school of management and entrepreneurship

Transfer Pricing Dispute with Shell India

Managerial Accounting Project Report

ByAkshatPaliwalAnkita Gupta

Mansi MakhijaniTushita Goel1 2/25/2014

ContentsIntroduction................................................................................................................................2

What is transfer pricing?............................................................................................................3

How the case evolved?...............................................................................................................3

Introduction

Royal Dutch Shell Plc commonly known as Shell, is an Anglo–

Dutch multinational oil and gas company headquartered in the Netherlands and incorporated

in the United Kingdom.Created by the merger of Royal Dutch Petroleum and UK-based Shell

Transport & Trading, it is the second largest company in the world, in terms of revenue,and

one of the six oil and gas "supermajors".

As of January 2013, the largest shareholder of the company was Capital Research Global

Investors with a holding of 9.85% with BlackRockat second place with 6.89%

shareholding.Shell topped the 2013 Fortune Global 500 list of the world's largest companies.

Royal Dutch Shell revenue was equal to 84% of the Netherlands's $555.8 billion GDP at the

time.

It has minor renewable energy activities in the form of bio-fuels and wind. It has operations

in over 90 countries, produces around 3.1 million barrels of oil equivalent per day and has

44,000 service stations worldwide. Shell Oil Company, its subsidiary in the United States, is

one of its largest businesses.

Shell has a primary listing on the London Stock Exchange and is a constituent of the FTSE

100 Index. As of 6 July 2012, it was the largest company on the FTSE, with a market

capitalisation of £140.9 billion. It has secondary listings on Amsterdam and the New York

Stock Exchange.

Transfer pricing issue:

It relates to the issue of 870 million shares by Shell India Markets Pvt Ltd to its overseas

parent company Shell Gas BV in March 2009. The shares were issued at Rs 10/share, which

was contested by the income tax authorities in Mumbai. The income tax department

challenged the valuation methodology of Shell India and pegged the value of the shares at Rs

180/share instead, that were transferred to the parent company by about $2.5 billion. The

income tax department charged Shell India of under-pricing a share transfer within the group

by Rs 15,220 crore, and consequently evading taxes. Earlier this year, the tax authorities

added to the company’s liability by issuing a show-cause notice,demanding tax on the interest

the company would have earned,adding another Rs 3,100 crore to Shell India's income for

FY09, taking the total taxable income to about Rs 18,000 crore.

What is Transfer Pricing?

The Transfer Price is the price at which divisions of a company transact with each other. As

per rules, such transactions between group companies based in different countries should

apply an arm's length pricing. This is to ensure that a fair price - one that would have been

charged to an unrelated party - is levied. Transactions may include the trade of supplies or

labour between departments. When different divisions of a multi-entity company are in

charge of their own profits, they are also responsible for their own "Return on Invested

Capital". Therefore, when divisions are required to transact with each other, a transfer price is

used to determine costs. Transfer prices tend not to differ much from the price in the market

because one of the entities in such a transaction will lose out: they will either be buying for

more than the prevailing market price or selling below the market price, and this will affect

their performance.

How the case evolved?

The Bombay High Court, on Tuesday, ruled in favour of Shell.

Shell India moved to the Bombay High Court challenging the tax notice. Funding a

subsidiary by issuing shares is a common practice among multi-national companies, which

view this as a capital transaction and out of the transfer pricing bracket, it said. However, the

tax department argued that such a deal is a transfer pricing arrangement by which the shares

issued were undervalued and hence the company is liable to pay tax on the income generated

out of it. The High Court did not agree with the department, quashed its order and issued a

show cause notice against Shell India. The Shell India case is significant — the principle

being that issuance of shares by an Indian company to its foreign parent is not exigible to

transfer-pricing provisions, as there is no income arising therefrom.

Some More Companies like Shell:

The judgment comes in the wake of two similar transfer pricing cases, which were ruled in

favour of the Indian subsidiary of Vodafone Group Plc, in which the I-T department had

sought adjustments of over Rs.4,500 crore last month.

There are more than a dozen such cases in various courts all over India. Multinational

companies have been complaining that Indian tax authorities are arm twisting them to derive

more tax revenue. In the earlier Vodafone case, the I-T department had sought adjustments of

over Rs 4,500 crore Indian subsidiary of Vodafone Group Plc. With Nokia, the department

had slapped Rs 2,000 crore notice. Other companies that are facing such demands include

IBM and Cairn. So, Vodafone and now Shell's win is likely to be a big boost for all these

companies.

"This is a positive outcome which should provide a further boost to the government

initiatives to improve the investment climate," a Shell India spokesman said in an e-mail

statement.