Unravelling the tax travails of NDTV
Seven years and counting. That is how long the Prannoy and Radhika Roy promoted New Delhi Television (NDTV) and the income tax department have been battling with one another to settle once and for all, the basic question: Did NDTV’s business operations in the financial year 2008-09 result in a figure of profit that is liable to be taxed, or a loss that needs to be set-off against future profits of the company?
Even as the battle was being fought in the forums of tax law, the media too had weighed in with its own assessment that ranged from adopting a lofty moral stand to label the Government’s initiatives a ham-handed effort at coercing independent media institutions into submission, to more mundane assertions such as tax-fraud and money laundering on the part of NDTV and its promoters. In the meanwhile, the tax claim had ballooned from an initial figure of ‘zero’ tax liability that NDTV had asserted, to a figure now that is in excess of Rs 832 crore as the IT department claims NDTV owes. What are the facts of the case? More importantly, how tenable are the department’s claims?
It was on September 30, 2009 that NDTV filed a ‘return of income’ --a formal declaration that every tax payer has to make as part of settling income tax dues to the State--claiming that its operations in the financial year 2008-08 resulted in a loss of Rs 64.84 crore. The IT department disagreed. It claimed instead that the broadcaster’s operations, far from resulting in a loss of Rs 64.84 crore that year, should actually be deemed as having resulted in a taxable profit of Rs 641 crore. In other words, it sought to add to the NDTV’s ‘returned’ figure of a Rs 65 crore ‘business loss’, a total sum of Rs 706 crore to arrive at a taxable income of Rs 641 crore.
There were quite a few adjustments. But an addition of Rs 642.54 crore stands out.
Did NDTV suppress a transaction?
The tax department has alleged that NDTV has suppressed a transaction of income of this order while claiming a business loss of Rs 64.84 crore for the financial year 2008-09. The company, which quite naturally felt aggrieved by the inclusion of such a large sum of money as ‘undisclosed income’, sought a ruling from the Dispute Resolution Panel (DRP), an internal panel of senior officials within the tax department, to adjudicate on this tax dispute between it and the assessing officer in the department.
The DRP heard the department’s side of the case as also that of arguments from the NDTV. Even as the process of adjudicating on the legal merits of inclusion of a figure of Rs 642.54 crore in concealed income was going on, the assessing officer in charge determining the NDTV’s tax liability brought to the notice of the DRP that an additional sum of Rs 254.75 crore needed to be added as well to the original figure of concealed income of Rs 642.54 crore mentioned earlier. The DRP ruled in favour of the department on both these claims. Consequent to such a favourable ruling, the IT department now contended that NDTV’s tax for the assessment year 2009-10 relevant to the financial year 2008-09, should be assessed at Rs 307 crore.
A hefty penalty
The stage had thus been set for an appeal before the Income Tax Appellate Tribunal (Tribunal) where the matter rests now. But even as the matter was being agitated before the Tribunal, the IT Department had in June 2016, issued a ‘show-cause’ notice against NDTV asking it to explain why a further sum of Rs 525 crore should not be imposed as penalty for concealment of income to the already assessed figure of tax of Rs 307 due on its assessed income. This took the total financial burden on NDTV (if the IT department’s case on the concealment of income is upheld) to a figure of Rs 832 crore.
Of course the penalty demand is incidental as it springs from the substantial additions of incomes made by the tax department to the original figure of loss claimed by NDTV. If the additions to income as sought to be imposed by the tax department are held to be not legally tenable then the penalty demand too, fails. If on the other hand the proposed inclusions are upheld by judicial authorities NDTV faced a huge additional financial burden. It boils down therefore to the legality or otherwise of additional figure of income that the tax department has sought to impose.
There were thus two principal financial transactions that had become the subject of scrutiny by the tax authorities. The legal grounds for inclusion are the same for both and we may therefore look at the nature of the case against NDTV with regard to the initial claim of Rs 642.54 crore to get a sense of why the tax department feels the way it does in this case.
