Can TP provisions make otherwise 'exempt share transfers' taxable?

Finance Act, 2012 has amended the definition of 'international transaction' u/s 92B with retrospective effect from April 1, 2002 to specifically include 'a transaction of business restructuring or reorganization entered with an AE irrespective of the fact that it has bearing on the profits, income glosses or assets of such enterprises at the time of transaction or in future'. Where business reorganization / restructuring involves transfer of shares, determining ALP for such shares assumes significance.


Earlier, AAR in Deere & Co [TS-394-AAR-2011] had held that the transfer pricing provisions were not applicable to share transfers in business reorganization, as the shares were transferred as a gift, without any consideration. AAR held that transfer pricing provisions were not applicable in absence of 'income' accruing on transfer of shares. In that case, the non-resident applicant transferred shares in an Indian subsidiary to another foreign subsidiary in the course of business reorganization. A similar view was taken by AAR in other rulings also. However, in a recent ruling in Castleton Investment Ltd [TS-607-AAR-2012], AAR departed from the precedents to hold that TP provisions were applicable despite capital gains being exempt under the India-Mauritius tax treaty.


Applying the Castleton ruling and the recent retro amendment to the definition of 'international transaction', the TPO can hold that transfer of shares in business reorganization is an international transaction subject to TP, even if there is no consideration. He can substitute ALP so determined for nil consideration agreed between the parties. For determining ALP, a recent ruling in  Ascendas India P Ltd [TS-1-ITAT-2013(CHNY)-TP] can provide useful guidance. In that case, Chennai ITAT had ruled upon the issue of method of valuation of shares in the context of transfer of shares to AE. 


The question which comes to one's mind is if a transaction being gift, which is not taxable in the absence of consideration, can be subjected to tax on the basis of ALP so decided? Whether TP provisions are charging provisions or computational provisions? Can otherwise exempt transaction result into a chargeable income by applying TP provisions?  Whether chargeability of income precedes application of the TP provisions or TP provisions themselves can result into chargeability? It is to be noted that as per Sec 92(1), "any income arising from an international transaction" shall be computed having regard to ALP.


Applying Castleton ruling, TP provisions can apply to transactions on which capital gains are exempt under the treaty provisions. In such cases, determining ALP of sale of shares is a futile exercise, if ultimate capital gains are going to remain as exempt under the treaty. 


Interestingly, in one ruling i.e. Orient Green Power Pte Ltd [TS-608-AAR-2012], AAR declined to rule on the question of taxability of a 'gift' of shares, calling it a 'strange transaction.' AAR held that the exemption available u/s 47(iii) was for a 'human agency' and a gift of shares held in a company by one company to another would not fall u/s 47(iii). This raises another question - whether a 'gift' of shares for no consideration can be said to be at arm's length at all?


Note: On January 23, 2013, ITAT Special Bench pronounced its ruling in the case of LG Electronics involving marketing intangibles [TS-11-ITAT-2013(DEL)]. ITAT SB made some interesting observations in respect of TP applicability in case of non-payment of consideration. "The mere fact that no consideration moved between the AEs for a transaction is not a decisive factor to have influence over its nature. Payment of consideration has not been made as a condition precedent for inclusion of any transaction within the ambit of section 92B. The transfer pricing provisions should be seen in the backdrop of the fact that these are special provisions for avoidance of tax on the transactions structured between two associated enterprises. The simple fact that the foreign AE did not pay any consideration to the Indian AE will not take the transaction out of the purview of the transfer pricing provisions, if it is otherwise an international transaction."