Tag Archives: Delhi ITAT

Cairn faces a INR 10,000 crore Tax spill

The Income-tax Appellate Tribunal has upheld a INR ~10,000 crore (approx USD 1.5 billion) capital gains tax demand on Cairn Energy UK, on a transaction which caused inversion of the group holding structure and resulted in the currently listed Indian entity of the group [Cairn India] becoming the holding company for the group’s oil and gas assets in India. The transaction in question happened before the sale of the group to Vedanta.

Grants interest relief

The Tribunal however spared the dual interest levies for non-filing of Tax return and non-payment of Taxes in India, in a total sum of further INR 14,000 crore. The Tribunal ruled that interest could not be levied as the Tax demand emanated from retrospective change to the Tax law. The Tribunal also held that there was no obligation for Cairn UK to remit advance tax in India on account of the retrospective change; as also for the reason that in the case of non-resident Taxpayers, the applicable taxes have to be deducted by the payer of income.

Ruling Debrief

The facts of the case

A simplified version of the complex facts of the Transaction is as follows. Cairn Energy Plc, the erstwhile ultimate holding company of the Cairn Group held diverse Oil and Gas assets across the globe – with Indian assets being most significant in value. The complex restructuring exercise leading to divestment of 30% of its Indian assets through an IPO in India was carried out through the following steps:

(i) The Indian holdings [held through various SPVs] of Cairn Plc were first transferred to Cairn Energy UK.

(ii) Cairn Energy UK in-turn hived off the Indian holdings to Cairn India Holdings, an entity based in Jersey.

(iii) Cairn Energy UK then moved its entire stake in Cairn India Holdings, Jersey to another of its subsidiaries in India – Cairn India. Cairn India acquired the Cairn India Holding, Jersey stake from its parent Cairn Energy UK partly by way of issue of shares and partly for cash consideration.

It is this transfer of Cairn India Holding, Jersey by Cairn Energy UK to Cairn India, which was subject to capital gains taxation by Indian Revenue authorities.

(iv) Subsequent to the above acquisition of Cairn India Holdings, Jersey, the Indian entity came-up with an IPO. Part of the IPO proceeds were used to pay Cairn Energy UK for acquisition of its stake in Cairn India Holdings, Jersey

Through the process, close to 30% of the Indian oil and gas assets were monetized / divested by the Cairn group, while retaining the balance 70%.

The Technical challenge to the Tax notice

The Tribunal first dealt with the elaborate filibuster on range of technical objections to the Tax Notice for re-assessment, which formed the basis for the proceeding culminating in the tax demand. The Notice was challenged on following grounds:

  • That the Tax notice was not in prescribed legal format, as it did not clearly state that due approvals have been obtained for issuance of the same
  • That the Tax notice was based on information which was already in possession of the Department as filed by the Indian entity [Cairn India] and not on basis of fresh material, and therefore not in conformity with legal requirements
  • the survey report which formed the basis for the Tax notice was ‘probably’ not in possession of the Tax officer at the time he issued the notice
  • the  communication which contained the “reasons” for issuance of Tax notice was not signed by the Tax officer
  • the authorization for the Tax notice was not from the appropriate officer

The Tribunal however rejected the technical objections and upheld the validity of the Tax notice, after a review of the record presented by the Tax Department to show that applicable legal processes were duly followed.

The core of the case

On merits, the Tax demand was resisted for following reasons:

  • That the transaction was in the nature of internal group re-structuring which did not result in ‘real income’ accruing to the group
  • That the retrospective change in Tax law was not constitutionally valid and Indirect transfers were not taxable in India, as held by the Supreme Court in Vodafone’s case
  • The Domestic Tax law which was prevalent  at the time India entered into Double Taxation Avoidance agreement with United Kingdom had to be applied (Another way of arguing that retro-amendment to the Tax law was not applicable)
  • That in any case, there was no gain arising in the hands of Cairn Energy UK, since Cairn Energy UK had acquired its stake from Cairn Plc and the cost of acquisition was the same as the sale consideration since the transaction of acquisition and disposal happened within a short time-frame

The Tribunal did not agree that the transaction was in the nature of internal group re-organization, not resulting in any ‘real income’ to Cairn Energy UK. Reference was made to the financial statements of Cairn Energy UK wherein the gain was disclosed and further stated to be tax exempt in UK. The Tribunal also did not agree that the law prevailing as on the date of entering into India-UK DTAA was applicable to the case.

