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Shell India tax dispute could lead to greater uniformity of valuation methods

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Shell India will challenge a claim by the Indian tax authorities that it undervalued shares issued to a foreign subsidiary on the grounds that the order is contrary to tax regulations. If Shell is unsuccessful the outcome could influence other multinationals to change their valuation method for share issuance.

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The Indian Revenue Service claims that Shell India undervalued 87 million-equity shares issued at Rs 10 ($0.2) each to its parent Shell Gas BV in March 2009. The Revenue has challenged the valuation methodology used by Shell, valuing each share at Rs 183 instead.

The exact grounds upon which the valuation of the shares by Shell has been questioned have not yet been released by the Revenue Services. However Daksha Baxi, executive director of Khaitan & Co, believes that the higher value was determined under the discounted cash flow (DCF) valuation method rather than simply Rs 10 per share.

Shell India have rejected the Revenue Service’s valuation, arguing that the transfer pricing order is based on an incorrect interpretation of Indian tax regulations and is bad in law since the shares issued are a capital receipt upon which tax cannot be levied.

“Taxing the money received by Shell India is in effect a tax on Foreign Direct Investment (FDI), which is contrary not only to law but also to the spirit of the recent global trip by the Finance Minister to attract further FDI into India”, said Yasmine Hilton, chairman of Shell Group Companies in India.

Shell has said that a certified, independent, valuer who assessed the value to be below Rs 10 per share undertook the valuation of the shares. The company claims there are no provisions under the income tax law for the revaluation of each share at Rs 183.

“Given that the dispute relates to valuation, it would be reasonable to assume that Shell would be successful to the extent of penalty, if levied, since valuation is really a question of interpretation and choice of the taxpayer,” said Abhishek Dutta, partner at HSA Advocates in India. “What lends more support to Shell’s case is that they have reportedly relied on an independent valuation expert’s report.”

However if Shell is unsuccessful, the Indian tax authorities will require all parent companies to subscribe to further share capital of their subsidiaries at DCF valuation.

“If they have not done so, they are likely to make a transfer pricing adjustment,” said Baxi. “Some completed assessments may even face reopening, though the reason for reopening would be a change in view and not a change in law and hence not likely to be sustainable.”

Baxi believes that, considering the aggressive stance taken by the Indian tax department, subsidiaries should generally use a DCF valuation method to determine the price at which to issue further shares to their existing shareholders unless there is a method used internationally that is more appropriate.

“In the mean time, for past transactions, it may be appropriate for the Indian companies to consult tax lawyers and assess their exposure and what corrective measures to undertake,” said Baxi.

“It is clear that Indian tax authorities are using all and any tool available at their disposal to ensure that their tax base is not eroded. In the process, perhaps they may go a little too far. Thus, this may be indicative of the trend of Indian tax authorities not accepting anything without considering the impact on their tax base.”

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