Column : Dialling into tax trouble

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: The recent decision of the Bombay High Court in the Vodafone case would have a significant impact on the cross border transactions relating to assets located in India. Vodafone, a mobile service provider had acquired 100% shares in a Cayman Islands company for $11.2 billion from Hutchison International, a Hong Kong based company. This Cayman Islands company previously owned by Hutchison, had a 67% shareholding in Hutchison Essar Limited, an Indian entity, through an intermediate Mauritius entity.

In effect, this acquisition had indirectly given Vodafone a controlling interest of 67% in the Indian entity and, in the process, gave access to it in the Indian market. The tax department issued show cause notice to Vodafone to explain why tax was not deducted at source by it before making payment to Hutchison. The tax department contested that in effect the purchase was of the business operations of the Indian company whose shares were held ultimately by the Cayman Island company. Vodafone contended that no tax was due in India because the deal was between two offshore companies and if any tax arose Hutchison was liable for it. It asserted that the tax withholding provisions of the Indian tax code do not have extra-territorial application.

The Bombay High Court rejected the Vodafone’s contention. The decision of the High Court can be summarised in the following three propositions.

First, even though the transaction was a transfer of a controlling interest in the Cayman Islands company, it was in essence a transfer of a capital asset located in India. As the Court observed, “the subject matter of transfer... is not actually the shares of a Cayman Island company, but the assets situated in India”. The transaction enabled Vodafone to be a joint venture partner in the Indian entity and acquire a beneficial interest in the license granted by the Indian telecom regulator. The Court emphasised that the object of the transaction was “to successfully pierce the Indian mobile market to enlarge its global presence”.