What was the Vodafone case really about?

The case involved the transfer of the share capital of a Cayman Islands company, which held a Mauritius company and this, in turn, held some other Mauritian companies. These second tier companies had a majority shareholding in Hutchinson Essar Ltd, the Indian operating company. This overseas transfer resulted in the underlying control in India being passed over to Vodafone.

The key question of law decided by the Supreme Court (SC) was whether one should place reliance on the ?situs? of an asset (share capital of the Cayman Islands company) that is the subject of transfer, while deciding taxability, or can the Income tax Authorities (ITA) tax the transaction contending that, in effect, the ?control? of Indian business has been transferred?

Is it possible to levy a tax on a transfer of shares where the underlying assets are based in India? What do other countries do when there is a transaction in a tax haven but where the underlying assets are located in their jurisdictions?

The present provisions, as held by the SC, of Indian domestic tax law provides for the taxation of gains arising from ?direct transfer? of capital asset situated in India and does not provide for the taxation of ?indirect transfer? of underlying capital asset situated in India as a consequence of a transfer of shares of a foreign company. To hold otherwise would mean re-writing the law as it stands today, as held by the SC. However, the proposed Direct Taxes Code Bill 2010 (DTC) contains a proposal to tax such indirect transfers on fulfilment of specified conditions and, thus, a similar transaction may get taxed in India if DTC is implemented, as has been observed by the SC in the order.

Some of the countries have issued regulations/circulars wherein indirect transfers have to be reported to the government to allow tax officers to analyse whether the same is taxable in those countries or not.

In December 2009, the Chinese tax authorities issued Circular 698, which had the effect of taxing indirect transfers of Chinese investments made by foreigners. This circular required a reporting to be made to the Chinese tax authorities to consider whether to levy a tax in China.

In July 2010, the Indonesian government released a regulation wherein any merger or acquisition exceeding a particular size was required to be reported to the Commission for the Supervision of Business Competition within 30 business days from close of the transaction. Under these regulations, the non-resident should demonstrate to the authorities that the intermediary treaty party is in fact the beneficial owner of the income.

What will be the impact of this on other cases where the tax authorities were banking on the Vodafone judgment?

The principles laid down by the Supreme Court on the key tax issues would be equally applicable to similar cases. However, one would need to apply the specifics of the judgment after analysing the fact pattern and legal issues involved in each individual case.

Will we see a spurt in sales right now since deals can be structured to ensure there are no capital gains taxes?

The Vodafone case had created a lot of uncertainty in the cross-border M&A space where the target had an Indian presence. The uncertainty related to what should be the tax cost and tax impact that should be considered for the India presence while exchanging the consideration, and whether a certain amount, and how much, should be withheld towards a potential income-tax liability in India. As a result, M&A pricing and uncertainty went up, some deals had legal indemnity clauses, escrow accounts were created with deposit of probable withholding tax amounts, etc. The SC?s verdict has addressed, to a large extent, this uncertainty, and this should result in creating a positive climate for doing deals.

How many such cases were being looked at?

Reports in the public domain indicate that around 300-400 cases could be under the radar of the tax authorities with similar issues.

Why did the Bombay High Court say the taxman had the right to tax part of the capital gains?

The Bombay High Court in 2010 was of the opinion that along with the transfer of a single share of the Cayman Islands company, Hutchinson had also transferred to Vodafone other rights and entitlements (through diverse agreements), such as controlling interest in the Indian company, etc, which was the essence of the transaction between the two parties and thus the real taxable event. Since such rights and entitlements, controlling interest, etc, constituted ?capital assets? situated in India (as defined in the Indian domestic tax law) according to the ITA, the overseas transaction is taxable in India.

Can the income tax department find some way to circumvent the judgment?

While the CBDT has already formulated a 10-member committee to evaluate the SC judgment and to provide recommendations/next-steps, one may have to wait and see whether the ITA seeks a review of this decision by a larger bench of the SC, though maintainability of such a review petition may be a challenge. Another possibility as witnessed in the past is that favourable decisions of the Courts have been nullified by amending the domestic tax law provisions, prospectively or retrospectively, and considering that the finance budget is around the corner in March 2012, this possibility cannot be ruled out. The DTC also provides, as noted earlier, for taxing similar transactions and it is possible that similar provisions may be introduced in the finance budget, since the implementation of the DTC by April 2012 does not seem to be a reality.

Are there instances where the government has overridden certain court rulings by way of amending the law?

A classic example is in the case of Ishikawajma-Harima Heavy Ind Ltd. vs DIT (288 ITR 408), where the SC, while dealing with the taxability of fees for technical services under section 9(1)(vii) of the Act, held inter alia that if services are rendered outside India, then a sufficient territorial nexus is not created for such services to be taxed in India. To overcome the effect of this principle, vide Finance Act, 2007, an amendment was made in section 9(1) with retrospective effect from June 1, 1976 to bring within the tax net those technical services which, even though are rendered outside India, are still liable to be taxed in India.

How will the DTC affect such deals in the future?

The DTC specifically contains a proposal to tax an indirect transfer of underlying assets in India on the fulfilment of specified conditions. Further, the provisions of the General Anti-Avoidance Regulations (GAAR) are also very wide ranging and give power to the ITA to disregard, recharacterise, etc, any arrangement entered into with a view to obtain tax benefit. However, implementation of the DTC by April 2012 does not seem to be a reality, and hence the possibility of an introduction of similar provisions in the current Income Tax Act, 1961 through the finance budget in March 2012 cannot be completely ruled out.

The author is executive director,

Tax & Regulatory Services, PwC India