An episode in Vodafone story 
 

In the Vodafone case that was keenly watched for the past several months, almost since August of last year, the curtain is yet to fall, says Mr Pranav Sayta, Tax Partner and Tax Leader Transaction Tax, Ernst & Young. The ‘action’, if one may term it that, is set to move on to the Supreme Court of India, he adds, during the course of a recent email interaction with Business Line.

“The observations of the Bombay High Court do throw up the importance of proper tax risk management. Foreign investors should appropriately plan for and manage the tax risks while structuring, global mergers and acquisitions,” advises Mr Sayta.

Excerpts from the interview:

First, a background of the case.

To cut to the chase, shares of CGP Investments, a Cayman Islands entity, were transferred by Hutchison Telecommunications (HTIL), another Cayman Islands entity, to Vodafone International Holdings BV, a Netherlands entity (Vodafone NL) for $11.1 billion (approximately). Vodafone International Holdings B.V. is an indirectly wholly-owned subsidiary of Vodafone.

CGP Investments, through a chain of intermediary entities (including Mauritius entities), indirectly held 67 per cent stake in Vodafone Essar Ltd (VEL), an Indian company, engaged in cellular services.

The Indian tax authorities issued show-cause notices to both the buyer Vodafone NL and VEL to show cause why it should not be treated as an ‘assessee in default’ for failure to withhold tax at source when making payment to the seller HTIL and VEL for being treated as a ‘representative assessee’. The tax demand ran into $2 billion (approximately).

The show-cause notices were challenged by Vodafone NL and VEL, in a writ petition before the Bombay High Court. The writ petition of Vodafone NL now stands dismissed by the Bombay High Court (HC).

 

The stay granted to Vodafone NL earlier has been extended by eight weeks and it is expected that Vodafone NL will move the Supreme Court. Interestingly, the HC has dismissed the writ petition by Vodafone NL alone and the writ petition of VEL is still pending before the Bombay High Court.

On the impact of the HC ruling.

It is a well accepted view based on international tax norms, that while gain arising to a non-resident from transfer of shares in an Indian company is liable to tax in India (subject to tax treaty provisions as in some tax treaties the gain is subject to tax not in the country of source but in the country of residence), the gain arising to a non-resident from transfer outside India of shares of a foreign company to another non-resident would normally not be chargeable to tax in India, even if the underlying value is derived from assets belonging to the Indian subsidiary of the company whose shares are transferred.

A company, it must be noted, is a separate and distinct legal entity. Now the larger question that arises is, whether in the case of an Indian company indirectly held by a parent through an overseas company or special purpose vehicle (SPV), such parent company can be regarded as the owner of an asset located in India.

Can transfer of shares of the overseas company or a SPV to a buyer abroad be regarded as transfer of an asset located in India? If one were to say yes, it could have major ramifications for multinationals having widespread global operations.

Of course, based on this decision, the tax incidence, if any, in India arising out of the Hutch Vodafone transaction is now to be determined by the Indian tax authorities. In this context it may be interesting to note the observations of the Supreme Court in the Union of India vs Azadi Bachao Andolan (263 ITR 706) case: An act which is otherwise valid in law cannot be treated as non est on the basis of the underlying motive.

In my view, if the shares in an Indian company are sold directly by holding companies situated in favourable tax jurisdictions such as Mauritius, Singapore, or Cyprus, then subject to treaty fulfilment (such as the LOB clause in the India-Singapore tax treaty), such capital gains cannot be brought to tax in India, as the tax treaty does not provide for its tax incidence in the country of source (that is, India).

On the issues before the Bombay High Court.

Broadly, the Bombay High Court (HC) had to examine whether the show-cause notice issued by the tax authorities was tenable in law (whether Vodafone NL could be held liable under Section 201 of the Income-Tax Act, 1961, for not withholding tax, and whether the provisions of Section 195 relating to withholding tax obligations could have extra territorial implications).

