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Written by HP Agrawal, assisted by Uday Agarwal (S S Kothari Mehta & Co.)   

India: Vodafone tax ruling - A legal analysis of the triumph

Facts of Vodafone's case are briefly as under.

Hutchison Essar is an Indian Company, the controlling interest of Hutchison Essar is held by a SPV of Cayman Island (CGP Investments Holding Ltd.). CGP is owned by Hutchison Telecommunications International Ltd (HTIL), Hongkong. In this manner the controlling interest of Hutchison Essar is held by HTIL, Hongkong through an intermediary Cayman Island company (CGP). Vodafone International Holdings, Netherland entered into an agreement with HTIL, Hongkong to buy the shares of CGP (Cayman Island). Since CGP is holding directly and indirectly 67% shares of Hutchison Essar (India), the above transaction results in transfer of shares and controlling interest of Hutchison Essar(India) from HTIL, Hongkong to Vodafone International Holding, Netherland. The consideration for transfer is stated to be USD 11.1 Billion.

The Income-tax Department issued a notice to Vodafone to show cause as to why it should not be treated as assessee in default for not withholding the Indian Capital Gain Tax on the payment made by it to HTIL for the transaction of sale of share of CGP (which in turn holds controlling interest of HTIL). Vodafone challenged the show cause notice by way of writ. The Hon'ble Bombay High Court dismissed the writ.

The High Court held that "the very purpose of entering into agreements between the two foreigners is to acquire the controlling interest which one foreign company held in the Indian Company, by other foreign company. This being the dominant purpose of the transaction, the transaction would certainly be subject to municipal law of India, including the Indian Income-tax Act". The Indian Law does not permit use of any "colourable" device by any tax payer for perpetuating tax evasion in India. The High Court remarked that "the present is a case of tax evasion and not tax avoidance".

Thereafter Vodafone approached the Supreme Court for stay of Mumbai High Court's decision. The Supreme Court on 27/09/2010 ordered that Vodafone has to deposit a part of the amount in dispute before its case is heard by the Court. Finally, the Supreme Court gave its verdict on 20.01.2012 and has decided the issue in favour of Vodafone. The Hon'ble Apex Court has held as under:

"Applying the look at test in order to ascertain the true nature and character of the transaction, we hold, that the Offshore Transaction herein is a bonafide structured FDI investment into India which fell outside India's territorial tax jurisdiction, hence not taxable. The said Offshore Transaction evidences participative investment and not a sham or tax avoidant preordained transaction. The said Offshore Transaction was between HTIL (a Cayman Islands company) and VIH (a company incorporated in Netherlands). The subject matter of the Transaction was the transfer of the CGP (a company incorporated in Cayman Islands). Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax the said Offshore Transaction."

A careful legal analysis of the aforesaid judgment will show that the following important issues were considered by the Hon'ble Apex Court in deciding the case in favour of Vodafone.

Whether the situs of shares of a foreign company holding controlling interest in Indian company can be said to be in India?

In the instant case of Vodafone, the Cayman Island company, CGP, was owning controlling interest in the Indian HEL. Therefore, it was revenue's contention that the situs of shares of CGP shall be deemed to be in India and accordingly the transaction of sale of CGP shares will be liable for tax in India.In this regard, the Hon'ble Supreme Court at para 82 and para 127 has held that situs of shares situates at the place where the company is incorporated and / or the place where the shares can be dealt with by way of transfers. In the instant case, the transfer took place in respect of shares of CGP. CGP is a company incorporated in Cayman Island and the transfer also took place outside India. Therefore, the situs of shares of CGP is not in India.

What principles should be applied to treat a transaction as sham and bogus?

The Hon'ble Apex Court has dealt with this issue in detail and has held that every foreign direct investment coming to India, as an investment destination, should be seen in a holistic manner. In this regard, the following factors should be kept in mind on the facts of the instant case:

  • the concept of participation in investment
  • the duration of time during which the Holding Structure exists
  • the period of business operations in India
  • the generation of taxable revenues in India
  • the timing of the exit
  • the continuity of business on such exit.

The Hon'ble Court examined the above facts. After a detailed analysis, the Hon'ble Court found that the aforesaid factors are in favour of Vodafone and therefore, held the entire transaction as not a sham and bogus transaction.

"Whether even an indirect transfer of property located in India will be covered under section 9(1)(i) of the Income-tax Act so as to render the same as liable for tax?

In the instant case, CGP held shares of an India company. It was the contention of the revenue that the transfer of shares of CGP outside India resulted into indirect transfer of shares of Indian company. Therefore, the transfer is liable for tax in India.

The Hon'ble Apex Court has dealt with this issue at para 71 and 165 of the order. It has been held that Section 9 covers only income arising from a transfer of a capital asset situated in India; it does not purport to cover income arising from the indirect transfer of capital asset in India. If the word indirect is read into Section 9(1)(i), it would render the express statutory requirement of the 4th sub-clause in Section 9(1)(i) nugatory. Therefore, Vodafone's transaction cannot be covered under section 9(1)(i) of the Income-tax Act.

Whether section 195 which casts obligation to deduct tax at source is applicable to non-residents also?

The Hon'ble Apex Court has dealt with this issue at para 178 to 187 of its order. It has been held that section 195 would apply only for payments made from a resident to a non-resident, and not between two non-residents situated outside India.

In the instant case, the Hon'ble Court observed that the transaction was between two non-resident entities through a contract executed outside India. Consideration also passed outside India. The transaction has no nexus with the underlying assets in India. In order to establish a nexus, the legal nature of the transaction has to be examined and not the indirect transfer of rights and entitlements in India. Therefore, the provisions of section 195 relating to deduction of tax at source will not apply.

Whether the Mcdowell case [154 ITR 148] in relation to permissible and impermissible tax planning is watered down by Azadi Bachao Andolan [263 ITR 706] case?

The Hon'ble Apex Court held that the observations made in the case of Mcdowell are clearly in the context of artificial and colourable devices. In cases of treaty shopping and / or tax avoidance, there is no conflict between the Mcdowell (supra) and Azadi Bachao (supra).

Further, it has been held that revenue's stand that the ratio laid down in Mcdowell is contrary to what has been laid down in Azadi Bachao Andolan (supra) is unsustainable and therefore, calls for no reconsideration by a larger bench.

Whether the Indian Tax Authorities have the territorial jurisdiction in respect of transaction entered into by two non-residents in respect of shares of a company incorporated outside India.

The Hon'ble Supreme Court in the instant case has observed that the entire transaction has been carried out outside India and in relation to property which is situated outside India.

It involves transaction between two non-residents in respect of shares of a company incorporated outside India. Therefore, the Indian Tax Authorities have no territorial tax jurisdiction over the said transaction.

For further information please contact: 

Mr. H.P. Agrawal
S.S. Kothari Mehta & Company
146-149, Tribhuvan Complex
Ishwar Nagar, Mathura Road
Phone: +91 11 4670 8888
Fax: +91-11-66628889
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