd. (Bombay High Court) revolves around the applicability of transfer pricing provisions under Chapter X of the Income Tax Act on the purchase of shares by an Indian company in its foreign subsidiary at a price exceeding the fair market value (FMV). The court ruled that such an investment is a capital transaction and does not generate taxable income, making transfer pricing adjustments inapplicable. The decision emphasized that Chapter X applies only when income arises from an international transaction, and in this case, the purchase of shares did not result in any taxable income.

Case Analysis: Pr. CIT Vs PMP Auto Components Pvt. Ltd. (Bombay High Court)

Court:

Bombay High Court

Citation:

Income Tax Appeal No. 1130 of 2016

Date of Judgment:

13th January 2016

Key Issue:

Whether the provisions of Chapter X of the Income Tax Act (Transfer Pricing) can be applied to tax the excess payment made by an Indian company for acquiring shares of its foreign subsidiary, where the purchase price exceeds the fair market value (FMV) of the shares.

Facts of the Case:

1. Assessee: PMP Auto Components Pvt. Ltd. (an Indian entity) invested ₹2.67 crores to purchase shares of its Associated Enterprise (AE), a foreign subsidiary.
2. FMV of Shares: The FMV of these shares was only ₹8.19 lakhs, meaning the assessee had paid an excess amount of ₹2.58 crores.
3. Revenue’s Position: The Revenue (Income Tax Department) sought to tax this excess payment under the transfer pricing provisions of Chapter X of the Income Tax Act. The Department argued that the excess amount paid over FMV constituted an international transaction, thereby triggering the requirement to make adjustments to the Arm’s Length Price (ALP) and tax the differential.
4. Tribunal’s Decision: The Income Tax Appellate Tribunal (ITAT) held that the investment in shares is on capital account and does not give rise to taxable income. This conclusion was based on the earlier ruling in Vodafone Services Pvt. Ltd. Vs Union of India.

Key Legal Provisions:

1. Chapter X – Transfer Pricing Provisions:
   • It deals with adjustments to transactions between related parties (AEs) to ensure that these transactions occur at Arm’s Length Prices (ALP).
   • Chapter X i.e. the Transfer Pricing Provision applies only if there is income arising from an international transaction.
2. Section 92B:
   • Defines what constitutes an “international transaction.”
3. Section 2(24) and 56(2)(viib):
   • Section 2(24) defines “income,” and section 56(2)(viib) deals with the receipt of excess consideration on the issue of shares, but this provision was only made effective from April 1, 2013, and is not applicable to this case (AY 2010-11).

Court’s Observations and Judgment:

1. Investment in Shares: The court reaffirmed that the purchase of shares by an Indian entity from its AE, even if at a price higher than FMV, is an investment on capital account and does not generate any income. Therefore, it cannot be subjected to transfer pricing adjustments under Chapter X of the Income Tax Act.
2. No Income from Capital Investment: Chapter X is a machinery provision to determine the ALP for taxation, but income must first arise from the international transaction. The court held that the purchase of shares in this case does not result in any income. Hence, the provisions of transfer pricing under Chapter X cannot apply.
3. Vodafone Ruling: The court relied on the ruling in Vodafone Services Pvt. Ltd. vs. Union of India, which established that investment in shares does not create taxable income. The distinction between inbound (into India) and outbound (from India) investments was considered irrelevant, as Transfer Pricing Provision applies only where income is generated, which was not the case here.
4. Potential Future Losses are Speculative: The Revenue’s argument that the shares might be sold at a loss in the future (since they were bought at a higher price) and thereby reduce future tax liability was dismissed as speculative. Tax laws are applied based on actual facts and legal provisions in the relevant assessment year, not on potential future events.
5. Amendment in Law Post-2013: The court noted that from 1st April 2013, section 56(2)(viib) was introduced, taxing consideration received for shares that exceeds the FMV. However, this provision was not applicable in this case as the assessment year in question was 2010-11.

Conclusion:

The Bombay High Court ruled in favor of PMP Auto Components Pvt. Ltd., holding that:

• Transfer pricing provisions under Chapter X of the Income Tax Act are not applicable to the infusion of funds for capital investments, such as purchasing shares in a subsidiary, even when the purchase price exceeds the FMV of the shares.
• The machinery provision under Chapter X is meant to address transactions that give rise to taxable income. Since the investment in shares is on capital account and does not generate income, it cannot be subjected to transfer pricing adjustments.
• The distinction between inbound and outbound investments is irrelevant as the law does not differentiate between the two for the purposes of determining the applicability of transfer pricing adjustments.

Summary:

The court established that capital infusions from India into foreign subsidiaries, even when made at a price exceeding the fair market value of shares, do not attract transfer pricing provisions under Chapter X. This ruling clarifies that no income arises from such capital investments and transfer pricing provisions can only be invoked when there is actual income arising from an international transaction. The decision is based on the premise that the mere purchase of shares does not generate taxable income.

Dipendra Jain