Summer of Discontent

Tax holidays are no more to be taken for granted. So will Shiv Nadar & Co

wiggle their way out of this one? After TCS and Wipro, next in the tax collector’s

line of fire is the promoter firm of Shiv Nadar-owned HCL Technologies. Slocum

Investments now faces an unwieldy tax bill of Rs 811 crore. The latest tax

dispute to hit the Indian IT services industry is over the alleged concealing of

income from capital gains.

Part of the issue rests on a phantasmal bridge leading to a cluster of

tropical islands in the Indian Ocean. More of that later. Even ahead of the

April 19 hearing of HCL’s writ petition in the Delhi High Court against the

I-T department move, I-T officials were working overtime to produce the

assessment order for the court’s perusal. The court on its part wisely

deflected the case to the Commissioner of Income Tax (CIT) Appeals.

The appeal before the CIT Appeals is set to be filed soon. Senior HCL sources

say that a new interpretation of the tax provisions by the I-T authorities was

the primary reason behind the dispute. Issues about pricing principles under the

provisions of the I-T Act are now coming to the fore. In fact, the HCL Group saw

its first I-T department raid about two years back. The latter claims that the

documents seized during that raid provided documentary evidence of capital gains

tax evasion. However, company sources maintained that the I-T department had

wrongly implicated the company in the case.

The Mauritius angle formed the cornerstone of the taxman’s arguments. Here,

the I-T department buttressed its stand by claiming that the HCL Group

transferred its share to a Mauritius-based company to avoid capital gains tax.

According to the I-T department, the seized documents show that key persons in

the HCL group allegedly knew that the real price of HCL Technologies’ shares

was much more than Rs 50 per share. HCL sources contend that the price of Rs 50

per share was the correct price at that point of time. All transparency was

maintained when the valuation was done.

HCL Corporation, Slocum Investment and Shiv Nadar Investment sold, on June

10, 1999, 70 lakh equity shares of HCL Consulting (now HCL Technologies) to

Mauritius-based Wintech Investments, an overseas corporate body, at a price of

Rs 50 per share. HCL Corporation and Shiv Nadar Investments were later merged

into Slocum Investments in August 2001. Company sources said though the

transaction pertains to a period before SEBI relaxed IPO norms for IT companies

on October 15, 1999, the company has not hidden this fact from the public. After

the merger of HCL Consulting with HCL Technologies, and the subsequent IPO of

HCL Technologies in January 2000, the company claims this deal was revealed in

the IPO filing with SEBI.

The I-T department is also adding another red herring by raising doubts on

the credentials of the evaluator of HCL Technologies. According to them, the

valuation was not carried out by someone who has an expertise in valuing

technology stocks, such as Merrill Lynch, Alex Brown JP Morgan etc. The

department claims it has taken all these names from a security purchase

agreement, dated January 27, 1998, between the Shiv Nadar group and Arjun

Malhotra group.

However, later when HCL Consulting shares were sold to Wintech, the banks

were ignored and the task for valuation was given to a chartered accountancy

firm called Purshottaman Bhutani & Co. HCL has defended the appointment of

its evaluator, pointing out that any chartered accountant is capable of doing

the valuation, in accordance with existing regulatory rules. Not sustainable,

said the I-T department, and calculated the actual share price at Rs 1,807.

According to them, the total undisclosed income of Slocum comes to Rs 1,319

crore. At a rate of 60% tax (including penalty) and 2.5% surcharge, the total

demand on Slocum is Rs 811 crore.

The only silver lining here is that most local companies providing

outsourcing services still enjoy tax exempt status if they are registered under

prescribed, tax-free schemes. Repatriation of capital gains to Mauritian

subsidiaries was earlier applicable more to the larger financial institutions

who registered their companies in Port Louis as Mauritian business entities to

repatriate their profits there and avoid the inevitable tax headaches back home

in India.

But now, as the question of taxes on software exports from subsidiaries

within the STPs has become a subject for taxation, as in Wipro’s case, the

Mauritius angle is just one more corollary to the tax issues.

The finance ministry has since clarified that there has been no withdrawal of

any tax incentives for software companies, and the government’s policy of

providing the tax holiday for software units under Section 10A and 10B of the

Income Tax Act continues unchanged.

Ravi Menon in Bangalore