The transaction relates to what NDTV had claimed as $150 million raised during the financial year 2008-09 by one of its ‘step-down’ subsidiaries from NBCUniversal, a US-based company in the broadcasting business, to fund its foray into a host of non-news general channels including entertainment. Or rather, it wasn’t NBCUniversal itself but one of its subsidiaries located in Netherlands. Again, rather than receiving the money directly into its coffers, NDTV chose to receive it against issue of shares by an overseas subsidiary company that was two steps removed from it. To put it in simpler terms, if NDTV can be labelled as Company A, the money flowed into company C which was a subsidiary of Company B and which in turn was the subsidiary of Company A (NDTV).
A multi-layered corporate structure
Adding another twist to the complexity of the structuring of the transaction, the money itself was to be utilised towards financing the launch of a host of new channels besides an outfit meant for production equipment and processing (NDTV Labs) each of which will be represented as distinct corporate entities with an independent existence. For the sake of convenience, we may label them as Companies F, G, H and I, all of which were subsidiaries of Company E that was a subsidiary of Company D and which in turn, was the subsidiary of Company C- the actual recipient of the money from NBCUniversal. The rupee equivalent of that sum of money (Rs 642.54 crore) as valued then is what the IT department has sought to tax in the hands of NDTV, as its own income for that year. In short, we have NDTV (Company A) and a series of companies B, C, D and E each one of which, is a subsidiary to the one above in the alphabet ranking. The arrangement was rounded off with companies F, G, H and I that were the subsidiaries of Company E.
The IT department contended that the transaction was effectively money received in the hands of NDTV even though there were layers of corporate structure involved in between. Since NDTV is a company incorporated in India, the tax department contended that it had the jurisdiction over NDTV and consequently, the latter is accountable for any monies that might have been received by the company’s overseas subsidiary as long as such monies could be legally deemed as belonging to NDTV.
The tax department went on to argue that no matter that the $150 million was originally received by an overseas subsidiary, legally the sum represented money flowing into the hands of NDTV. It thus became the responsibility of NDTV to explain the source this money and even more importantly, whether the person who is claimed to have supplied the money (whether as equity investment or even as a loan) had the means to do so. If both these conditions are not satisfied then the IT department, as it argued, was empowered under the tax law to treat it as ‘income’ under one of two sections.
One section looks at a situation where the tax-payer (in this case, NDTV) is shown to have some credit entry in the books of account of its business which it could not explain, to the satisfaction of the tax authorities, the source of such a credit entry and the surrounding circumstances (Section 68). For example, let us assume that you are running a proprietary business for which you maintain books of account. The assessing officer while inspecting the books of account of your business comes across a credit entry. If you are unable to explain how the credit entry came about then the tax official, is entitled to presume that this represented payment for some goods sold earlier which had not been recorded in the books. In other words, it amounted to a source of income which had not been accounted for. The other situation is when the tax authorities find the tax-payer to be in possession of cash (or money in the bank, for that matter) without any corresponding entry in the books of account (Section 69A).
Money in a subsidary’s account is money in your account
In the instant case the tax department has sought to establish there was some money in the bank account of a NDTV subsidiary that by an act of legal fiction represented money in the bank account of NDTV. Note that the transaction supposedly involved an NBC Universal’s subsidiary investing in the shares of a two-step down subsidiary of NDTV (Company C in our illustration). So we have a situation where there is technically some money in the bank account of NDTV as by piercing the corporate veil of the NDTV subsidiary, the IT department has succeeded in pinning the amount on NDTV itself. But equally, there is no corresponding entry in the books of account of NDTV which then becomes taxable in the hands of NDTV by virtue of the operation of Section 69A of the IT Act.
There is an element of circular logic here. The $150 million is money in the bank account of NDTV because money in the bank account of an NDTV subsidiary is as good as money in NDTV’s own bank account (piercing the corporate veil). But there is no corresponding entry in the books of account maintained by NDTV at its business headquarters in New Delhi because well, it didn’t actually receive it. If this makes you feel like Peter Yossarin, the hero of the Joseph Heller’s novel ‘Catch 22’, it is entirely understandable. The laws of income tax can sometimes be as quirky as regulations of the US Army.
In sum, the offending transaction can be brought to tax as ‘íncome’ of NDTV either as ‘unexplained credit’ in the books of NDTV (Section 68) or as unexplained ‘cash’ without corresponding entry in the books of NDTV (Section 69A). The DRP thought that the circumstances in the instant case merited application of either of the two sections of the IT Act.
