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TRANSFER PRICING SHARE VALUATION 1.

. Transfer Pricing Officer (TPO) have been making adjustments in respect of socalled under valuation of shares issued by Indian Companies to their related parties and the issue has generated lot of controversy more particularly with reference to the valuation of shares made in the case of Shell India Markets Pvt. Ltd. and Vodafone India Service Pvt. Ltd. Similar adjustments have been made in many companies all over India where the difference in valuation of shares between the transaction value and valuation adopted by TPOs runs into more than Rs.30,000 crores. TPOs are relying upon the decision of the Income Tax Appellate Tribunal in the case of Ascendas (India) Pvt. Ltd. TPOs are making adjustments adopting Discounted Cash Flow Method (DCF) as most appropriate method to determine the Arms Length Price (ALP) of share transaction. In view of the public debate on the issue of jurisdiction of TPO in making the adjustments on account of under valuation of the shares allotted or sold to related parties, Honble Finance Minister has sought legal opinion of Attorney General of India on various questions. The opinion sought is on the primary issue as to whether the TPOs have the jurisdiction to determine ALP and whether the TPOs are right in adopting DCF method as the most appropriate method. More importantly the question raised is whether the difference between the valuation adopted by TPOs and the transaction price of the shares result in income as defined in the Inc ome Tax Act. It is understood that Attorney General has not yet given his legal opinion on the questions raised by the Finance Ministry. The real issue in the actions of TPOs is whether TPOs have power to make adjustments in respect of share valuation which is on capital account and not on revenue account. When the shares are issued by Indian Companies to its related parties, the transaction is on capital account and even if there is a difference in valuation, the difference cannot be and should not be considered as income as the transaction is on capital account. What some TPOs have done is that they have considered the difference being the under valued price as the amount not received by the Indian Companies and thereby the Indian Companies have allowed the same to be retained by the foreign related party and recharacterised the differential amount as socalled loan and have attributed interest thereon as the income which Indian Companies could have or should have earned on the said amount. Thus there is already difference in approach between various TPOs where some have taken the differential amount as income whereas others have recharacterised the same as loan and attributed income by way of interest. Thus there is no unanimity amongst the Transfer Pricing Wing on the action to be taken in such cases. Even the Finance Ministry in their reference to Attorney General has not considered the issue whether the TPO can recharacterise the transaction and take it as a mix of share issue and deemed loan. To this extent, the answer of Attorney General will be incomplete. 5. In all cases TPOs have applied DCF method as the most appropriate method in working out the valuation of shares. Income Tax Act and Rules have provided 5

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methods for determining ALP. Cost plus method, Resale price method, Transactional net margin method and Profit split method are not applicable to the share valuation. Only method which is available is Comparable Uncontrolled Price Method. DCF method of valuation cannot be considered in any of the methods prescribed. The adoption of DCF method is therefore not the prescribed method. This aspect also requires the opinion of Attorney General. 6. Thus the Attorney General should consider following aspects:a. Whether TPOs have the powers to make adjustment in respect of share valuation. If yes, which of the prescribed methods will be applicable to the determination of Arms Length Price. Whether DCF method is a method which can be adopted and is it covered by the Comparable Uncontrolled Price Method. Whether the TPOs have the powers to recharacterise the transaction between capital and deemed loan. Whether the differential between the share valuation made by TPOs and transaction value can be treated as income inspite of transaction being on capital account. Whether the TPOs can consider the differential as deemed loan and attribute interest thereon and make addition of interest.

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There are differential treatment given by TPOs in various region and therefore there is no unanimity on the types of additions on this issue. It is necessary that Directorate of International Tax provides suitable guidelines on common issues for the benefit of general public as well as departmental officers. The above is in respect of under valuation of shares. It is not known as to what stand Directorate of International Tax wants to take in case of over valuation of shares.

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