The issue of constitutional validity of retro-amendment was not decided on the basis that such an issue can only be decided by a constitutional institution [i.e. a proper Court of law] and not by a Tax Tribunal, which is a creature of the Tax statute.

The Tribunal also rejected the contention on behalf of Taxpayer that there was no gain in the hands of Cairn Energy UK, since acquisition and transfer of the Indian business had happened over a short time-span; and that the cost of acquisition would be equal to sale consideration. The Tribunal held that since the earlier steps in the transaction were not brought to tax, the entire gain could be taxed in the hands of Cairn UK.

Our View & comments

While most of the arguments presented on behalf of the Taxpayer seem to have been dealt with appropriately, the argument to the effect that cost of acquisition at fair value should be equal to the sale consideration seemed the most attractive one, which may save the day for the Taxpayer at a higher forum. Perhaps a more refined argument would be to admit a certain upside [earned between the time of acquisition and disposal] as the Taxable gain. If such an argument were to be accepted, this would still leave a significant upside [between the time the assets were originally acquired by the group till the same was transferred to Cairn Energy UK pursuant to the re-organization] going un-taxed, which would obviously leave the Revenue dis-satisfied.

Perhaps the need of the hour is to have enabling mechanism in Tax laws to deal with taxation of complex re-organisation transactions which result in part disposal of stakes, while retaining larger control. A pragmatic and fair resolution in such cases would be to proportionately tax the divestment component [for instance, the 30% dilution to public in this case]. Properly used, the General Anti-Avoidance framework which comes into force from 1st April 2017 could well be the tool for equitable taxation of such complex arrangements.

 

Delhi Tribunal sets out TP Adjustment formula for late realization of sales

In a recent ruling in the case of Techbooks International Private Limited, the Delhi Tax Tribunal proceeded to lay down the formula for making Transfer Pricing adjustment for late realization of sales proceeds.

 

Formula adopted by TPO

The Transfer Pricing officer noted that the Taxpayer had realized the sales invoices late and carried out Transfer pricing adjustment by applying interest rate of 15% on the late receipts, after allowing for a normal credit period of 60-days.

The Taxpayer protested the adjustment and also pointed out that as  the terms of the services agreement provided for a credit period of 150-days.

Tribunal Ruling

The Tribunal upheld in-principle the need for making the TP adjustment for late realization, taking note of the fact that the Finance Act 2012 widened the scope of international transactions to include inter-alia debts arising during the course of the business.

The Tribunal however altered the basis adopted to carry out the adjustment. The Tribunal reasoned that since the sale price of the Taxpayer was arrived on the basis of a 150-day credit period, the adjustment to late realization had to be made on the following basis:

(i) In the first instance, the credit period of the comparables had to be determined and the revenue of comparable companies had to be re-computed based on the 150-day credit period, to bring them on par with the Taxpayer

(ii) The delay in realization by the Taxpayer beyond the contracted 150-day credit period to be taken as another international transaction, and adjustment made therefor

For the purpose of making the adjustment, the Tribunal upheld the use of LIBOR rate in foreign currency relevant to a particular Associated Enterprise

 

Other Issues

a) Companies following different financial year

The Tribunal also provided an opportunity to the Taxpayer to re-determine the margins of the comparable companies which were rejected for following financial year-end different from fiscal year-end and reporting period of more than 12 months.

b) Selection /Rejection of comparable companies

Companies which had undertaken M&A transactions were held not comparable. Claims for selection / rejection of comparable companies on grounds of high / low turnover were also not entertained.

c) Risk Adjustment

Claim for Risk adjustment by the Tax payer since it was a “captive” service provider was negatived on the basis that it faced a “single-customer” risk and also on finding that the Taxpayer had created a provision for doubtful Advances against Associated concerns.

d) Margin computation

Forex fluctuation and provision for doubtful debts held to be an operating item while bank charges held as a non-operating item for the purpose of margin computation.