What are these grounds on which the IT department contends that the subscription by a subsidiary of NBC Universal via its Netherlands subsidiary to the shares of a Netherlands-based subsidiary of NDTV is a fit case to be treated as income that is taxable in the hands of NDTV? The tax department’s case against NDTV has the following ingredients.
- The department says that neither NBCUniversal nor NDTV had done a proper valuation of the business before arriving at the price at which these shares will be issued to the former. As the assessing officer argued before the DRP, ‘subscription to the shares of the subsidiary company without determining any valuation for the same and receiving such funds by a foreign party raises suspicion regarding the true nature of the transaction'.
- The value of the shares of the company having a face value of $1 or roughly equivalent to Rs 40-50 was subscribed to at the rate of Rs 7,015.05 per share. Though it is not uncommon for shares to be issued at a premium to the face value the IT department contends that the valuation is far in excess of what could be justified for a start-up company with no assured cash flows, as yet.
- The shares were bought back by a step-up subsidiary (Company C) from the Dutch subsidiary of NBCUniversal which initially subscribed to the shares of Company D.
- The whole arrangement had neither any commercial purpose nor economic substance warranting the IT department to the conclusion that the whole transaction was a ‘sham’.
- The conclusions of the Supreme Court in the famous Vodafone case in 2012 wherein the Court had said that whenever there is an abuse of the corporate structure or legal form without reasonable business purpose which results in tax avoidance, then the tax department is entitled to disregard such arrangements. In the eyes of the tax department at least, the elaborate corporate structure put in place by NDTV for sourcing money from NBCUniversal represents a form of abuse of the corporate structure.
- Lastly, the tax department also contended that there were infirmities in the documentation that was got up to show that the NBCUniversal subsidiary did indeed remit the cash to the account of the NDTV subsidiary in Netherlands. This has given rise to a suspicion that it was NDTV’s own money that had been pumped into the subsidiary ostensibly as contribution by NBCUniversal. Since NDTV had not been able to establish that the investor in question was indeed NBC Universal the true identity itself was in doubt, and the question of whether the investor had the financial capacity to do so too, did not arise. In other words NDTV failed on both counts namely, the true identity of the investor and his financial capacity to make that investment thereby setting the stage, for inclusion of that receipt as income either under Section 68 or Section 69A of the Income Tax Act, in the hands of NDTV.
A mystery investor?
The argument that NDTV failed to establish the true identity of the investor is a bit intriguing. One would have thought that the question of whether NBCUniversal or for that matter, any of its subsidiary did in fact invest in the shares of the NDTV’s Dutch subsidiary would have been the easiest question to dispose off. Just the simple question of authentication of banking records to show that the money did indeed come from an affiliate of NBCUniversal. Strangely enough, this question did not get the attention that it deserved either in the DRP order that ruled on the tax dispute between the IT department and NDTV or in the investigations of the assessing officer.
The DRP in its order on the tax dispute merely noted that NDTV had submitted a notarized confirmation letter from one I.J. Broadband regarding remittance of $150 million into the bank account of the NDTV subsidiary in Netherlands. The order was silent on whether the DRP was satisfied that a remittance had indeed come from an affiliate of NBCUniversal. This is an important issue for consideration.
If it had turned out that that the genuineness of the bank remittance from an NBC Universal could not be established it strengthens the case of the IT department that the whole arrangement was a sham designed to avoid any tax liability either then or at any time later. On the other hand if it could be established that the remittance did indeed come from a NBCUniversal affiliate then it strengthens the NDTV case that there was a business rationale for structuring the transaction in the manner that it had done.
If this was not perplexing in itself, the show-cause notice issued by the income tax authorities in 2016 on the issue of levy of a penalty for possessing undisclosed income was even more forthright. It dismissed the documentary evidence of a share-purchase agreement (NDTV-NBCUniversal) submitted by NDTV in connection with the receipt of $150 million by NDTV, as a mere photocopy possessing no evidentiary value. It wasn’t authenticated as a replica of the original document by a notary public, the IT department had said. It also went on to claim that the document lacked signatures of representatives of the two companies on each of the pages of the agreement (customary in such documents). If that was indeed the case, there was nothing on record to suggest that the IT department sought authenticated copies of the agreement from NDTV or that despite its repeated efforts could not succeed in getting them.
