The Supreme Court on Friday settled a controversy, overruling the decision of the Bombay High Court in one of the landmark cases in the Indian tax jurisprudence, ruling in the favour of Vodafone.
The Supreme Court held that the IT department does not have jurisdiction over transactions involving the sale of shares of foreign company and could not give rise to tax in India, ruling that the IT department does not have jurisdiction over offshore transactions.
The story began when Netherlands-based Vodafone International Holdings BV (Vodafone) acquired Cayman-based CGP Investments from Hutchison Telecommunication International Limited (HTIL), also based in the Cayman Islands. CGP Investments held a number of underlying subsidiaries in Mauritius, which, along with certain Indian companies, ultimately held an approximately 67% stake in Hutchison (now Vodafone) Essar, one of largest players in the Indian telecom industry.
In September 2007, revenue authorities initiated proceedings against Vodafone in an attempt to recover around $2.1 billion in taxes, contending that the sale of shares of a Cayman Islands company, which ultimately held approximately 67% in Hutchison Essar, gave rise to capital gains tax liability in India, and that Vodafone was required to deduct tax on payments made to Hutchison for the acquisition of the shares.
In response, Vodafone, inter alia, contended that the transaction was not taxable in India and that the Indian income-tax authorities did not have jurisdiction to proceed against them for any alleged failure to withhold tax in respect of a transaction involving sale of shares of a foreign company outside India.
By May 2010, the revenue authorities, after scrutinising the various agreements/documents, issued a voluminous order asserting that they had the necessary jurisdiction to proceed against Vodafone. It also stressed on its ability to look through the structure of the transaction, and argued that the form of the transaction itself contemplated transfer of a bundle of assets situated in India rather than a single share of a Cayman-based company. Vodafone, then, immediately filed a writ petition before the Bombay HC challenging the revenue authorities? jurisdiction to pursue an offshore transaction having absolutely no nexus with the territory of India.
The contention of the tax authorities in this case, as well as the increased scrutiny over several other similar global transactions attracted much attention in the global investing community, particularly considering that the tax authorities approach represented a fundamental change to India?s long-standing position on the taxability of such transactions. Given that transactions like these are fairly common in all cross-border investments into India, the need to evaluate the uncertainties surrounding such transactions added a whole new dimension to the economics of investing in India.
The Bombay HC in September 2010 had ruled that the transaction involved the transfer of rights and entitlements situated in India other than the shareholding of the Cayman entity alone ? including a right to use Hutch brand in India and, therefore, the tax authorities had jurisdiction to proceed against Vodafone for failure to deduct tax.
The Supreme Court negated the above theory of the Bombay HC and also observed that a controlling interest is an incident of ownership of shares and not identifiable or distinct capital asset. Further, it observed that at present, the Indian tax laws do not contain any look through provisions, which need to be introduced through specific legislation to tax indirect transfers.
Reinforcing the principle that bonafide transaction structures cannot be frowned upon, merely because of tax avoidance, the SC, emphasising that certainty and stability as the basic foundation of the fiscal system, said that the investors should know where they stand as regards their tax liability.
SC also said that transfer of shares, which results in change of ownership does not result in transfer of underlying assets as well and, hence, it is not permissible to dissect lump sum consideration received for transfer of shares. To determine whether a particular transaction is genuine, every transaction for investment in India should be seen in a holistic manner keeping in mind the following factors:
– 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; and
– The timing of the exit; and
– The continuity of business on such exit.
This is a welcome judgment by the SC, which will be a great relief not only for Vodafone, but also for similar transactions which are already under investigation. Further, the ruling will also send out a very strong positive signal to the investing community removing uncertainties on taxability of offshore transactions in India and reaffirming faith in Indian judicious system. However, it would be interesting to see the proposals in the forthcoming Budget 2012 and also the impact of the general anti-avoidance rules proposed to be introduced through the Direct Tax Code Bill, 2011.
– The writer is partner, KPMG, India