It also had to examine, whether the transaction, per se (the transfer of shares of CGP Investments by HTIL to Vodafone NL) resulted in ‘taxable’ income, in India.

The HC held that prima facie the said transaction would be subject to Indian tax law, since the dominant purpose of the transaction was to acquire the controlling interest in an Indian company.

Hence, the notice issued by the Indian tax authorities cannot be termed extraneous or irrelevant or erroneous on its face so as to require it to be quashed under the writ jurisdiction of the HC. However, the HC has ruled that whether the transaction was taxable in India or not must be investigated by the Indian tax authorities.

It is important to note that the HC has not given its verdict on the chargeability of the transaction to tax in India. However, it has upheld the issue of the show-cause notice. In addition, while dismissing the writ petition, the High Court made some prima facie observations regarding chargeability to tax of the transaction

On the key observations made by the court.

The HC has inferred that the subject matter of the transaction between Vodafone NL and HTIL is nothing but transfer of interests, tangible and intangible, in Indian companies of the Hutch Group, in favour of Vodafone NL and not an acquisition of shares of CGP Investments.

In this context, perhaps, it is essential to take a step back and examine the chronicle sequence of events. HEL, a joint venture company of the Hutch Group (foreign investor) with the Essar Group (Indian partner), was engaged in the business of cellular services. HEL obtained a telecom licence to provide cellular services in different circles in India from November 1994. On February 11, 2007, Vodafone NL entered into an agreement with Hutch Group for acquisition of its Indian interests in HTIL.

Through filings with the stock exchange and other statutory authorities in the US and Hong Kong (jurisdiction of the parent company of Vodafone NL), it was made known to shareholders of HTIL that it was selling its controlling interest in HEL for $11.1 billion (approximately) and the transaction was expected to realise an estimated before tax gain of $9.6 billion (approximately).

Vodafone NL also applied to Foreign Investment Promotion Board (FIPB) and sought approval for indirect acquisition of 52 per cent stock in the Indian entity, HEL. In May 2007, approval was granted by FIPB stipulating that there should be compliance and observance of applicable laws and regulations in India, including Indian tax laws. Thereafter payments were made by Vodafone NL to HTIL for acquisition of shares of CGP Investments.

The HC observed that with the signing of the agreement by Vodafone NL in February 2007 to acquire the interests in India, a nexus to a source of income in India was clearly established, even before the actual payment in May 2007. Thus, prima facie, HTIL, by reason of this transaction, has earned income liable for capital gains tax in India as the income was earned towards sole consideration of transfer, to Vodafone NL, of its India business/ economic interests as a group.

The High Court also emphasised that representations made before FIPB, shareholders, regulatory authorities in the US and Hong Kong made it clear that the Hutch Group was transferring its interest in the Indian company.

In its order the HC states: “In the instant case, the subject matter of transfer as contracted between the parties is not actually the shares of a Cayman Island Company, but the assets situated in India.”

Moreover, while Vodafone NL has admitted acquiring cumulatively 67 per cent controlling interest in HEL, it has failed to produce the original agreement dated February 11, 2007, and other related agreements/documents either to the HC or to the Indian tax authorities, in spite of repeated demands made by the latter.

In the absence of these agreements, the HC observed that it would be impossible to ascertain the true nature of the transaction. Thus the High Court observed that it was left with no option but to draw an adverse inference against Vodafone NL since there was withholding of best evidence, even assuming that the onus of proof does not lie on Vodafone NL.

On the principle of the ‘Effects Doctrine’ brought out by the HC in its order.

In its judgment, the HC accepted the American principle of ‘Effects Doctrine’ put forth by the Indian tax authorities. This principle states that “Any country may impose liabilities, even upon persons not within its allegiance, for conduct outside its borders that has consequences within its borders which the country represents.”

Reliance was also placed on certain Supreme Court decisions on applying this principle to hold that even though an agreement is executed outside India, if it has an impact in India, India would have the jurisdiction to impose tax liabilities.

Article earlier published in the hindu business line.