A similar approach was evident with regard to the tax treatment of a receipt of $ 100 million amounting in rupee terms to Rs 254.75 crore. The assessing officer claimed that NDTV failed to produce any certificate from the banker to Universal Studios International BV, a Dutch subsidiary of NBCUniversal that they have remitted a $ 100 million to the account of NDTV Networks BV. It is rather strange that the assessing officer should have required of NDTV that it produce a certificate from the lender’s banker about monies it had paid out from one of its own clients’ account. But quite apart from that, why had it not occurred to the assessing officer that the authenticity of receipt of any money into NDTV Networks BV’s bank account could have been easily confirmed by that company’s own banker? There is no evidence on record in the DRP’s ruling on the tax dispute that this was sought and NDTV failed to produce such documentary evidence.
Cayman Islands investors
Elsewhere in the assessing officer’s report to the DRP it was noted that NDTV submitted a list of eight entities as initial investors for the loan transaction. The assessing officer points out that many of them were investors from Cayman Islands. Granted that Cayman Islands authorities are not known for enforcement of stringent ‘Know Your Customer’ norms with regard to investors who bring money into the country’s banking system but even so an opportunity must have been given to NDTV to establish the genuineness of the identity of these initial investors. At least there is no evidence on record that this was done and that NDTV failed to capitalise on that offer. Curiously enough, the assessing officer’s report only talks of ‘many’ among the initial list of eight investors as hailing from Cayman Islands. That means there were at least a few amongst them, who were not operating from Cayman Islands and hence suffered from no identity infirmities as their counterparts from Cayman Islands did. However, their investments were not kept out and instead the entire sum of $100 million (Rs 254.75 crore) was sought to be brought to tax as undisclosed income in the hands of NDTV.
To compound it all, the DRP in its order goes off on a completely different track. It found defects in the clauses of the loan agreement to rule that the loan itself was a ‘sham’ transaction. It said that the loan agreement did not have any clause as to the rate of interest to be charged. It noted that the NDTV subsidiary was to have completed certain prior formalities before becoming eligible to receive the loan and that there was no evidence that these were complied with and so on.
The Vodafone precedent
As things stand now the department’s case against (in the absence of any incontrovertible evidence that there never was any agreement between NDTV and NBCUniversal or remittance of money by the latter) the company rests only on interpretation of the Supreme Court’s reasoning in the Vodafone case regarding abuse of corporate structures to escape payment of legitimate tax dues. The DRP has quoted extensively from the above ruling and sought to draw parallels from it to the present case involving NDTV.
In the Vodafone case the issue was whether Vodafone should have deducted tax at source against the purchase consideration involved in the acquisition of Hutchison’s (a Hong Kong based company) mobile telecom business in India. The deduction of tax at source by the person paying the purchase consideration is a legal requirement so that the tax authorities get a slice of the eventual tax on the profits from the sale of assets. In substance the transaction consisted of sale of assets that were clearly located in India. But the form of the transaction was one of sale of shares in a Mauritius incorporated company that was purchased by Vodafone and the profits such as there are, are subject to the tax laws of Mauritius.
The question was whether Vodafone should have deducted a percentage of the purchase consideration payable to Hutchisons as tax at source and remitted it to Indian tax authorities. Vodafone argued that the transaction consisted of sale of shares in a Mauritian company and hence did not attract any tax under the Indian tax law and hence there was no question of any deduction of tax at source. But the Indian tax authorities argued that the transaction in substance was one of sale of Indian assets and tax had to be deducted at source out of the purchase consideration against possible tax liabilities that would be determined at a future date. The Supreme Court while clearing Vodafone of any wrong doing in the transaction was sympathetic to the IT department’s point of view as well. It laid down some criteria as to when the tax authorities can ignore the form of a transaction and go to its root or substance.
For instance, the Supreme Court laid down the principle that where a corporate ownership structure has no commercial/ business substance and had been created solely to avoid tax then the corporate veil can be pierced. The assessing officer had argued and the DRP concurred that there was no reason for NDTV to have formed so many layers of overseas corporations to achieve its business purpose whatever they might be. There isn’t enough material in the DRP ruling to suggest that the business logic for the corporate structure that NDTV had adopted is completely without substance.
Let us take the case of separate companies for different genre of television channels that NDTV had floated. It is easy to see why this should be so. For one, they couldn’t have been part of NDTV. As a news channel it certainly had constraints on ownership structure as foreign ownership in news media companies had a ceiling of 26%. Since the capital requirements of news channels and general entertainment channels and for that matter, the risk profiles of the two types of businesses are so completely different it is too simplistic to assume that the same class of investors would show interest in both. Hence it certainly made sense to house them in separate corporate entities.
As regards multiple layers of foreign incorporated enterprises, here too, the structure is not altogether bereft of commercial logic. NDTV could see itself as engaged in just television broadcast or define itself as having interests in all manner of communication businesses ranging from television to radio to print and perhaps even education. The technology backbone or human resource infrastructure created for this purpose in turn could be leveraged for additional streams of revenue. Viewed thus, it is entirely possible that you need different corporate silos for different businesses that would island the risk appetites of different classes of investors who might come in and exit at different points of time.
The Supreme Court also made a reference to the fact that if a certain corporate structure is created and existed for a limited duration of time that is prima facie a ground for disregarding the separate corporate forms. The DRP made a reference to this principle as well and pointed out to the fact that how NDTV dismantled all those structures within a matter of three and a half years. But this ignores the fact there could be a perfectly alternative explanation which can be ignored only with the benefit of hindsight.
There was nothing on record that DRP placed before the general public that the NDTV management had intended all along to keep these overseas corporate structures going for exactly three and a half years. If one discounts the principle of premeditation, a perfectly alternative explanation presents itself. That NBCUniversal had plans to get into the Indian market in a major way and had identified NDTV as the partner to steer into broadcast-related ventures. But the global financial crisis of 2008 put paid to all those hopes especially when you considered the fact that NBCUniversal’s parent General Electric had been badly affected by the crisis. That GE itself shed its stake in NBCUniversal in the later years in favour of Comcast a rival media organisation, was not without some significance.
It is evident that in the Vodafone case, the Supreme Court was responding to a particular situation and laying down certain general principles in that context. It was confronted with a situation where there was manifest evidence of taxable profits under Indian laws but niceties of distinct identities that are the hallmark of corporate forms of organisations was coming in the way of Indian tax authorities appropriating their legitimate tax dues. One must therefore tread with caution while applying rules of interpretation crafted to deal with current and real profits that might escape taxation and apply to investments decisions where profits are as yet only a chimera. The DRP had been guilty of such extended application that might not stand the test judicial scrutiny.
But if the starting point is the notion that NBCUniversal or its parent General Electric had allowed any of its offices to have been used as a conduit for round tripping NDTV’s hidden stash of cash and the piercing the corporate veil was only an expedient course of legal calisthenics to bring it to tax, then nothing more need be said. That is a different kettle of fish where objective business analysis of facts and circumstances has little or no role to play.
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Why has a case relating to FY 2009 gone on for this long?
The draft assessment order proposing roughly Rs 700 crore in additions to the income (loss in this case) returned by NDTV for the AY 2009-10, was issued only on March 31, 2013. NDTV promptly disputed it on April 29, 2013. The matter was referred to the DRP which then had a round of sittings from October to December 2013. The DRP gave its ruling on December 31, 2013. A draft assessment order was passed in April 2014. The matter went to the Income Tax Appellate Tribunal (ITAT) where it still remains. The ITAT stayed the demand for recovery of tax till the appeal was disposed.
Then in 2016 the penalty demand of Rs 525 crore was raised. The ITAT stayed the recovery. The department went in appeal before the Delhi High Court which for a while stayed the demand but lifted the stay giving the IT department the power to proceed with recovery of the penalty amount. NDTV went in appeal before the Supreme Court. The Supreme Court directed the Delhi High Court to dispose off the case within ten days. This was in April 2017. The Delhi High Court concluded its hearing in May 2017 and has reserved its judgment.
*The author is a consultant with Hindu Business Line.
